Push For Credit-Fuelled Growth Led To U-Turn On Banking Clean-Up: Viral Acharya
The Bharatiya Janata Party-led government promised a cleaner, more independent banking sector when it first took over. From an intent to end ‘phone banking’ to ‘gyan sangams’ organised to generate ideas, for awhile it looked like the government was serious about a banking clean-up.
For awhile, it was. It went along with an asset quality review conducted by the Reserve Bank of India and pushed through with the Insolvency and Bankruptcy Code.
But the mood changed and the government started to push for relaxations in banking regulations. Viral Acharya, former deputy governor of the RBI, told BloombergQuint that the change in mood was because of a lack of fiscal space, which meant the government went after credit-driven growth.
Ultimately, they realised that what they wanted was what the previous governments wanted. They wanted banks to be lending left, right and centre. They wanted credit and liquidity taps to be opened up. I think the pressures became intense as horizons became short term around 2019, for reasons we can all understand. So I think there was a backtracking.Viral Acharya, Former RBI Deputy Governor
Acharya, who recently released a book titled ‘Quest For Restoring Financial Stability In India’, said that for the past few years, fiscal management went out of “whack” and accounting policies followed by the government were “appalling”, Acharya said.
The result was that there was no fiscal space left to support growth. “Our fisc has not left any room for counter cyclical expenditure.”
There can be growth ups and downs, due to your own mistakes or external shocks or shocks such as the one we are experiencing now. Nevertheless, if there is capacity in the fiscal balance sheet to take on meaningful expenditure, spend on infrastructure or health or education, you can create a movement towards long run growth. But when the capacity is not there, ultimately you want the banks to do the growth push.Viral Acharya, Former RBI Deputy Governor
The government’s desire to push growth via banks eventually led to pressure on the RBI to loosen regulations. This, together with a perceived disagreement on the amount of capital the RBI should hold on its balance sheet, are believed to have led to the abrupt exit for former RBI governor Urjit Patel. Acharya left a few months later before his term ended.
Acharya said all of these issues—pressures for regulatory forbearance, pressures to provide liquidity, lack of recognition of one-day default on bank loans, the push for short-term external debt and the pressure on the RBI’s balance sheet—are ultimately tied to the government trying to solve its fiscal problems by turning to the central bank for concessions.
A central bank’s horizon, given its mandates of protecting depositor interest, of external stability, of inflation stability, is very long term. The government’s objectives, unfortunately, can be very short term. When they come to a head, the central bank has to have the ability to say no. We did say no. I think we put up the right defense and resistance that we needed to put up otherwise we would have seen a repeat of the mistakes of the last decade, without having solved them in the first place.Viral Acharya, Former RBI Deputy Governor
Acharya said “exits are a form of voice” when one has to stand up for what one believes in. “I have no disappointments whatsoever. At some point, I had to take a call on what I thought I was capable of doing and my personal constraints....I would not do anything differently,” Acharya said responding to a question about his premature exit from the central bank.
Commenting on the current environment and the renewed calls for a one-time debt restructuring of stressed loans, Acharya said that he is not averse to debt restructuring per se, but this has to be properly accounted for on bank books.
If a loan is non performing, it is non-performing. And adequate provisioning has to be applied right away. To borrow a phrase from Dr. Urjit Patel’s book—the restructured standard account is an oxymoron. He’s absolutely right. If it is restructured, it is not a standard asset. And that needs to be recognised as such.Viral Acharya, Former RBI Deputy Governor
Fiscal Influence On Liquidity Policy
While the fiscal influence on banking regulations is most extreme, Acharya said that limited fiscal space also weighs on the RBI’s liquidity policy from time to time.
For instance, in recent months, the RBI has maintained large surplus liquidity, which some believe makes the policy repo rate ineffective.
With the system that the RBI currently has, the only way it can control the money market rates and the yield curve with the policy repo rate as the linchpin, is if the system is in a small deficit. If the RBI wants to maintain the system in a surplus, “then to restore monetary policy control, the MPC has to set the reverse repo rate,” Acharya said.
Since the outbreak of the Covid-19, the RBI has maintained large surplus liquidity and cut the reverse repo rate, while the MPC has voted on the policy repo rate.
We are now in this little bit here, little bit there kind of situation, where the effective money market rates are being controlled by a rate that is set outside the MPC. Institutionally, this violates the spirit of the inflation targeting framework, it violates the spirit of the MPC.Viral Acharya, Former RBI Deputy Governor
Acharya added steps like ‘operation twist’ and ‘long term repo operations’ are inspired by central banks of other countries. In deciding whether India should go down this route, Acharya said the RBI should consider a few questions.
According to Acharya, the reason developed countries went down the quantitative easing route is because they had hit the ‘zero lower bound’ on interest rates with very low inflation. India is no where close to that with the repo rate at 4% as inflation has been closer to the upper band of the MPC’s comfort zone.
So if the objective is to push growth, then you have to convince the MPC or that framework that we are happy to accept higher inflation and lower the interest rates. “If they are not doing that, then to bypass the MPC and manage the yield curve, at a minimum, it reflects inconsistency in my view,” Acharya said.
Time For Fiscal Reform
Acharya argued that it is time that India debate its fiscal frameworks and considered putting in place structures such as an independent fiscal council.
Such a framework should ensure transparency of accounts, of adherence to fiscal targets, ensuring that real disinvestments take place.
We need a genuine open debate on how to give confidence to external investors on debt sustainability to external investors so the government can undertake fiscal expenditures that are necessary to deal with the Covid-19 crisis.Viral Acharya, Former RBI Deputy Governor
Watch the full conversation below: