Cost of Funds Not Binding Constraint
Resolving the bad loan problem is priority
The markets yawned and shed a few points on the day the Monetary Policy Committee (MPC) announced a 25-basis-point reduction in the central bank’s policy rate to 6%. The markets had already priced in the development; further, State Bank of India had lowered its savings bank interest rate by 50 basis points the previous day. Too much money with the banks is chasing too little demand for credit and bank lending rates would have been in free fall, had it not been for the bad loan problem that hobbles them. The primary constraint on the flow of credit is not the cost of borrowing but the twin balance-sheet problem, the non-performing assets of the banking system and their counterpart, the unserviceable loans of large companies. Policy energy must be spent on tackling the bad loan problem, more than on anything else.
In its assessment of real activity, the MPC noted that while the outlook for agriculture appears robust, underlying growth impulses in industry and services are weakening, given corporate deleveraging and the retrenchment of investment demand, says the RBI press release. This is the real problem, not the cost of money. The challenge is to address it. Investment as a proportion of GDP at current prices is down to 27.9%,10 percentage points below the peak achieved before the financial crisis. Big projects in infrastructure is the only way to boost investment. The central government is doing its best to step up public investment. State governments, in contrast, are cutting back on capital formation, preferring, instead, to use their fiscal capacity to waive farm loans and take on the debt of state power utilities that do not recover from consumers the cost of the power supplied. The MPC frets that enhanced allowances recommended by the 7th Pay Commission would further eat up fiscal resources and create excess demand, feeding inflation.
Resolute action to resolve the bad debt problem of the banks and to recapitalise them is the first step to reviving growth. Preparing viable infrastructure projects and finding agencies to implement them is the next.