A worker moves a sheet of plywood onto a pile at a workshop in Muzaffarpur. (Photographer: Prashanth Vishwanathan/Bloomberg)

SMEs Need Lower Rates, Support To Overcome Disruptions, Says Sanjeev Sanyal

Among the nearly dozen issues being debated between the government and the Reserve Bank of India is the issue of support to small and medium enterprises.

Following a meeting last week, the RBI’s central board advised the regulator to consider providing relief to SME borrowers. But where is that demand stemming from? The government’s Principal Economic Adviser Sanjeev Sanyal says that SMEs have faced the brunt of some of the structural changes in the economy and may now need some support. Apart from the near-term concerns, Sanyal said that the real rate of interest for SMEs remains too high.

Commenting on the discussions to put in place a new economic capital framework for the RBI’s balance sheet, Sanyal said that any transfers from the RBI’s reserves, if required, would be staggered over a period of time.

Watch the full conversation here:

Edited excerpts of the interview below:

The Twin Deficits

Oil has turned around in a big way. There is downside if these lower oil prices are emerging from global growth concerns, but, on balance, this is the best case scenario for India?

There is no doubt that oil prices coming down is good for India as we’re a big oil importing country and we remain dependant on imported oil. If, as per the earlier trajectory of crude oil prices, we were looking at a 2.8 percent of GDP as the current account deficit,  the current trajectory brings it closer to 2.2 percent of GDP for 2018-19. If these levels are maintained, we may get a number below 2 percent next year. We like cheaper oil. For every dollar reduction we save about $850-900 million over the course of the year. So, cheaper oil is good for us.

The focus has shifted to the fiscal deficit. The concern is that weaker-than-expected GST revenues and slow disinvestment could make the 3.3 percent fiscal deficit target tough to achieve...

With the exception of Air India, on the whole disinvestment has been strong, if you look at the fair amount of disinvestment we are doing in various forms. With the one exception of Air India, which I admit has not happened, on most other things, we are doing reasonably well.

Custom duties should be better as the rupee depreciated. We see direct taxes growing strongly. Even on GST, we should see things picking up.

So you don’t see the need to trim capital spending for the remainder of the year?

I don’t think there’s any such need. Capital spending of the government on infrastructure continues. A lot of major projects are getting completed. Those which are ongoing will not have funding problem at all.

We do expect capital expenditure to come back in many private sector areas where capacities that have been underutilised for a long time are now finally getting used up.

In fact, banking credit, which has been subdued for a long time, has picked up to over 14 percent year-on-year growth. So, we are seeing a revival in bank credit too.

Demand For Easier Banking Rules

With 14 percent bank credit growth, which is above nominal GDP growth, why this clamour from the government to ease restrictions on banks which are still weak? Shouldn’t the government permit that clean up to be completed?

This is something that the Financial Services secretary has also spoken of. We do need to have a plan of getting PCA (prompt corrective action) banks up and running again and expanding credit.

One is, the banks which are in a better position than they were and are in position to expand should be encouraged to lend as it is one of the ways in which they can grow out of their current situation. We are not saying that all caution should be thrown to the wind. But we do need to have a clear plan about exit from PCA.

Second, we are concerned that many of the NBFC (non-banking finance companies) will see much slower credit growth than in recent past. Also, SMEs (small and medium enterprises) continue to suffer from a credit crunch. We do need some part of the banking system to expand.

We are not saying that we should roll back and indiscriminately begin to take banks off the PCA. We are very much in favor of maintaining discipline. Now that we have spent couple of years cleaning the banks, we think that some of them should be allowed to take wing again.

So, you are not asking for relaxation in threshold levels? You are saying that banks which come to 6 percent net NPA should be allowed to exit PCA. But that would anyway be the plan.

We keep reviewing the situation. It is matter of judgement here. It is not just matter of applying mechanical rules. If it appears that some of the institutions are capable of coming out, then they should be allowed to. After all, we don’t want large parts of the banking system permanently under PCA. We need to have a exit plan.

With the RBI’s decision to defer the last tranche of the capital conservation buffer, government officials have said that Rs 3.6 lakh crore in fresh lending could be enabled. But a lot of these banks haven’t reached even the requirement of reduced capital conservation buffer. So, they still have to get to regulatory before lending capital gets freed up...

Those who have yet to reach the basic level will still need to reach that basic level. In certain cases where the government is doing re-capitalisation, we will continue to do it to enable the banks to reach regulatory requirements.

The question is whether you want to build the extra buffer during these times or should that be done later in different time when you have the space for creating these buffers. After all a buffer is that which you build out in good times so that you use it in not so good times. It’s supposed to be anti-cyclical and not pro-cyclical.

Is the government satisfied with the deferral of the capital conservation buffer or do you till want the total capital requirement to be reduced from 9 percent to 8 percent.

The statement which was put out after the RBI board meeting mentions what the position is and that remains the case.

NBFC Strains

What is your assessment of credit markets, refinancing and roll-overs that NBFCs are seeing?

There is no doubt that a few months ago the NBFCs were facing problems in the credit markets, roll-overs were tough and yields had spiked up in a few cases and this was a concern. But in last 10 days credit markets are functioning better and yields come back very substantially. Generally, yields have come off even for the sovereign and world-wide the tension has reduced on yields. You have seen the margins have come down too. You now have a credit market which is rolling over, but we watch it very carefully to ensure that it remains orderly.

