Important to deal with non-performing assets: Viral Acharya
I think the developed economy stimulus has been very-very large. But the key focus has to be on the health curve. The US is still not doing that great, said Viral Acharya on his reading of global economy.
1. In his speech at the SBI Conclave, the RBI governor said that we are entering a phase where extant wisdom about capital requirement of banks and potential growth of economy might not be of much use. What do you make of his remarks?
My interpretation of his remarks is that we might have to encounter scenarios of stress which far exceed the usual standards of Basel capital requirements. Implicitly what he was suggesting was that the hit of a prolonged lock down on bank loans of individual and MSMEs might far exceed traditional losses. The latest Financial Stability Report endorses his remarks. The Non Performing Assets (NPAs) to advances ratio is far in excess of what we have ever seen. With the GDP set to contract anywhere between 5% and 10%, some analysts believe that the NPA ratio could end up even higher. I think there is still time. I am hoping that the RBI will use some of these estimates to get both public sector and private sector banks to shore up their capital. The debt moratorium has still not expired. The RBI should use this time, so that we do not run the risk of questions being posed ex-post.
2. Financial sector stability isn’t like normal economic metrics such as growth rate. It is missed only when there is a crisis. How difficult does it make the job of preserving it?
It is very difficult exactly for the reason you mentioned. When you succeed with it, nothing happens. It is just that the counter factual would have been very bad. However in some times the job is a bit easier. Look at our last decade. While there are many hits and misses, most would agree that our NPA problem on the banking and even non-banking sector are the two most important problems we have to deal with. These are the times when politics and economics have to align themselves, because you have a striking example of what has gone wrong. What I’ve tried to argue in my book is that somehow in spite of that collective movement having gained ground, within a short period of time we seem to have reversed the gains. This is the result of divergence between short-term horizons of governments and long-term horizons of central bank. It is this divergence of horizons which makes the central bank’s job more difficult.
3. In a country like India, where a vast majority does not have any significant monetary savings, are political incentives heavily aligned against governments pursuing financial stability?
I think that is a very deep question. If you look at our leverage boom and bust cycles, it has not happened with small borrowers. Think about the fiscal constraints that come about when the financial sector does not do well as result of bad loans. Bank bail-outs effectively mean tax-payer money going into the pockets of wealthier segments of the society. In my view, lack of financial stability in India has actually transferred taxpayer funds through the route of poor underwriting standards away from the re-distributive and developmental objectives for which fiscal policy should be working.
4. In his foreword to your book Dr Y V Reddy underlines the importance of government borrowing crowding out markets for private bonds. We have banks and stock markets to raise capital. Why are bond markets necessary and desirable?
First and foremost they are desirable precisely because our bank underwriting standards are not up to scratch. Except a few well capitalised private banks and handful of public sector banks, the track record has not been very impressive. In an environment like this you would want to reduce reliance on banks. If banks are not keeping well, at many points of time they are actually very risk averse to lend. In such a time it is a boon to have a well-functioning bond market. It allows savings in the economy to get channeled through non-bank routes. Developing the corporate bond market is another step in the direction of developing more diversified sources of funding in India. I fully agree with Dr Reddy that until government borrowing does not become more manageable in size, it is going to be a herculean challenge to develop the corporate bond market in India.
5. You’ve always warned against the wrath of financial markets. Today, when the real economy is doldrums, stock markets, where global finance is a big player, are doing relatively better. How should we reconcile the two?
This has multiple potential explanations. One view is that the pandemic is going to be a one-two year slow growth scenario, while the stock market is really a very long term claim. The second view is that central banks all over the world have responded with massive rate cuts and flooded the system with liquidity. Some of this safe haven excess liquidity is chasing emerging markets. Deposit rates in markets like India are not offering much return. So it is natural that investors turn towards higher yielding assets. Historically Indian investors have gone towards real estate, but that was not in great condition even before Covid-19. A lot of it is now going towards equity markets. But some of the stock market rally could be just froth. When the conditions reverse and interest rates are increased, this could burst in a very short period of time. One has to always watch out for this kind of external sector scenario.
6. Your book discusses demonetisation’s shock to the financial sector. Had demonetisation not happened, do you think that the agenda of cleaning India’s financial sector mess, which brought you to the RBI would have gone further?
I wasn’t at the RBI when that phase happened. Even in the post-demonetisation phase, post the normalisation of liquidity, the government was very much on board in some of the critical moves in getting the Insolvency and Bankruptcy Code to be applied on stressed assets. In my view demonetisation was not the critical event, although it did trigger a complex process of liquidity flowing into shadow banks and Non Banking Financial Companies. The glut of liquidity led to them underwriting very poor quality loans.
The critical issue vis-a-vis financial sector stability in my view was political pressures that were coming up in 2018-19. The government wanted to go for liquidity and credit led short run boost to growth, not much unlike the kind of push that we saw for generating higher growth in the last decade. We felt that we could not allow the system to repeat its mistakes while we were still trying to clean up the previous leverage boom and bust cycle.
7. You describe financial stability as a necessary condition for sustainable growth. This means you don’t see this as a sufficient condition. What role do you see for fiscal policy in a country like India?
Fiscal policy should really be focused on infrastructure, health and education. If we had a superior health infrastructure, that would have been a tremendous advantage at the current juncture. This is not to take away from the excellent work our medical workers are doing. Similarly, if we need to benefit from the anti-China sentiment in developed countries, we need seamless infrastructure zones to facilitate companies to execute their projects on time. Reliance on revenue spending in fiscal policy, which is what we do, gives short term growth benefits. But it does not generate high multiplier effects, the way infrastructure, health or education would. Some reorientation of fiscal policy is absolutely necessary. Fiscal stretch is most worrisome when it is only going to generate a short term benefit. It is not worrisome when it puts the economy on a long-term growth path.
8. Two policies have been discussed a lot in connection with India: bad banks and universal basic income (UBI). At the current juncture what do you think about both of them?
If government is required to put up capital for a genuine fast-track resolution of stressed assets, it will be seen as credit positive for the financial sector and growth and credit positive for the economy as a whole. Recapitalisation of banks, not so much of weaker banks, is a fiscal stretch which puts the economy on a high growth path. If UBI is a replacement for all kinds of other subsidies we have, it is a win-win for everyone. This could be a good time to introduce it, but it would be a big-big mistake to layer it on top of the subsidies we are already giving.
10. What is your reading of the global economy? Some people are warning that a premature withdrawal of the stimulus could make things worse.
I think the developed economy stimulus has been very-very large. But the key focus has to be on the health curve. The US is still not doing that great. Things are not looking great in Brazil and India. If big parts of the world are still facing the pandemic, an economic recovery is going to be hard. This is as much a behavioural challenge, as it is an economic policy challenge.