Falling, not rising, cronyism is the main cause of non-performing assets
Former RBI chief Raghuram Rajan has dissected the banking crisis in his recent analysis of non-performing assets (NPAs). He implies that cronyism is an important cause. I would say the anti-corruption activism of NGOs, the Comptroller and Auditor General (CAG) and courts — all aimed at reducing cronyism — has played a major role too.
Rajan says one reason for NPAs was over-optimism after the initial success of public-private partnerships (PPPs) in infrastructure during 2006-08, leading to explosive expansion without due diligence. Second, slower GDP growth after 2008 meant that traffic and industrial demand were far less than projected. This was exacerbated by delays in land acquisition, and non-availability of gas and coal for power plants.
Pros and Conspiracies
Third, promoters and banks conspired to hide the rise of NPAs, evergreening loans. Fourth, malfeasance and inflated cost projection by promoters proliferated, to skim off the excess. Fifth, fraud and diversion of funds were unchecked by banks and RBI, which lacked the capacity to monitor projects and diversion. Thus, says Rajan, did bankers, promoters and circumstances create massive NPAs.
Agreed. But there was much more. Pronab Sen argues (‘What Ails the Indian Banking Sector’, Mint, goo.gl/ xX3zx7) that banks should not have been forced to get into project finance at all, let alone on a grand scale. They grew for decades through working capital and retail lending. They had no ability to judge project costs or risks. But they jumped in, often on political orders or pressures.
Sen thinks that, ideally, the bond market should finance all or most infrastructure. This has advantages, but the bond market is far too small for this. Besides, bond buyers — mutual funds, pension funds, insurance companies — will be decimated if bond defaults are as common as bank NPAs, and the human and economic impact may be just as bad.
Rajan says he sent a list of prominent bank fraud cases to the PMO, but heard nothing more about it. This has led to accusations that cronyism has been the root cause of record NPAs. That is simply wrong.
Before 1991, in the licence-permit raj, every clearance, permit and licence was a favour. There was nothing but cronyism. Quasi-monopolies spread across the economy, since free competition was forbidden.
Economic reform after 1991deregulated large parts of the economy, creating competition that destroyed old crony quasi-monopolies. In most areas, cronyism disappeared. But in some areas — minerals, energy, infrastructure and government contracts — clearances remained controlled by politicians, and outcomes depended on political discretion and bribes. After 1991, politicians gave up kickbacks in liberalised sectors, but more than made up from the remaining controlled sectors. Record sums were spent by politicians on elections. (Gopinath Munde confessed to spending ₹8 crore in the 2009 elections.) Public anger against corruption skyrocketed after 2011, fuelling the Anna Hazare agitation. This was buttressed by CAG and Supreme Court activism. An outraged Supreme Court cancelled spectrum and coal-block allocations, decreeing fresh auctions. The court also closed several iron ore mines to curb illegal mining.
Winning Bids, Losing Bets
Checking corruption was surely necessary. Yet, let it be acknowledged that court activism massively expanded NPAs. Many steel and thermal power plants that lost their coal and iron ore mines went deep into the red. The telecom sector was savaged by the cancellation of spectrum licences, and by the resale of cancelled spectrum at very high prices. The ‘winner’s curse’ meant auctions were won at inflated prices by the most overt-optimistic bidders, creating potential NPAs even before the bids were opened.
These problems were magnified by the ending of the old culture of the licence-permit raj, in which success flowed from grabbing any and every licence available, no matter how bad economic conditions were, and then manipulating politicians for policy changes to make bleeding projects profitable. Dhirubhai Ambani was the master of such manipulation. But others were not far behind. To avoid job and production losses, policy changes could sometimes be arranged even without bribes.
That old culture continued till the 2000s. Out of Andhra came the ‘Andhrapreneurs’, contractors from the state’s irrigation works. These were new names at the national level: GVK, GMR, Lanco, IVRCL, Nagarjuna. They won enormous infrastructure contracts by bidding aggressively. But many ran into problems of land acquisition, non-availability of fuels and exaggerated demand forecasts.
They expected that, as in the past, they would be rescued by policy and contract changes. But after the activism of Hazare, CAG and Supreme Court, such manipulation became impossible. The result was an explosive growth of NPAs.
To be sure, there was also plain crookery in some failed projects, with promoters diverting funds after inflating project costs. But such crookery was common during the licence-permit raj too. The big difference after 2012 was that failed projects could not easily be revived by changing contract conditions.
There is no silver bullet for NPAs. Banks must take haircuts and be recapitalised. Bust companies must be sold at a discount or liquidated under the Insolvency and Bankruptcy Code (IBC). Political discretion in allocations must be curbed. The auctioning of not only spectrum and coal, but all minerals, is now reducing cronyism. But the unfinished agenda remains large.