Lower Interest Rates Good for Govt, Banks and Corporates, Not for Average Indian

The new monetary policy committee which met for the first time over the last two days has decided to keep the repo rate unmoved at 4%. Monetary policy committee is a committee which decides on the repo rate of the Reserve Bank of India (RBI). Repo rate is the interest rate at which RBI lends to banks and is expected to set the broad direction for interest rates in the overall economy.

The RBI has been trying to drive down the interest rates in the economy since January 2019. In January 2019, the repo rate was at 6.5%. Since then it has been cut by 250 basis points and is now at 4%. One basis point is one hundredth of a percentage.
This has had some impact in driving down fixed deposit interest rates of banks. Take a look at the following chart.

The Crash

Source: ICICI Securities, October 3, 2020.

From the peak they achieved between March and June 2019, fixed deposit interest rates have fallen by 170 to 220 basis points.
This in an environment where the inflation has been going up. In March 2019, inflation as measured by the consumer price index was at 2.9%. It had jumped slightly to 3.2% by June 2019. In August 2020, the latest data available for inflation as measured by the consumer price index, had jumped to 6.6%. Meanwhile, fixed deposit rates which were around 7-8%, are largely in the range of 4-6% now (of course, there are outliers to this).

Hence, inflation is greater than interest rates on fixed deposits, meaning the purchasing power of the money invested in fixed deposits is actually coming down.

In fact, interest rate on savings bank accounts, which in some cases was as high as 6-7%, has also come down. Take a look at the following chart.

Another crash

Source: ICICI Securities, October 3, 2020.

Savings bank accounts now offer anywhere between 2.5-3%.

The fall in interest rates is not just because of the RBI cutting the repo rate. A bulk of this fall has happened post the covid breakout. Banks haven’t lent money post covid.

Between March 27 and September 25, the outstanding non-food credit of banks has fallen by 1.1% or Rs 1.1 lakh crore to Rs 102 lakh crore. This means that people and firms have been repaying their loans and net-net in the first six months of this financial year, banks haven’t given a single rupee of a fresh loan.

Banks give loans to Food Corporation of India and other state procurement agencies to buy rice and wheat directly from the farmers. Once these loans are subtracted from overall lending by banks, what remains is non-food credit.

During the same period, the deposits of banks have risen by 5.1% or Rs 6.97 lakh crore to Rs 142.6 lakh crore. With people saving more, it clearly shows that the psychology of a recession is in place.

Banks have not been lending while their deposit base has been expanding at a rapid pace. The point being that banks are able to pay an interest on their deposits because they give out loans and charge a higher rate of interest on the loans than they pay on their deposits.

When this mechanism breaks down to some extent, as it has currently, banks need to cut interest rates on their deposits, given that they are not earning much on the newer deposits. This is bound to happen and accordingly, interest rates on fixed deposits have fallen.

While the supply of deposits has gone up, the demand for them in the form of loans, hasn’t. This has led to the price of deposits, which is the interest paid on them, falling.

But there is one more reason why interest rates have fallen. There is excess money floating around in the financial system. The RBI has printed money and pumped it into the financial system by buying bonds from financial institutions.

This excess money has also helped in driving down interest rates. While banks haven’t been able to lend at all in the first six months of the year, the government borrowing has gone through the roof. As the debt manager of the government, the RBI has printed and pumped money into the financial system to drive down the returns on government bond, in the process allowing the government to borrow at lower interest rates. Take a look at the following chart, which plots the returns (or yields) on 10-year bonds of the Indian government.

Going down

Source: Investing.com

The yield on a government bond is the return an investor can earn if he continues to own the bond until maturity. The above chart clearly shows that as the government has borrowed more and more through the year, the interest rate at which it has been able to borrow money has come down, thanks to the RBI and its money printing.

Of course, with banks not lending on the whole, they are happy lending to the government. In fact, in his speech today, the RBI governor Shaktikanta Das said that the central bank planned to print and pump another Rs 1 lakh crore into the financial system in the days to come.

With more money expected to enter the financial system the 10-year government bond yield fell from 6.02% yesterday (October 8) to 5.94% today (October 9), a fall of 8 basis points during the course of the day.

The monetary policy committee also decided to keep the “accommodative stance as long as necessary”, with only one member opposing it. In simple English this means that the RBI will keep driving down interest rates as long as necessary “at least during the current financial year and into the next financial year – to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy.”

The assumption here is that as interest rates fall people will borrow and spend more and corporations will borrow and expand more. This will help the economy grow, jobs will be created and incomes will grow. While, this sounds good in theory, it doesn’t really play out exactly like that, at least not in an Indian context.

Let’s take a look at this pointwise.

1) A bulk of deposits in Indian banks are deposited by individuals. In 2017-18, the latest data for which a breakdown is available, individuals held around 55% of deposits in banks by value. This had stood at 45% in 2009-10 and has been constantly rising. Hence, it is safe to say that in 2020-21, the proportion of bank deposits held by individuals will clearly be more than 55%.

When interest rates on deposits (both savings and fixed deposits) go down individuals get hurt the most. There are senior citizens whose regular expenditure is met through interest on these deposits. When a deposit paying 8% matures and has to be reinvested at 5.5%, it creates a problem. Either the family has to cut down on consumption or start spending some of their capital (the money invested in the fixed deposit).

This also disturbs many people who use fixed deposits as a form of long-term saving. The vagaries of the stock market are not meant for everyone. Also, in the last decade returns from investing in stocks haven’t really been great.

2) When interest rates go down, the families referred to above cut down on consumption and do not increase it, as is expected with lower interest rates. This may not sound right to many people who are just used to economists, analysts, bureaucrats, corporates and fund managers, mouthing, lower interest rates leading to an increase in consumption all the time. But there is a significant section of people whose consumption does get hurt by lower interest rates.

3) It’s not just about bank interest rates going down. Returns on provident fund/pension funds which hold government bonds for long time periods until maturity and post office schemes (despite being higher than banks), also come down in the process.

4) Also, no corporate is going to invest just because interest rates are low right now. Corporates invest and expand when they see a future consumption potential. This is currently missing. Also, banks lending to industry peaked at 22.43% of the GDP in 2012-13. It fell to 14.28% of the GDP in 2019-20. During the period, interest rates have gone up and down, but corporate lending as a proportion of the GDP has continued to fall. So clearly increased borrowing by corporates is not just about interest rates.

But corporates love to constantly talk about high interest rates as a reason not to invest. This is just a way of driving down interest on their current debt.

As former RBI governor Urjit Patel writes in Overdraft:

“Sowing disorder by confusing issues is a tried-and-trusted, distressingly often successful routine by which stakeholders, official and private, plant the seeds of policy/regulation reversal in India.”

One can understand interest rates going down in an environment like the current one, but there is a flip side to it as well, which one doesn’t hear the experts talk about at all. Also, anyone has barely mentioned the excess liquidity in the financial system, which currently stands at Rs 3.9 lakh crore. Why is that? Let’s look at this pointwise.

1)  The equity fund managers love it because with interest rates going down further, many investors will end up investing money in stocks despite very high price to earnings ratio that currently prevails. The price to earnings ratio of the Nifty 50 index currently is at 34.7. This is a kind of level that has never been seen before.

But with post tax real returns from fixed deposits (after adjusting for inflation) in negative territory, many investors continue to bet on stocks, despite the lack of earnings growth.

2) The debt fund managers love it because interest rates and bond prices are negatively related. When interest rates come down, bond yields come down and this leads to bond prices going up. This means that the debt funds managed by these fund managers see capital gains and their overall returns go up. Hence, debt fund managers love lower interest rates.

3) Banks invest a large proportion of the deposits they gather into government bonds. When bond yields fall, bond prices go up. This leads to a higher profit for banks. This in an environment where banks aren’t lending. Hence, bankers love lower interest rates.

4) Corporates love lower interest rates at all points of time, irrespective of whether they want to borrow or not. I don’t think this needs to be explained.

5) The government loves low interest rates because it can borrow at lower rates. Second, with the stock market going up, it can sell a positive narrative. If the economy is doing so badly, why is the stock market doing well?

6) This leaves economists. Economists love lower interest rates because the textbooks they read, said so.

The question is do lower interest rates or interest rates make a difference when it comes to borrowing by an average Indian? Let’s take a look at non-housing retail borrowing from banks over the years. In 2007-08 it stood at 5.34% of the gross domestic product (GDP). In 2019-2020, it stood at an all-time high of 5.97% of GDP.

In a period of 12 years, non-housing retail borrowing from banks, has barely moved. What it tells us to some extent is that the idea of taking on a loan to buy something (other than a house), is still alien to many Indians.

So, the idea that interest rates falling leading to increased retail borrowing is a little shaky in the Indian context.

To conclude, today the RBI governor Shaktikanta Das gave a speech which was more than 4,000 words long. In this speech, the phrase fixed deposit interest rate did not appear even once.

A whole generation of savers is getting screwed (for the lack of a better word) and the RBI Governor doesn’t even bother mentioning it in his speech. The RBI seems to be constantly worried about the interest rate at which the government borrows.

A central bank which only bats for the government, corporates and bond market investors, is always and anywhere a bad idea.

Shaktikanta Das’ RBI is at the top of this bad idea.


An Appreciating Rupee and Atmnirbharta Don’t Go Together

One dollar was worth around Rs 77.6 in mid-April. Since then, the rupee has appreciated against the dollar and now one dollar is worth around Rs 73.5.

In a press release on August 31, the Reserve Bank of India (RBI) explained the mystery of the appreciating rupee by saying: “the recent appreciation of the rupee is working towards containing imported inflationary pressures.

Before analysing this statement, it is important to understand what it means. India’s imports are consumption oriented and not capital goods oriented. This can be gauged from the fact that non-oil, non-gold and non-silver imports, a very good indicator of consumer demand, moved from 55.8% of the total imports in 2011-12 to 69.7% in 2016-17. In 2019-20, these imports at 65.9% of total imports.

What this also tells us is that Indians prefer to buy imported goods than what is produced in India, wherever there was a choice. Their revealed preference is very clear on this front.

In this scenario, when the rupee appreciates against the dollar, the cost of imports comes down. Let’s say a product is imported for $10. At one dollar being worth Rs 77.6, it costs Rs 776. At one dollar being worth Rs 73.5, it costs Rs 735. There is a clear fall in price as the rupee appreciates. This helps control inflation or the overall rate of price rise.

As the RBI pointed out in its monetary policy report released in April earlier this year: “An appreciation of the INR by 5 per cent could moderate inflation by around 20 basis points.” One basis point is one-hundredth of a percentage.

An appreciating rupee is basically an indicator of excessive dollar inflows into India. When these dollars come into India, they need to be converted into rupees. This pushes up the demand for rupees, leading to the rupee appreciating.

One way of preventing this is the RBI buying the dollars that are coming in by selling rupees, in order to ensure that there are enough rupees in the system and in the process, the rupee doesn’t appreciate against the dollar or at least appreciates at a gradual pace. The RBI is not doing this or to put it more specifically isn’t doing as much of this as it was in the past.

This, as the RBI has explained is being done to control imported inflation.

The inflation as measured by the consumer price index, between April and July this year, was at 6.7%. Core inflation which ignores food, fuel and light items, was at 5.1%, with non-core inflation being at 8.6%. The high non-core inflation was on account of food inflation being at 9.8% between April and July. RBI has no control over food inflation.

Also, food inflation has been primarily on account of supply chains breaking down on account of the spread of the covid-pandemic. So, is the RBI getting too desperate, is a question well-worth asking here.

An appreciating rupee benefits imports and importers. This in a scenario where the government of the day has been talking about India becoming atmnirbhar or promoting self-reliance. In order to promote this, higher-tariffs on imports, like a higher customs duty on specific-imports, has been the way to go.

As the late Arun Jaitely said in the 2018-19 budget speech: “In this budget, I am making a calibrated departure from the underlying policy in the last two decades, wherein the trend largely was to reduce the customs duty.” This has been the policy stance of the government over the last few years.

But all this gets undone if the rupee is allowed to appreciate against the dollar. It makes imports cheaper and domestic producers will find it even more difficult to compete against the imports. Hence, this goes against the entire idea of atmnirbharta or encouraging domestic producers. It also goes against the idea of getting foreign companies to produce within India. If the rupee keeps appreciating they might just like the idea of importing most of the inputs and then assembling the end product in India.

This is quite weird, given that since Shaktikanta Das took over as the governor of the RBI, India’s central bank has more or less acted on the instructions of the government, rarely having a mind of its own. That makes me wonder what is really happening here?

Having said that, this is good news for the Indian consumer. As David Boaz writes in The Libertarian Mind: “The point of economic activity is consumption. We produce in order to consume… For each participant in international trade, the goal is to acquire consumption goods as cheaply as possible.”

So, is the RBI really batting for the Indian consumer in the aftermath of the economy being hit by the covid-pandemic? Or is there something more to the entire thing? On that your guess is as good as mine.

RBI Gives a Covid Spin to Cash Touching Pre-Demonetisation Levels

We live in an era of narratives. Politicians create them. Corporates create them. Social activists create them. Commentators, public intellectuals, economists and analysts also create them. And there are days when we are even lying to ourselves in our heads and creating narratives for ourselves.

In all this, it is hardly surprising that the Reserve Bank of India (RBI), with Shaktikanta Das at its helm, has also padded up and gotten into the business of narratives and spin. Before I explain this in detail, let me give you some background to this piece.

In November 2016, the central government demonetised Rs 500 and Rs 1,000 notes. The citizens had to deposit these notes into their bank accounts. The result was that 86% of the currency by value suddenly went out of the financial system.

Paper money has different uses, but its main use is as a medium of exchange. It basically facilitates the process of buying and selling. Of course, if people want to, the process of exchange can be carried out through other means like issuing a cheque, making a demand draft, carrying out a money transfer or even paying money digitally.

But India back in 2016 was a country which believed in operating in cash. When the cash went out of the system, the economic transactions especially in the informal sector took a beating. The gravity of the situation never really came out fully, except perhaps anecdotally, given that the government data collection for the informal part of the economic system was and continues to remain abysmal. I guess, which is why it is called an informal sector in the first place.

Between November 2016 and now, I have closely tracked the total amount currency in circulation gradually increasing. Of course, as the economy expands, the currency in circulation is bound to go up. In order to take care of this, the data that needs to be tracked is the currency in circulation divided by the gross domestic product (GDP), expressed as a percentage. (I will refer to this as cash in the system). The GDP is the measure of the size of any economy. The cash in the system basically adjusts for the size of the economy.

My contention over the years has been that the cash in the system will eventually rise to touch the pre-demonetisation level. Earlier this year, in April 2020, writing in the Mint, I had said: “The cash in the system [as of March 2020] works out to 12% of GDP.” I had made this calculation on the basis of the currency in circulation as of March 27 and the GDP forecast for 2019-20 (up until then, the actual GDP numbers were yet to come in).

A formal confirmation of this came yesterday with the RBI  releasing its annual report. In the annual report, the RBI says: “The currency-GDP ratio increased to its pre-demonetisation level of 12.0 per cent in 2019- 20 from 11.3 per cent a year ago, indicating the rise in cash-intensity in the economy in response to the pandemic [emphasis added].” The currency in circulation constitutes of cash with banks and cash with the public.

Before analysing this statement, let’s look at the following figure, which plots the currency in circulation to the GDP ratio or the cash in the system, over the years.

Cash in the System

Source: Reserve Bank of India.

In March 2017, a few months after demonetisation was carried out and after the whole country had queued up to deposit the demonetised Rs 500 and Rs 1,000 notes into their bank accounts, the cash in the system fell to 8.7% of the GDP.

