Attacking Raghuram Rajan to defend demonetisation is not justified

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New Delhi | Updated: September 5, 2018 1:51:15 AM

Had Rajan not initiated banks’ clean-up, there may not have been any banking system left. Apart from this, Rajan’s actions are what led to the BJP’s biggest reform, on insolvency.

People stand in queue outside ATM during demonetisation (File photo)

It is ironic NITI Aayog vice-chairman Rajiv Kumar should criticise former RBI Governor Raghuram Rajan’s tremendous effort to clean up the banking system when the NDA government’s biggest achievement has been to bring errant promoters to book via the insolvency code.

Indeed, the process that Rajan started has been taken forward by the current RBI Governor Urjit Patel with the strong support of the government. Rajan called out errant promoters, saying many of them were “freeloaders” with scant regard for the debt contract. Had he not initiated the clean-up, there may not have been any banking system left.

Of course, NPAs have ballooned to over Rs 10 lakh crore. That was because, between 2009 and 2013, banks lent large sums to industry and a substantial chunk to infrastructure projects, which ran into trouble.

This has, no doubt, stalled lending because banks have been busy trying to salvage what’s left of their loans. And what little capital they had was used up to shore up their balance-sheets.

But had Rajan not initiated the AQR—asset quality review—in Q4FY16, the appalling quality of banks’ balance-sheets would never have come to light. His tough and decisive stance has prevented at least some banks from collapsing altogether, though about a dozen of them no longer have the ability to lend.

To attribute the sluggishness in the economy to the increase in NPAs is nothing short of absurd. The fact is the private sector has not had the capacity to invest because it is so hugely over-leveraged and has lacked the capital to fund projects. Earlier, few promoters actually contributed to the equity of a project—it came from the bank loans—but that is changing, with banks now much more cautious. It is true banks are now apprehensive and have turned risk-averse, and the government needed to have handled the situation better.

With a bunch of infrastructure projects in trouble—either for lack of fuel linkages or other reasons—cash-flows have been weak, leaving promoters with little financial wherewithal to invest. It hasn’t helped that the government’s policies have nearly bankrupted sectors such as telecom which spend huge sums on capex. Also, while the government claims its attitude is non-adversarial, there has been way too much price-control and interference, and very few incentives. For instance, easier labour laws could inspire confidence in industry, but these intents have remained on paper.

Not surprisingly, a large number of projects are stalled and few new ones are taking off, with the result that job creation has been very slow at a time when the manufacturing sector has been automating faster. In the absence of any buoyancy in demand, the private sector has justifiably not felt the need to create fresh capacity. Had promoters had the necessary capital, they could always have tapped the overseas markets for loan and bonds. It is true the smaller companies have suffered because banks have become far more cautious. But then, that is the price we are paying for the reckless lending during the UPA regime—when they did not even ensure they had adequate collateral.

To argue that demonetisation did not damage the economy is to be in denial. No economy can function effectively if 70%-plus of the cash is pulled out of it, especially one like India’s where the agricultural markets and much of the unorganised sector—which is more than three-fourths of the economy—runs on cash. The acute shortage of currency notes crimped cash flows of small-scale units and the agri-economy, not to mention the inconvenience caused to millions of households. The reason there is no evidence to prove there was a direct link between DeMo and the slowdown is because there is no data for the informal economy.

The slowdown in the economy started with two successive bad monsoons in 2015 and 2016, and DeMo exacerbated the situation. It also coincided with a global slowdown. Government economists probably need to defend DeMo, but any attempt to do so must at least seem credible.


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