The overall picture is of serious impediments in some segments that require urgent reform or resolution if encouraging private investment is a policy priority.
A new government will be formed by the end of this month. The current political occupation of minds will soon end and attention will turn to the economy. The arriving government will have to confront several problems—some long-standing, others more recent. While the departing government introduced some key reforms, especially the IBC and a nationwide GST, it has to be said that it also ducked or shied away from taking several other important reforms—dubbed as ‘hard’ options in political economy context. In some cases, it also avoided even softer options. The overall picture is of serious impediments in some segments that require urgent reform or resolution if encouraging private investment is a policy priority. The pretext of ‘all is well’ will have to be shed as these can no longer be brushed under the carpet. Undoubtedly, the new government will be challenged in redressing these because of a significantly weakened fiscal position, decelerating growth and an uncertain outlook.
The topmost concern is the vulnerable financial system. Both public and private banks are beset with unique issues. Those in the public sector banks are old—monumental overhang of bad assets leading to a virtual retreat from crucial functions such as lending and transmission of monetary policy actions. The main casualty of this stalemate has been the economy. The NPA problem was initially allowed to fester by the outgoing government with modified restructuring schemes, a lightweight reform package (Indradhanush) and the failed gamble of growth-driven resolution. Recognition and disclosures did accelerate thereafter, but insufficient recapitalisation and slow-paced resolution have prolonged the impasse. The most glaring omission in this regard is the departing government shied from taking hard decisions such as privatisation, and even the easier option of governance reforms to professionalise functioning if it preferred retaining public ownership.
The pending public banking reforms will now be the next government’s charge. Should it take the ‘hard’ privatisation route? Or should it take the ‘soft’ course of governance overhaul recommended by the Nayak Committee? These are the choices it faces. Then again, governance and disclosure issues have surfaced in private sector banks too in last two years. Will stronger supervision, sterner regulatory actions suffice to avoid repetitions? Or is it time to debate reform of private banks’ governance structures equally?
In the last one year, the banking system’s vulnerabilities spread to the non-banking segment, which grew rapidly to fill the lending vacuum. The IL&FS default last October exposed serious faultlines, including that of regulation, in the NBFC segment and related financial market parts. Default risks and costs have since remained elevated with occasional eruptions, downgrades and gathering expectations of a vicious, market-driven elimination of ‘lemons’ and survival of the fittest. Tighter regulation to address asset-liability mismatches in NBFCs is in the pipeline. But the next government needs to consider the speed of consolidation likely to occur here as NBFCs are a vital financing source for those unable to access banks. Again, there is the ‘soft’ option of handholding, protection to unviable, weak entities or the ‘hard’ choice of letting these fail.
Next is the nonfinancial corporate sector where defaults and failures have risen. Aviation and telecom are two struggling segments. The leaving government did try selling the ailing public airline, but was unsuccessful. Meanwhile, a large private airline, whose precarious condition was inordinately stretched but eventually went bust last month, has tossed aviation into a mess. The arriving government will have to choose between the hard choice of renewed sale of the public airline and the ‘soft’ option of turning it around, in which case it must scramble enough resources to put it back on track. It will also have to accelerate resolution of the failed private airline to restore civil aviation health.
Similarly, the retiring government dragged its feet over the ‘hard’ option of divesting two public telecom firms, BSNL and MTNL. The new government will have to bite the bullet on these, i.e., choose tough action and sell these off for a leaner, healthier telecom sector. Indeed, there is no soft option here!
The power sector comes up next. The much-touted UDAY scheme to reform the power sector has failed to improve efficiency and viability; it was always an old idea that had been tried and failed but was presented as new. A huge amount of capital lies locked up in 30-odd debt-laden firms (combined debt estimated above `1.5 trillion) with 39,000 MW of production capacity. The retiring government dithered on this too, i.e. shying away from tough action to force reform at state-owned entities to reduce losses and raise revenues, nor fully resolving issues surrounding fuel-availability, power-purchase agreements, and promoters’ inability to infuse equity/working capital, etc., while risk-averseness of banks /financial institutions magnified the problem. The next government will have to weigh the ‘hard’ and ‘soft’ choices urgently. It is bad enough this capital remains unproductive, but will be worse if eventually liquidated for the scale of capital destruction would be an adverse portent for future investments.
There is also the rest of infrastructure sector, where stalled projects remain accumulated and private participation is restricted to EPC projects. This testifies to risk-aversion that persisted throughout the outgoing government’s tenure. There is also the ‘unease’ of doing business and ‘fear’ of tax-terrorism. The next government will have to improve this environment.
The departing government also conducted questionable divestments such as takeover of one PSU by another to merely drawdown cash for fiscal targets. For example, ONGC bought HPCL, PFC bought out REC, stake sale of NHPC to NTPC, and so on. These ingenuities squeezed out almost all surplus cash lying with PSUs, leaving little retained earnings for their investment and profitability, e.g. ONGC’s cash reserves plunged to `167 crore in Sept. 2018 from `9,511 crore in March 2017 after HPCL acquisition, hefty dividend payouts, etc. The new government must work on a genuine divestment policy, similar to one followed by NDA-1. Given the budgetary constraints, this is a must—there is no other option.
The many hard decisions avoided by the departing government fall into the incoming one’s lap amidst a worsened fiscal position. On the macroeconomic front, the overarching, fundamental question is of high real interest rates. While the retiring government controlled inflation, the real rate did not decline. How to bring down the real cost of capital is the important question for the next government? Monetary policy is committed to price stability; it can accommodate growth only within the inflation target bounds. That leaves the ‘hard’ option of greater fiscal compression than the current consolidation roadmap. The outgoing government also avoided ‘hard’ consolidation, e.g., subsidy reduction, primarily food subsidy, expenditure on which ballooned; it chose instead the easier path of direct benefit transfers. The new government will now have to seriously consider expenditure rationalisation at a time when tax revenues have slowed, non-tax revenues have nearly emptied out. A lot on the plate out there for the next government to worry about once the victory euphoria subsides.
Author is New Delhi-based economist