India’s GDP growth slowed down to 5 per cent in the April-June quarter, the lowest in the past decade. From 8.2 per cent last year, growth has fallen sharply in the first and second quarter of this fiscal. This is the combined effect of a cyclical global downswing and serious structural flaws that are pulling down long-term growth. Exports, which revived in 2018 after five years, are falling again. Manufacturing growth has sunk to the lowest ~ just 0.6 per cent. Investment has slumped further. The bad loans of banks are shrinking too slowly, and the current slowdown threatens to expand them again.
The crisis in non-banking financial corporations (NBFCs) arising from the collapse of IL&FS is still not over. Meanwhile, the worst budget follies have sent foreign portfolio fleeing from India, with the Sensex plummeting 3,000 points and declining from bad to the worst. Attributing the slowdown in GDP growth to domestic and global factors, Chief Economic Adviser KV Subramanian has said that the government is taking various steps to boost economic expansion and effect a rcovery of the economy. He is confident that the country will be on a high-growth trajectory “very soon”. The government remains committed to its fiscal glide path, he added. Union Minister Prakash Javadekar said after completing 100 days in office that the fundamentals of the Indian economy are strong and there is “no panic situation”.
Finance Minister Nirmala Sitharaman announced the merger of 10 public sector banks into four, thus bringing down the number of state-run lenders to 12 from 27 in 2017. Besides this, the minister had announced a slew of measures, including steps to increase liquidity in the critical NBFC sector. Alas, this is too little too late. The package may be a shortterm palliative treatment. But only major structural reforms can tackle the fundamental flaws that are slowing long-term growth, and there is no sign of these. The PSB model of banking with government ownership, control and also lending support to the government’s agenda (priority sector, financial inclusion, Mudra etc) has been a major impediment for bringing about a change in their functioning. In fact, the merger announcement doesn’t address the core structural and fundamental issues that plague the PSBs.
The setting up of the Bank Board Bureau (BBB) by NDA-I was path-breaking, but this model was not pursued to its logical end. The bureau power was restricted only to appointments of senior management levels and directors. The government didn’t extend BBB’s model to human resource reforms, NPA and stressed assets resolution, risk management etc. This announcement has given power to bank boards and also offers operational flexibility in hiring from the market, but the question is whether the talent would be willing to join a PSB. Four mega mergers of PSBs, which control two-third of India’s banking in terms of advances and deposits, are meant to create a stepping stone to the government’s $5 trillion GDP target. The PSB universe will now have half a dozen large banks with Rs 10 lakh crore plus balance sheets, two national banks and four regional banks.
The biggest advantage, says State Bank of India (SBI) Chairman Rajnish Kumar, is that bigger banks have greater ability to absorb shocks, reap economies of scale as well as enhanced capacity to raise resources without depending on the exchequer. Banks are indeed the backbone of the economy in their role in credit intermediation. Fewer but larger banks will also help the Centre monitor their performance better, ease credit decisions and facilitate quicker restructuring or resolution plan in a consortium in the event of defaults. Several weaker public sector banks have been merged with strong ones. The total number of public sector banks is now down to 12 from 27 two years ago.
Optimists hope the mergers will provide scale economies, and improve management in the worst banks. For years, the worst banks had been put under prompt corrective action (PCA) by the RBI, meaning they could collect deposits but do very little commercial lending, so bad was their lending record and so high were their NPAs. To absorb past losses and recreate lending ability, the government has pledged to give Rs 70,000 crore for bank recapitalisation, buttressing the bank mergers. This will be a short-term reprieve. But only structural change will prevent public sector banks from sliding downhill again. A mere freeze on lending by the worst banks was never a long-term solution. They could have been closed.
Or, the bulk of dud loans of the whole banking system could have been transferred to a separate “bad bank”, letting the system lend freely again. Instead finance minister Sitharaman has merged the worst banks with the bettermanaged ones, hoping to improve management quality and risk-taking skills. Will this really end the culture of giving dubious loans because of political pressures and lack of lending skills? Finance minister Nirmala Sitharaman wants banks to be professionalised, hiring risk managers at high commercial wages from the private sector. Alas, several efforts at professionalising banks have failed because that is simply not compatible with the political and bureaucratic culture of the public sector. Past mergers of weak banks with strong ones have not been encouraging.
The merger of Punjab National Bank with the troubled New Bank in 1993 was messy and failed to create significant synergies. Early this year, the strong Bank of Baroda was merged with the weaker Vijaya Bank and Dena Bank, but postmerger performance shows little obvious improvement, and its share price has slumped from Rs 150 a year ago to Rs 92. The danger of mergers is that instead of the strong banks lifting the weak, the weak ones may sink the strong. Other measures that are supposed to boost the economy include killing an ill designed “angel tax” that hit investors in start-ups.
The income-tax surcharge on capital gains, which had caused a flight of foreign portfolio investors, was withdrawn. Also reversed was the illconceived move to criminalise shortfalls in spending by corporations on corporate social responsibility (CSR). Marginal tax-breaks were given for buying autos and trucks. While these measures are in the right direction, they are minor short-term fixes that ignore the structural reasons for India’s economic slowdown. Compared with its Asian competitors, India has some of the most costly land, capital, labour, electricity, railway freight, corporate tax and income-tax.
This has made India a high-cost country that cannot compete. Third-rate graduates from unprofessional colleges and universities are failing to provide the skills and productivity that firms badly need. The government does not acknowledge the structural problem, let alone tackle it. Prime Minister Modi found that incremental reforms in his first term sufficed to produce 7 per cent growth and win re-election. If he thinks the same approach will succeed in his second term, he is sadly mistaken.
(The writer is author of World Trade Organisation: Implications for Indian Economy (Pearson Education) and is retired senior professor of International Trade. He may be reached at [email protected])