The reason for this was very straightforward; the government and the RBI couldn’t replace the cash in the system at the same pace as they had taken it out. There were all kinds of problems, including banks having to reset ATM trays in order to take care of the smaller size of the new notes.

As of March 2020, the cash in the system is back to 12% of the GDP, which is at an almost similar level of 12.1% of the GDP as of March 2016, before demonetisation was carried out. The RBI feels this has happened because there has been a dash for cash in light of the spread of the covid-19 pandemic. People hoarded on to more cash than they normally do and this led to a faster rise in the cash in the system than it normally would have.

The point to be remembered here is that we are talking cash in the system as of March 2020 and not August 2020. At that point of time, people had just started to take covid-19 seriously. Let’s take a look at the monthly increase/decrease in currency in circulation during the course of 2019-20.

Changes in currency in circulation

Source: Author calculations on data from Reserve Bank of India.

It is very obvious from the above chart that at Rs 99,040 crore, the maximum monthly increase in cash in the system during the year, happened in March 2020. Does this then imply that there was a dash for cash as the fear of the pandemic spread? In order to say this with surety we will have to look at weekly increase in cash levels in the system during the course of March 2020.

Dash for Cash?

Source: Author calculations on Reserve Bank of India data.

India went into a physical lockdown starting March 24, 2020. It is only around then that most of the country realised the gravity of the pandemic. This can be seen by increase in cash in the system in the week ending March 27. This implies a higher than normal increase in currency with public with a higher withdrawal of money from the banking system than would have been the case if all was well.

But the bulk of the increased withdrawals in March had happened before March 20. Close to 62% of the withdrawals in March (at Rs 61,354 crore) had happened before March 20. Interestingly, up until then the fear of the pandemic hadn’t really spread. This weakens the entire dash for cash argument.

Let’s say if things had gone on normally then it is safe to say that the increase cash in the system in March would have been around 80-85% of what it eventually got to. At this level of increase, the cash in the system as of March end would have been around 11.95% of the GDP, which is not significantly different from 12.03% of the GDP, it eventually came to. The RBI’s dash for cash argument hangs on a few basis points.

Even if assume, that increase in the cash in the system in March 2020 was at around 60% of the actual number, the cash in the system would have worked out to 11.84% of the GDP, which is slightly lower than 12.03% of the GDP. And even at 11.84% of the GDP, the cash in the system would have been higher than where it was as of March 2019, and would have continued to go up, as it has since November 2016. This is the more important point.

While India of November 2016 was a country which believed in operating in cash, so is the India of March 2020. Yes, digital transactions have gone up along the way and that’s a good thing. But that could have happened anyway without putting the country through the trouble that demonetisation did.

Also, it is time we realised that people don’t store their black money in cash. In fact, data from a White Paper on black money published in May 2012 showed that around 4.9% of the total undisclosed income admitted to during search and seizure operations between 2006 and 2012 was held in the form of cash. Cracking down on black money is much more complicated operation than just cracking down on cash in the system.

Further, societies with more cash aren’t necessarily more corrupt. If that was the case Japan with a cash in the system of around 20% of the GDP would be more corrupt than India. On the flip side, Nigeria which has a cash in the system comparable to that of Norway, wouldn’t be a country as corrupt as it is. The government needs to make peace with this fact.

To conclude, I think one reason the RBI might have resorted to this spin and is trying to create a narrative, lies in the fact that when demonetisation was carried out, the current RBI governor Shaktikanta Das was the finance secretary.

My guess is that a part of Das still wants to justify demonetisation as a good thing and show it by telling the nation that the cash in the system rose to the pre-demo level simply because of the Covid-19 pandemic, something that wouldn’t have happened otherwise.

But as I showed above that is a very weak argument. It is time the RBI sang a different tune on this front and moved a dash for cash to Das for cash.

Taxpayer Funded Bailouts of Public Sector Banks Will Only Get Bigger


In the first column that we wrote this year, we said that even the Reserve Bank of India (RBI) is not sure of how deep the bad loans problem of India’s public sector banks, runs. And from the looks of it, the central bank has finally gotten around to admitting the same and doing something about it.

