The Union Budget had plenty of detail. Some of it impacts banks, and is a good point to start. First, there is the matter of loans for cars being easier to obtain than loans for tractors. The policy conclusion is to encourage private banks to open rural branches. One hopes that it stops at encouragement and does not take on the colours of moral suasion. The idea, as the finance minister said, of ?examin(ing) afresh this whole question of franchising agricultural credit, including through Post Offices? is welcome, for it has been too long overdue.
The organisational structure of banks is singularly unsuited to small credits, especially in the climate of the power structure of rural India. The administered rates of bank credit for agriculture is half that of the prevalent rates of informal credit. Rent-seekers therefore crowd around the transaction like vultures around a carcass. Quite often, the farmer affixes his signature or thumb impression on a loan document for a much higher amount than what he receives. Say against a loan of Rs 25,000 he gets Rs 15,000. The rest is pocketed by the rent-seekers who ?manage? the transaction.
If the farmer services the loan, the effective interest is sky high and the enterprise of providing cheap credit to the farm sector is totally defeated. Given the prevalence of corrupt practices the extent of default by such farmers is understandable. If the local power brokers are not obliged to service the sizeable chunk of the bank loan that they pocket, why only the poor farmer? But the security with the bank loan is a mortgage on the land. Little surprise that the moneylender continues to flourish. At least there the farmer knows what he is getting into. Bank re-finance of Self Help Groups and perhaps the moneylender ? the traditional village financier ? are a better option than feeding the scavengers of rural society. But spare the Post Office ? it is an excellent institution but unsuited to lending operations.
Second, we come to debt swaps. Government has decided to pre-pay around $3 billion of multilateral debt and the pre-payment penalty booked is Rs 331 crore, that is 2.4 per cent. Since neither the line item (2048/34) in the Expenditure Budget, nor the Grant item (34), nor the concerned section in the Receipts Budget tell us what the residual tenor or the interest rate was, there is no way of confirming the extent of saving achieved. The financing is through placement with the Reserve Bank, which means that it is zero cost for the government. But surely that ought not to be a consideration? Or was it a reaction to the pressure to do something to reduce the forex reserves?
Then there is the debt swap with banks for high coupon bonds. They are ?thinly traded? because the banks value the continuing cash flow for the residual period over up-fronted profits, given the re-investment risk on the cash generated. Issuers do buy back securities when their cash hoard mounts. As some years ago the US Federal Reserve was doing given the large fiscal surpluses. But here what is being proposed is essentially re-purchase to be financed by fresh issuance at lower coupons. It is reasonable to surmise that government is proactively trying to re-price its liabilities in anticipation of the near term when rise in private demand for credit might raise the expected yield on gilts.
To sweeten the deal, public sector banks (only they hold sizeable old gilts) are being tempted with the offer that capital gains on such re-purchase will be set off against provisioning for non-performing assets (NPA). Now, the tax rules qualify (with some exceptions) for purpose of tax deductibility only write-offs, not provisioning. So all banks have excess provisioning in a tax sense. That would mean banks could use this excess to protect the profits on the gilts they sell back to government from taxes. Which effectively means a re-capitalisation of these banks as long as they are profit-making, which they mostly are. But at the same time it removes the cushion against squeezed net lending spreads and operational profitability going forward. One is left wondering whether this is an intended or unintended outcome?
The author is economic advisor to ICRA (Investment Information and Credit Rating Agency)