Former RBI Governor Raghuram Rajan has put out his full 17-page response to the Lok Sabha's Committee on Estimates which had issued him a letter seeking his inputs on the current Non-performing Asset (NPA) problem that is being faced by Indian banks and also, consequently, as the debate has turned, to the Indian economy.
Rajan, who had exited India's central bank in September 2016, had also had the RBI's action during his high-profile three-year term cited as having eventually led to the two-year slowdown in India's growth -- a period that also witnessed demonetisation and the implementation of GST. The specific argument, made by Niti Aayog Vice Chairman Rajiv Kumar was that mechanisms instituted during Rajan's term saw NPA's being earmarked at a large scale, ballooning from about Rs 4 lakh crore to almost Rs 10 lakh crore, thereby impacting banks who moved to rein in their outlay and NPA debtors who faced a squeeze in working capital, impacting ongoing projects. In his response, Raghuram Rajan has addressed the matter, at one point, explicitly.
"Think therefore of the NPA classification as an anaesthetic that allows the bank to perform extensive necessary surgery to set the project back on its feet. If the bank wants to pretend that everything is all right with the loan, it can only apply band-aids – for any more drastic action would require NPA classification."
"The RBI has been accused of slowing the economy by forcing NPA recognition. I actually gave a speech in July 2016 on this issue before I demitted office, knowing it was only a matter of time before vested interests who wanted to torpedo the clean-up started attacking the RBI on the growth issue."
"Simply eye-balling the evidence suggests the claim is ludicrous, and made by people who have not done their homework."
At this point, Rajan produces credit growth charts (reproduced with the full note below) of private banks vs public sector banks with respect to non-food credit growth, industry, MSMEs, Agriculture, Personal loans and housing, from which he concludes:
"What we see here is a slowdown in lending by public sector banks vis a vis private sector banks"
"The reality is that public sector banks slowed lending to the sectors where they were seeing large NPAs but not in sectors where NPAs were low"
"The fact that the public sector bank credit slowdown to industry dates from early 2014 suggests that the bank cleanup, which started in earnest in the second half of fiscal year 2015, was not the cause"
"Indeed, the slowdown is best attributed to over-burdened public sector bank balance sheets and growing risk aversion in public sector bankers. Their aversion to increasing their activity can be seen in the rapid slowdown of their deposit growth also, relative to private sector banks. After all, why would public sector banks raise deposits aggressively if they are unwilling to lend?"
His final assessment is that this is 'classic behaviour' and he also presents a solution, which he pointedly says isn't a "foreign solution", likely in reference to a certain allegation made against him:
"In sum, the Indian evidence, supported by the experiences from other parts of the world such as Europe and Japan, suggests that what we were seeing was classic behavior by a banking system with balance sheet problems. We were able to identify the effects because parts of our banking system – the private banks -- did not suffer as much from such problems. The obvious remedy to anyone with an open mind would be to tackle the source of the problem – to clean the balance sheets of public sector banks, a remedy that has worked well in other countries where it has been implemented. This is not a “foreign” solution, it is an economically sensible solution. It is something that has been repeatedly flagged by the government’s own Economic Survey, under the guidance of the respected Dr. Arvind Subramanian. Clean up was part of the solution, not the problem."