Institutions which have financing needs are able to meet them as we go along. So, the issue now is more about the real economy impact of this episode. Even those institutions who are ready to roll over will be conserving capital and not lending. We need to ensure that credit requirements of the growing economy in this situation is now the thing we focus on.

Are you still arguing for easier liquidity?

More liquidity is required and how that is provided is the RBI’s prerogative. If you look at LAF (liquidity adjustment facility) and other indicators, liquidity remains tight. Even M3 (broad money supply) is growing at 10 percent and thereabouts. Although reserve money has grown somewhat faster, you will see the multiplier process is subdued. I will argue that liquidity in general remains tight, particularly for SMEs, real estate firms.

Given that inflation is not an issue, oil prices are coming off, food prices are coming down, non-core inflation has also come off very strongly, there is no real inflation in the system. There is a case for keeping liquidity easy.

Supporting The SME Sector

What are the relaxations the government is seeking for the SME sector? Is it forbearance for restructuring of SME loans, one-time settlement? And what is the problem on the SME side?

I am not in position to comment on what the discussion is with the RBI. As a general principle, there are various issues. The channels of credit to the SME sector, because of banking sector slowing down credit and now with the NBFC sector strains, is that there is channel issue.

An even more problematic fact is that the credit when it reaches is very expensive. In the last several years, you have seen structural inflation decline from 8-10 percent range to now 4 percent range, right now running even lower. When you have reduced structural inflation by 600-700 basis points then you have to think of what happened to the lending rates. On the other hand, SMEs are borrowing at 10-12 percent. If you are borrowing at 12 percent and pricing power is growing at 4 percent, then that is 800 bps real interest rate. So, we have to understand that 800 bps real interest rate is very expensive for anybody. This is the issue that, not just the central bank, but as a country we need to think about. The cost of capital does feed through not just to competitiveness of manufacturing but also to sustainability and stress of the system. Conventional economists only looks at the demand impact of interest rates whereas interest rates also have a supply side impact, risk impact on financial system. We need to think about these issues.

Making cheaper capital available where it’s needed for the SME sector is a critical thing which we need to think about. While this sector has paid the price for structural lowering of inflation rates, we need to give them support of carrying out the massive inflationary adjustment. We have to bring down interest rates to align with the new level of inflation. This is something which we need to take into account in the medium term.

In the shorter term, there is talk of forbearance on restructuring of SME loans. Is that advisable?

There are many things we need to do. There is a short-term issue about monetary policy and current institutions that exist. There is the larger issue of credit delivery to the sector. We need to get institutional support and make sure the credit reaches where it does at a price which is reasonable to the sector. We cannot have the same format that we had before. It is sector that did go through some disruption as a result of many changes that happened including introduction of GST and so on. Now, the time has come to support this sector and give the benefits of going through all this disruptions and change. So, the purpose is to lower inflation for everybody so that we can lower interest rates, too.

Broadly, are real rates too high given the way inflation has panned out?

Real interest rates are too high. For a country like us, whose inflation is below 4 percent, even the sovereign borrows at 400 bps in real terms. SMEs have to borrow at 800 bps. During the period of adjustment, you may have a period where inflation falls and interest rates don’t fall, but you cannot sustain it for long period of time. Over a period of time, you have to allow adjustment otherwise you will stress the system out. That is something which need to take into account.

Many economists take the first-round impact that higher interest rates bring down inflation, but we keep real interest rates high for very long period of time, you will end up having higher inflation. Remember, capital is an input to production. If you keep interest rates high, then it means that certain capacities are not getting created, infrastructure is not getting built. We have to think about the second order impact on the supply side in longer term. Especially, as we have done the painful bit of lowering inflation. We now need to think about whether or not we have to keep interest rates at these levels for long periods of time. Cyclically you have to nuanced it in order to keep inflation under check. Right now, inflation too is under check.

RBI’s Economic Capital Framework

Where do we go from here on the discussion on the economic capital framework of the RBI? How soon do we see the committee? Are past reserves still on table or is the government okay at looking future transfers only?

A new committee will look into the matter. It is matter of arriving at a set of rules which is reasonable for how much capital the central bank for a country like India needs to have and allow for rest of the seignorage to be passed on to the government, which is its right. We need to agree on a reasonable rule based way of going about this.

If the committee comes to a conclusion that a certain amount has to be transferred, or it is in excess, then we will have to have a trajectory over time to ensure that certain amounts of transfers are made. I would not presume to judge of what this committee will say. Let the committee being formed and come to an agreement.

Would that transfer only be possible from the contingency reserves? Because if you try and do it from the revaluation reserve, it can be disruptive...

It will not be disruptive and it will be done in a responsible way. If, for whatever reasons, some amounts are to be given, then it would be staggered over several years. I don’t know whether that situation will arise as I don’t know the formula is.

But theoretically is it possible to transfer from the revaluation reserves?

There is too much speculation. There is too much of a misinformed debate going on about it. It is about finding a rule-based approach to go about it. Whatever the rule is, if there is discrepancy on the current level and where it should be, it will be done through transfers on an ongoing basis. If there is a case of adjusting the stock, it is not something which will be done overnight. It will be done as a part of flow spaced over a period of time.

This is not something that I can presume to judge. There is a committee which will sit and look at it and arrive at something. Let’s not get ahead of ourselves.