Up until now, the banks (including public sector banks) could use myriad loan restructuring mechanisms launched by the RBI and available to them, and in the process, postpone the recognition of a bad loan as a bad loan. Restructuring essentially refers to a bank allowing a defaulter more time to repay the loan or simply lowering the interest that the defaulter has to pay on the loan. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more.

These mechanisms came under fancy names like the strategic debt restructuring scheme to the 5/25 scheme. Banks, in particular public sector banks, used these mechanisms to keep postponing the recognition of bad loans as bad loans. This allowed banks to spread out the problem of bad loans over a period of time, instead of having to recognise them quickly.

This has led to a situation where the bad loans of public sector banks in particular, and banks in general, have kept going up, with no real end in sight.

We have seen senior bankers say, the worst is behind us, for more than a few years now. And that is clearly not a good sign.

The bad loans of banks jumped to 10.2 per cent as on September 30, 2017, up by 60 basis points from 9.6 per cent as on March 31, 2017. One basis point is one hundredth of a percentage.

This basically means that for every Rs 100 that banks have lent, more than Rs 10 has been defaulted on by borrowers. The situation is worse in case of public sector banks. For every Rs 100 lent by these banks, Rs 13.5 has been defaulted on by borrowers. For private sector banks, the bad loans stood at 3.8 per cent.

This has led to the RBI, having to revise its future projections of bad loans, over and over again. In fact, in every Financial Stability Report, published once every six months, the RBI makes a projection of where it expects the bad loans to be in the time to come. And in every report over the past few years, this figure has been going up.

As the latest Financial Stability Report points out: “Under the baseline scenario, the GNPA ratio [gross non-performing assets ratio] of all scheduled commercial banks may increase from 10.2 per cent in September 2017 to 10.8 per cent by March 2018 and further to 11.1 per cent by September 2018.”

In the Financial Stability Report published in June 2017, the RBI had said: “Under the baseline scenario, the average GNPA ratio of all scheduled commercial banks may increase from 9.6 per cent in March 2017 to 10.2 per cent by March 2018.”

In June 2017, the RBI expected the bad loans figure in March 2018 to be at 10.2 per cent. Now it expects it to be at 10.8 per cent. This is an increase of 60 basis points. This revision of forecasts had been happening for a while now. This is a problem that needed to be corrected. The bad loans of Indian banks need to be recognised properly, once and for all. The farce of the bad loans increasing with no end in sight, needs to end.

Earlier this week, the RBI did what it should have done a while back. But, as they say, it is better late than never. India’s central bank has done away with half a dozen loan restructuring arrangements that were in place and which allowed banks to keep postponing the recognition of their bad loans as bad loans.

As per a notification issued on February 12, 2018, a bank has to start insolvency proceedings against a defaulter with a default of Rs 2,000 crore or more, if a resolution plan is not implemented within 180 days of the initial default. The banks will have to file an insolvency application, singly or jointly (depending on how many banks, the borrower owes money to), under the Insolvency and Bankruptcy Code 2016 (IBC) within 15 days from the expiry of 180 days from the initial default.

The resolution plan can be anything from lowering of interest rate, to converting a part of the loan into equity or increasing the repayment period of the loan. The banks have a period of 180 days to figure out whether the plan is working or not. If it is not working, then insolvency proceedings need to be initiated.

This particular change will not allow banks to keep postponing the recognition of bad loans, as they have been up until now. One impact of this move will be that the bad loans of public sector banks will shoot up fast in the near future. While that is the bad part, the good part is that now we will have a better understanding of how bad the bad loans problem of Indian banks really is. The farce of every increasing bad loans is likely to end quickly.

In addition to this, the notification has also asked the banks to report to the Central Repository of Information on Large Credits (CRILC), all details of borrowers who have defaulted and have a loan exposure of Rs 5 crore or more. This has to be done weekly, every Friday. This will give the RBI a better understanding of the bad loans problem. And with more information at its disposal, it will also be in a position to see, whether banks are recognising bad loans as bad loans, or not.

