BQ - Our experiments with truth

(The following article appeared in Bloomberg Quint on February 10, 2020, per the link below

https://www.bloombergquint.com/opinion/our-experiments-with-truth )

Our experiments with truth

For a nation that has adopted “Satyameva Jayate” – truth alone shall prevail – as its motto, we have trouble dealing with the truth.

We are yet to acknowledge the full extent of non-performing assets in our financial services ecosystem. We skirt around the truth in our budget math. We publicly applaud reforms such as Uday, Sashakt, Samadhan and bank consolidation, but privately complain that these are just not enough. 

Some would argue that truth is overrated, or even dangerous. I make the case that truth – particularly around the state of our financial services and public finances – can show us the way to achieving our immense economic potential.  

The truth about asset quality

As far back as in 2012, Credit Suisse showed that many of the large infrastructure loans doled by Indian banks after the global financial crisis were stressed. Back then, however, we pretended that the loans were okay, even when they were not. With that false comfort, there wasn’t enough focus on addressing the core economic issues in a timely manner. 

After RBI finally launched the Asset Quality Review (AQR) in late 2015, banks were slowly forced to recognise the truth around their asset quality. Official bank Gross Non-Performing Assets (GNPAs) went up from 4.5% of advances in March 2015 to 11.6% of advances in March 2018. As write offs and loan loss provisions concomitantly rose, the government has had to inject over INR 2.5 lakh crores of equity into Public Sector Banks (PSBs) over the past 3 years. 

Truth is catching up, with larger consequences to the economy than had it been acknowledged and acted upon earlier. 

Sadly, the extend and pretend culture still lingers. The RBI itself had earlier warned of growing stresses in bank loans to Micro Small and Medium Enterprises (MSME). Ironically, the government and RBI have handed banks ‘forbearance’ – banks can now pretend stressed MSME loans are fine, even when they are not. 

In addition, while bank books have gone through an AQR, Non-Bank Finance Company (NBFC) books still do not pass the truth smell test.  At 6.3% of advances as of September 2019, the official NBFC GNPA is suspiciously well below the official banking GNPA of 9.3% of advances. 

As before, being economical with the truth hits us in multiple ways. 

Policy makers do not seem to realise how serious the problems facing the financial services ecosystem truly are. We are stopping short of undertaking the strong measures and reforms that could address the issues now. 

At the same time, the lack of truth adds to the severe trust deficit in financial circles, and has put the brakes on much-needed credit growth in our economy. 

The budget math

Our central and state budgets also experiment with the truth.

Take this year’s central budget, for example. The official fiscal deficit for the current fiscal year 2019-20 (FY20) is 3.8% of GDP. In the fine print, the budget says that an additional 0.8% of GDP of fiscal deficit has been pushed down to a few public sector enterprises, by the government not releasing their dues. The real fiscal deficit for FY20 is thus ostensibly 4.6% of GDP. 

Sadly, it doesn’t stop there.

The budget estimates that FY20 central tax revenues will grow by a healthy 14.3% over FY19. However, for the 9 months till December 2019, the centre’s tax revenues were 3.3% lower than the same period last year. To achieve 14.3% full year growth, central tax collections will have to grow by an incredible 57.5% year-on-year in the last three months. 

More likely, as with the last year, final central tax revenues will fall short of this revised estimate by 0.9% of GDP. Again, as with last year, the government will likely use its opaque cash accounting, and avoid, defer or delay payments to show a concomitant lower expenditure. Magically, a lower tax revenue will not result in a higher headline fiscal deficit. 

Shorn of these accounting smokescreens, however, the true FY20 central fiscal deficit could well top 5% of GDP. State governments deploy exactly the same smokescreens. This explains why entities dealing with our governments often face delayed payments.  

Here again, the lack of truth gives us the worst of many worlds. By underplaying the core issue – the sharp slowdown in tax revenues – we fail to recognise how urgently we need bring back sustainable growth. On the other hand, by delaying and deferring government payments just to show better headline deficits, we are actually worsening the slowdown in the economy. 

The truth about reforms 

Good reforms – such as the IBC, GST, increased digitisation of financial transactions, corporate tax rate cut and now proposals around labor law reform - have been put through in recent times. 

However, other schemes – such as UDAY, Sashakt, Samadhan and bank consolidation fall well short of what is truly needed to resolve the serious issues they are meant to address.  Our power sector remains in a mess, and our critical financial services ecosystem is in no position to fund our economic aspirations. 

That itself is not a cause for despair – after all, it is unreasonable to expect that solutions will always be found at the first pass. But course correction requires open feedback and acknowledgement – it doesn’t help if honest conversations are limited to whispered chats around the water cooler.

Will truth help, or hinder?

From a practical angle, some argue that truth is overrated, or even dangerous. 

They point out China is hardly the paragon of truth, and that hasn’t stopped its remarkable economic progress. While whataboutism of this kind is hardly useful, perhaps when we are on our way to becoming a manufacturing and technology powerhouse like China, we can afford to follow their approach to truth. 

Similarly, some argue that we cannot handle the truth. What would happen if we were to reveal a large additional GNPA and fiscal deficit? Wouldn’t viable businesses suddenly find their funding tap closed? Wouldn’t there be a violent reaction from rating agencies, investors and financial markets? 

My counter is that acknowledgment of the truth would push us to take the right steps at the right time, and help us achieve our true economic potential. None of the issues we face are unresolvable. But by playing the ostrich, we are refusing to see the solutions that stare us in the face – and inordinate delay can risk converting our demographic dividend into a curse.

At any rate, I cannot imagine that our country needs any dilution of the truth to sustain or survive. 

Truth shall show us the way

The true fiscal and monetary math will tell us that we are already in the midst of an large print and spend stimulus. While the context currently allows for such a stimulus, we have to assume that as a young, poor, emerging market, this party cannot last forever. We have to dramatically increase our growth and increase tax revenues.

A sustainable high growth needs large credit growth that feeds domestic employment rather than imports, and does not lead to a fresh cycle of GNPA.

Credit growth and fresh investments cannot be achieved merely by exhorting bankers to lend and corporates to invest.  Indeed, our financial services ecosystem is currently in no shape to foster the kind of credit growth that we need. 

First, given the true extent of our GNPA stock, we likely need a one time solution – perhaps a bad bank along the lines of Malaysia’s Danaharta, perhaps a TARP – to isolate the GNPA, and to free up the rest of the ecosystem to focus on normal commercial lending.

Of course, bad asset resolution will then need addressing the core issues that beset many troubled sectors of the economy, such as real estate, construction, power, airline and shipping, and telecommunications. The solution blueprints are all available, awaiting intent and execution. 

Second, there is the need for Public Sector Banking (PSB) reforms. While all types of banks have faced serious governance issues, the extent of GNPA is far higher in PSBs. Across allegations of telephone banking a decade ago, and the fears of GNPA in MSME and Mudra loans now, the fingerprint of New Delhi on PSB lending quality is unmistakeable. PSBs need to be ultimately run by accountable, motivated and professional career bankers – not by babus and netas, and not under the fear of CVC, CAG and CBI. The recommendations of the P J Nayak committee need to be implemented in this regard.

To ensure that credit growth fosters employment rather than imports, there is a need for serious improvement in on-the-ground ease of doing business, across land laws, labor laws, contract enforceability, and policy consistency. Make in India and Make for India have to become a reality. 

Even as we experiment with the snake oil of fiscal and monetary stimulus, truth could show us that there is little alternative to undertaking these difficult boil-the-ocean reforms to achieving our true economic potential.