When small children don’t get enough attention from their parents, they cry. And until they get attention, they keep crying.
Big business in India is a tad like that. For the last one year it has been crying itself hoarse in trying to tell the Reserve Bank of India(RBI) to cut interest rates. But the RBI led by Raghuram Rajan hasn’t obliged.
In the monetary policy statement released yesterday, the RBI decided to maintain the status quo and not cut the repo rate, as big business has been demanding for a while now. Repo rate is the interest rate at which RBI lends to banks.
The lobbies which represent the big businesses in India reacted in a now familiar way after the monetary policy. The Confederation of Indian Industries said that the economic recovery was still fragile and a decision to cut interest rates would have helped the small and medium enterprises (SME) sector, which is credit starved currently. The lobby further added that if interest rates would have been cut businesses would have borrowed more.
On the face of it this sounds like a very genuine concern. But Raghuram Rajan explained the real issue with SMEs not getting enough loans in a recent speech. The bad loans of Indian banks, in particular public sector banks, have gone up dramatically in the recent past.
As on March 31, 2013, the gross non performing assets (NPAs) or simply put the bad loans, of public sector banks, had stood at 3.63% of the total advances. Latest data from the finance ministry show that the bad loans of public sector banks as on September 30, 2014, stood at 5.32% of the total advance.
Why have bad loans gone up by such a huge amount? “The most obvious reason,” as Rajan put it was “that the system protects the large borrower and his divine right to stay in control.” Who is the large borrower? Big business.
As Rajan explained: “The firm and its many workers, as well as past bank loans, are the hostages in this game of chicken — the promoter threatens to run the enterprise into the ground unless the government, banks, and regulators make the concessions that are necessary to keep it alive. And if the enterprise regains health, the promoter retains all the upside, forgetting the help he got from the government or the banks – after all, banks should be happy they got some of their money back.”
Banks have tried to repossess assets offered as collateral against these loans in order to recover their loans, but haven’t been very successful at it. As Rajan put it in his speech: “The amount recovered from cases decided in 2013-14 under debt recovery tribunals was Rs. 30,590 crore while the outstanding value of debt sought to be recovered was a huge Rs. 2,36,600 crore. Thus recovery was only 13% of the amount at stake.”
Big businesses have been able to hire expensive lawyers and managed to stop banks from repossessing their assets. The small and medium enterprises haven’t been able to do that. Rajan said just that in his speech:“The SARFAESI [ Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest] Act of 2002 is, by the standards of most countries, very pro-creditor as it is written. This was probably an attempt by legislators to reduce the burden on debt recovery tribunals and force promoters to pay. But its full force is felt by the small entrepreneur who does not have the wherewithal to hire expensive lawyers or move the courts, even while the influential promoter once again escapes its rigour. The small entrepreneur’s assets are repossessed quickly and sold, extinguishing many a promising business that could do with a little support from bankers.”
Hence, small and medium enterprises have had to face problems because big businesses have decided to borrow and not to repay.
The CII further suggested that if RBI had cut interest rates businesses would have borrowed more. It needs to be clarified here that interest rates are not simply high because the repo rate is high at 8%. There are other reasons for it as well.
Big businesses have defaulted on such a huge quantum of loans that banks have had to charge the borrowers who are repaying a higher rate of interest. As Rajan put it in his speech “The promoter who misuses the system ensures that banks then charge a premium for business loans. The average interest rate on loans to the power sector today is 13.7% even while the policy rate is 8%. The difference, also known as the credit risk premium, of 5.7% is largely compensation banks demand for the risk of default and non-payment.”
This when the average home loan in the country is being given at 10.7%. Hence, a home loan to an individual is being given at a lower rate of interest than loans to power companies. And only big businesses defaulting on their loans are to be blamed for it.
Rana Kapoor who is the President of a business lobby called Associated Chambers of Commerce and Industry of India said: “RBI has obviously overlooked strong demand from the industry for a cut in the interest rates. The industry’s demand for lower interest rates was fully justified.”
Kapoor is the founder managing director and CEO of Yes Bank. It needs to be pointed out here that the bad loans of Yes Bank for the period of three months ending September 30, 2014, went up by 178.3% to Rs 54 crore in comparison to the same period last year.
What is surprising here is that a banker whose bad loan book has exploded is demanding a rate cut. I am sure Mr Kapoor understands how credit risk operates.
Also, business lobbies and businesses tend to totally ignore the fact that the RBI cannot do much about creating economic growth beyond a point. As economist Tim Dudley puts it: “As long as people have babies, capital depreciates, technology evolves, and tastes and preferences change, there is a powerful underlying (and under-appreciated) impetus for growth that is almost certain to reveal itself in any reasonably well-managed economy.”
The phrase to mark here is “well-managed economy” and that is largely the government’s prerogative. Rajan acknowledged this in the latest monetary policy statement. As he said towards the end of the monetary policy statement “A durable revival of investment demand continues to be held back by infrastructural constraints and lack of assured supply of key inputs, in particular coal, power, land and minerals. The success of ongoing government actions in these areas will be key to reviving growth.”
Criticising or trying to tell RBI what it should be doing, is not going to help big business much. If they have to criticise, it is the government they should be criticising. But that as we all know is not going to happen any time soon. Meanwhile, the RBI will continue to be the favourite whipping boy of big business.
The article originally appeared on www.FirstBiz.com on Dec 4, 2014
(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)