Indradhanush framework is not “sanjivini booti” for govt banks

On August 14, 2015, the ministry of finance released the Indradhanush framework for transforming the government owned public sector banks (PSBs), which are currently in a bad shape primarily due the bad loans that have piled up over the years.

In fact, the press release accompanying the announcement was extremely self-congratulatory in nature and pointed out: “Indradhanush framework for transforming the PSBs represents the most comprehensive reform effort undertaken since banking nationalisation in the year 1970. Our PSBs are now ready to compete and flourish in a fast-evolving financial services landscape.”

The framework has seven steps, and hence has been named Indradhanush or rainbow (which has seven colours). Enough has been written in the mainstream media regarding what these steps are. Hence, in this column I will concentrate on what is missing in the Indradhanush framework and why it is unlikely to help the public sector banks in a major way.

The third step in the Indradhanush framework talks about the government putting in Rs 70,000 crore into these banks over the next four years. Of this Rs 50,000 crore will be invested in the current and the next financial year.

There are a number of questions that crop here. The first question is whether this is going to enough? The PJ Nayak committee report released in May 2014 estimated that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.” The committee further said that: “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.”

The government on the other hand estimates that “the capital requirement of extra capital for the next four years up to FY 2019 is likely to be about Rs.1,80,000 crore.” Of this amount it proposes to invest Rs 70,000 crore.

In a research note titled A Growing Need for Indian TARP, Anil Agarwal, Sumeet Kariwala and Subramanian Iyer, analysts at Morgan Stanley, estimate that an immediate infusion of around $15 billion (or Rs 97,500 crore assuming $1 = Rs 65) is needed in these banks.

The international rating agency Standard & Poor’s said: “The Central government’s planned capital infusions come at a good time for public sector banks. But they don’t go far enough.”

So, the government is clearly not investing as much as the public sector banks really need to get out of the current mess that they are in. Further, as I have pointed out in the past, the government putting in more money into public sector banks goes totally against the “minimum government maximum governance” philosophy that Narendra Modi had espoused in the run-up to the Lok Sabha elections that happened last year.

This does not mean that the government should abandon these banks. But there is no reason that it should own 25 public sector banks, especially given that they require a massive amount of money to continue functioning. It is best to own five or six big banks and sell out of the others. In this way it will be able to concentrate its efforts on managing the big banks. At the same time, it will get more bang for the buck on the money that it is putting into the public sector banks.

This brings me to the next point I want to make. There is nothing in the Indradhanush framework that talks about the government trying to sell its stake in the public sector banks. Many public sector banks have a very good branch network in place and hence, will be attractive buys despite their balance sheets being in a mess.

This non-reference to disinvestment is not surprising given that it will be a politically very difficult thing to do. And from whatever evidence we have had from the Modi government up until now, it has shown no zeal to push through politically difficult reform. Given this, the government will continue to own 25 banks and hence, it is likely to pump more tax payer money into these banks in the days to come, because Rs 70,000 crore is clearly not going to be enough.

The fourth point in the Indradhanush framework talks about de-stressing public sector banks. The press release has a long-winded paragraph written in a fine bureaucratic way which comes up with practically every possible reason to explain the bad loans that have piled up with public sector banks.

Here it goes (you won’t miss much if you decide to skip it): “Due to several factors, projects are increasingly stalled/stressed thus leading to non-performing assets(NPAs) burden on banks. In a recent review, problems causing stress in the power, steel and road sectors were examined.  It was observed that the major reasons affecting these projects were delay in obtaining permits / approvals from various governmental and regulatory agencies, and land acquisition, delaying Commercial Operation Date (COD); lack of availability of fuel, both coal and gas; cancellation of coal blocks; closure of Iron Ore mines affecting project viability; lack of transmission capacity; limited off-take of power by Discoms given their reducing purchasing capacity; funding gap faced by limited capacity of promoters to raise additional equity and reluctance on part of banks to increase their exposure given the high leverage ratio; inability of banks to restructure projects even when found viable due to regulatory constraints.  In case of steel sector the prevailing market conditions, viz. global over-capacity coupled with reduction in demand led to substantial reduction in global prices, and softening in domestic prices added to the woes.”

There is no mention of how the banks are going to go about recovering the loans that they have given out and which are not being repaid. As an editorial in The Financial Express points out: “The lack of a concrete plan to tackle NPAs is worrying. There is no mention of how the debt of state electricity boards (SEBs), running into several lakh crore rupees, is going to be recovered or that from wilful defaulters or highly-leveraged promoters.”

Further, many measures that the government has listed out as a part of the Indradhanush framework have already been around for a while now, having been put in place by the Reserve Bank of India.

The fifth point in the Indradhanush framework talks about “no interference from government,” in the functioning of banks. It further states that “banks are encouraged to take their decision independently keeping the commercial interest of the organisation in mind.”

How are banks supposed to interpret this point given that in his Independence Day speech Prime Minister Narendra Modi talked about “Start-Up India, Stand-Up India”. The idea, as Modi explained during the speech, is that each of the 1.25 lakh bank branches all across India “should encourage at least one Dalit or Adivasi entrepreneur, and at least one woman entrepreneur”.