While this is a good move, it does not solve the basic problem of the public sector banks i.e. they are public sector banks. With these changes made by the RBI, the real extent of the bad loans problem is expected to come out. With more bad loans, more capital will have to be written off in the days to come. This means that the government, as the major owner of public sector banks, will have to infuse more capital into these banks, if it wants to maintain its share of ownership in these banks. And from the looks of it, there is no reason to suggest otherwise. This means that the taxpayer funded bailout of public sector banks, is likely to get bigger in the days to come.

As we have been saying for a while, the government only has so much money going around, and if the taxpayer funded bailouts of public sector banks bailout are likely to get bigger, that money has to come from somewhere.

Where will that money come from? The money will come from lesser government spending on agriculture, education, health etc. That is something which has been happening for the last few years. It will also come from more farcical decisions like LIC buying shares in other public sector enterprises, and companies like ONGC having to borrow money to buy a big stake, in companies like HPCL, with the overall government ownership not changing at all.

As we like to say very often, the more things change, the more they remain the same.

The column was originally published on Equitymaster on February 14, 2018.

The Orwellian Economics of Indian Banking

George Orwell towards the end of his brilliant book Animal Farm writes: “There was nothing there now except a single Commandment. It ran: All animals are equal but some animals are more equal than others.”

Nowhere is this more visible these days than at Indian banks, in particular the government owned public sector banks, and the way they treat their different kind of borrowers. As is well known by now, Indian public sector banks have a massive bad loans problem. This basically means that borrowers who had taken loans over the years are now not repaying them. The bad loans of Indian banks are now among the highest in the world, only second to that of Russia.

The borrowers who have defaulted on their loans primarily consist of large borrowers i.e. corporates, who have taken on loans and are now not repaying them. As per the Economic Survey of 2016-2017, among the large defaulters are 50 companies which owe around Rs 20,000 crore each on an average to the banking system. Among these 50 companies are 10 companies which owe more than Rs 40,000 crore each on an average to the banking system.

These are exceptionally large amounts. Typically, when a borrower defaults the bank comes after him with full force, in order to recover the loan, by selling
assets offered as a collateral against the loan. But this force is not felt by the large corporates. It is felt by the small entrepreneurs who borrow from banks or people like you and me who take on retail loans like home loans, vehicle loans, credit card loans etc.

As former RBI governor Raghuram Rajan said in 2014 speech: “Its full force [i.e., of the banking system] 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.”

Given that they have access to the best lawyers and are close to politicians, the large borrowers don’t feel the heat of the banking system.

In fact, the large borrowers given that they are large, get treated with kids gloves. In some cases, the repayment periods of their loans have been extended. In some other cases, the borrower does not have to pay interest on the loan for a specific period. But all this hasn’t really helped and the banking mess continues.

The Economic Survey of 2016-2017 has recommended based on the data for the year ending September 2016 that “about 33 of the top 100 stressed debtors would need debt reductions of less than 50 percent, 10 would need reductions of 51-75 percent, and no less than 57 would need reductions of 75 percent or more.”

This basically means that banks will have to take on what is technically referred to as a haircut. Let’s say a corporate owes Rs 100 to a bank. A haircut of 51 per cent would mean that he would now owe only Rs 49 to the bank. The bank would have to take on a loss of Rs 51.

The Economic Survey offers multiple reasons why haircuts will be required. The first and the foremost is that the borrowers simply do not have the money to repay. Secondly, large corporates owe money to many banks and these banks need to agree on a strategy to tackle the defaults. That hasn’t happened.

Of course, what the Economic Survey does not tell us is that the large borrowers are politically well connected. It also does not get into the moral hazard haircuts would create. Once corporates are bailed out this time around, why would they go around repaying loans the next time around? They simply won’t have the economic incentive to do so.

And finally, the Survey does not tell us anything about why only the large corporates are being treated with kids gloves? I guess it does not need to because that was something Orwell explained to us many years back.

The column originally appeared in Bangalore Mirror on March 29, 2017.