Fixing economy is govt's job, not that of RBI governor's

For a couple of months, before Urjit Patel finally resigned, there was a whisper campaign about how the Reserve Bank of India governor was obstinately creating a lot of misery for everyone from Non-Banking Financial Companies (NBFCs) to the troubled power sector to the SME sector and proving a real hurdle to the government's efforts to further accelerate the economy. Now that Shaktikanta Das has taken charge as the new governor of the RBI, will all those problems get sorted quickly? It would be tempting for many people to think so, but it is unlikely.

The problems with the SMEs, the troubled power companies, and the NBFCs among others have hardly been created by the RBI. And while the government would love to believe that a more reasonable (or pliable) central bank will solve all the problems, this is not going to happen. Even if the RBI agrees with everything in the finance ministry's wishlist, the problems will still persist. That is because the problems with all these sectors have to solved by well-thought-out policy decisions, and not by the RBI opening the money tap a bit more wide.

Let's take the case of the SMEs first. Much as the government likes to deny it, I am sure they know the real issue why these businesses have been hit so badly. Demonetisation was a serious body blow to the entire group of small and medium industries but it was really the hiccups and the imperfections of the Goods and Services Tax (GST) that dealt the knockout punch to many small and medium sized firms. When they initially complained about the faulty GST implementation, I remember one senior finance ministry official laughing and telling me: "If their (SMEs) only business strategy is to evade taxes, they deserve to go out of business." It is nobody's case that a lot of SMEs do try to avoid or minimise tax (and even evade them). But that was not the problem with the GST. The core problem was the working capital and liquidity problem that cropped up for all companies because of the complexities of the GST filing and refunds. It is an issue that has, even now after one year of the GST implementation, been only partially sorted out.

Will opening the liquidity tap, allowing public sector banks currently under the RBIs' prompt corrective action (PCA) and initiating a loan mela for the SMEs, help the sector? I doubt, because the core problem needs to be addressed. Loans may be temporary relief but if cash flows don't improve, the SMEs are unlikely to get out of trouble. On the other hand, they may have trouble repaying the loan itself. And that would create the next wave of NPAs. In fact, periodic loan melas have always ended badly with banks having to write off large chunks of their loan portfolios.

This is not just true for loan melas (or anything you want to name it) to farmers or small entrepreneurs -- it equally holds true for big companies if the business horizon itself is not stable. Just like the UPA-2 found out when they exhorted PSBs not to be too strict and to give loans on demand to everyone from steel barons expanding to unsustainable to loss making airlines.

Ditto for the problems of the power producers who are stuck with big debts and unsustainable business models. Their problems stem from a number of factors - gas-based plants that were promised gas did not get them, coal-based plants that banked on regular coal supplies found themselves with irregular or no coal supplies. And sometimes those who had based their business models on coal mines they owned in other countries found themselves in a spot because of regulatory changes in those countries.

There were still many who got into trouble because of mounting receivables from sick public sector distribution companies of several states. The RBI under Urjit Patel wanted these troubled power assets to be treated much like the other big troubled assets like steel and others. The only problem, as the government realises, is that while there are plenty of buyers for stressed steel assets, there wasn't too much interest in sick power producers until all the other problems got sorted out.

Forcing the RBI to have a different set of rules for power producers compared to other NPAs might seem like a good solution to the government but it will only lead to more headaches for the government. For example, there is nothing to prevent the promoters of companies under NBC to go to courts and ask why no other sector was given the same sort of consideration as the power sector?

Then there is the case of NBFCs. In a way it is linked to the SME problem and the infrastructure financing problem, which we will come to in a bit. Some time ago, banks turned cautious about taking on what they perceived as higher risks. The infra and SME loans were the first ones affected. Private sector banks have always been cautious about lending to SMEs, and infrastructure projects expect to blue chip companies such as L&T.

The public sector banks were more accommodative - but even they did not want to take too much risk. So they preferred lending to NBFCs, which in turn gave out these loans. The problem was the IL&FS defaults have shaken the confidence in the NBFCs. That is because several of them had a severe asset liability mismatch - they gave loans on long-term basis, for example, for infrastructure projects or SMEs trying to increase capacity. But their own funds were short-term borrowings. So the willingness to give loans to NBFCs suddenly came down. The other NBFCs - which primarily built businesses around short-term loans - say working capital loans to SMEs or consumer durable or auto loans of shorter duration - were not seriously affected.

This is again something the RBI can't do much about. It can improve liquidity further - but banks still are not willing to lend because they consider these projects to be too risky. Forcing banks to lend for such projects can only lead to an even greater NPA problem. Finally, of course, there is the demand of the government that the RBI hands over a third of its reserves to the government to spend and make sure the fiscal deficit remains under control. That again is a moral hazard - once the government starts dipping its fingers in the central bank reserves, it will never be able to stop itself. And when the RBI needs to use those reserves, it will be in a bit of spot.

The government needs to realise that fixing the economy is its problem. The RBI can at most help a bit. But eventually, the central bank can't really fix all the issues. The government is the one that needs to think of the policy solutions.