So how independent does this make the banks, given that they have to follow diktats like these from the government? Also, it is worth mentioning here that lending to start-ups is a very high risk kind of lending. Further, do public sector banks have the capability to analyse the loan proposals of start-ups, is a question worth asking here.

To conclude, it is safe to say that the Indradhanush framework is essentially a clever repackaging of steps and processes that are already in place. It is not the sanjivini booti that it is being made out to be.

The column originally appeared in The Daily Reckoning on August 20, 2015

Is Narendra Modi ready for the creative destruction that Start-Up India will unleash?

In their brilliant book, Why Nations Fail: The Origins of Power, Prosperity and Poverty, Daron Acemoglu and James A Robinson recount a story from ancient Rome that is relevant even today: “During the reign of the emperor Tiberius, a man invented unbreakable glass and went to the emperor anticipating that he would get a great reward.” Tiberius ruled between 14 AD and 37 AD.

This anticipation of a reward came from the fact that the Roman state did encourage new inventions. Nevertheless, this did not happen and the man was in for a surprise. As Acemoglu and Robinson recount: “He demonstrated his invention, and Tiberius asked him if he had told anyone else about it. When the man replied no, Tiberius had the man dragged away and killed, ‘lest gold be reduced to the value of mud’.”

A similar story comes from the era of Elizabeth I, who ruled England and Ireland from 1558 to 1603. William Lee made a knitting machine in 1589 and approached the Queen for a patent, so that others would not copy his invention and he could cash in on it.

The Queen refused to grant him a patent and told him: “Thou aimest high, Master Lee. Consider thou what the invention could do to my poor subjects. It would assuredly bring them to ruin by depriving them of employment, thus making them beggars.”

Lee went to France and was refused a patent there as well. Back in England, James I (Elizabeth’s successor) also refused to give a patent to Lee’s knitting machine.

By now, dear reader, you must be wondering why I am telling these historical tales, particularly given the headline suggests this is a column on Prime Minister Narendra Modi. Allow me to explain.

In the Independence Day speech Modi gave a few days back, he initiated a new call: “Start-Up India, Stand-Up India”. Whether this was just another marketing slogan Modi and his backroom boys are so good at coming up with, will only become clear in the time to come. But the idea, as Modi explained during the speech, is that each of the 1.25 lakh bank branches all across India “should encourage at least one Dalit or Adivasi entrepreneur, and at least one woman entrepreneur”.

On the face of it, like most of Modi’s big ideas, this makes tremendous sense. Around 13 million Indians enter the workforce every year, and it is start-ups that have the potential to generate the huge number of jobs that India needs to create for its burgeoning workforce.

The trouble is that start-ups also challenge the existing way of doing things and lead to what economists call creative destruction.

Creative destruction was a term coined and defined by Austrian-American economist Joseph Schumpeter in Capitalism, Socialism and Democracy as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one”.

This process of “industrial mutation” challenges the existing paradigm, and it is messy, causing reluctance among governments and politicians to accept the new inventions, discoveries and ideas of start-ups.

Here’s Acemoglu and Robinson again: “For sustained economic growth we need new technologies, new ways of doing things, and more often than not they will come from newcomers such as Lee [in today’s terminology essentially start-ups]. It may make society prosperous, but the process of creative destruction that it initiates threatens the livelihood of those who work with old technologies, such as hand-knitters who would have found themselves unemployed by Lee’s technology.”

The point is that if Modi’s “Start-Up India, Stand-Up India” call is more than a marketing slogan, it has the potential for widespread creative destruction, and this will challenge the incumbents and their way of doing things.

Obviously, the incumbents will try to do everything to stop their businesses from becoming irrelevant…including trying to get politicians on their side.
Take the case of what has happened around the entire issue of “net-neutrality, which the mobile phone companies have opposed tooth and nail because it would make substantial portion of their business model irrelevant.

Or take the case how life is being made difficult for taxi-cab operators like Ola and Uber who’ve challenged the existing paradigm. As Acemoglu and Robinson write: The elite, when their political power is threatened, form a more formidable barrier to innovation. The fact that they have much to lose from creative destruction means not only that they will not be the ones introducing new innovations but also that they will often resist and try to stop such innovations. Thus society needs newcomers to introduce most radical innovations.”

If “Start-Up India, Stand-Up India” goes beyond just being a marketing slogan, a whole host of existing businesses will feel threatened, and will approach the government for relief. Given the close relationship most governments share with existing businesses, they are more than likely to oblige.

Acemglou and Robinson offer the example of manufacturers of woollen textiles in England who, when faced with fierce competition from imported textiles, “lobbied Parliament to pass legislation in 1666 and 1678 that would make it illegal for someone to be buried in anything other than woollen shroud’.

If the creative destruction of “Start-Up India, Stand-Up India” is indeed unleashed, Modi and his government will have to resist the temptations of doing similar things. However, India is ranked 158th among 189 countries worldwide, and last among the eight South Asian countries (Afghanistan, Sri Lanka, Pakistan, Maldives, Bangladesh, Nepal, Bhutan and India) in the World Bank’s annual Ease of Doing Business Rankings.

Before we see creative destruction in India…before Modi is even in a position to grant protections to fading industries…the ease of doing business in India must improve.

I remain sceptical.

(The column originally appeared in The Daily Reckoning on August 19, 2015)