Puzzle solved

The Indian government has removed the last 20 items reserved for production in small-scale industries. It is hugely symbolic. Ends the policy game that was began fifty years ago that reserved big items for big companies and small items for small companies. Road to hell was paved with good intentions. Did not work. Link to the FT story on the end of small-scale reservations in India.

The government is also embarked on changing the very character of Indian banking. It is another 50-year relic. The moves are interesting and exciting. The ‘Business Standard’ has a story on the changing face of Indian banking, with the government refusing to capitalise inefficient public sector banks. The article starts by praising only the governor of the Reserve Bank of India for the changing face of Indian banking. That is a usual Indian failing. The RBI Governor himself has gone on record saying that none of the policy decisions of the RBI is taken without prior consultation with the government. Second, one cannot change the face of Indian banking without the government agreeing to it since it is dominated by public sector banks with the government as the largest stakeholder. The article makes partial amends later:

The recent decision of the government to capitalise public sector banks based on their efficiency could go a long way in ending the muscle power that the state-run banks enjoy, if the government sticks to the strategy of selective infusion of capital. Weaker banks’ survival would be in question as their ability to raise capital from the market would be limited because of mounting non-performing loans. For diluting their owner’s stake by tapping equity markets, these banks need the government’s approval, and the latter is in no mood to oblige due to poor valuations.

Data compiled by the finance ministry show public sector banks’ combined market capitalisation is only 36 per cent of the banking sector’s total market cap even though they control 77 per cent of the loan market while their average price-to-book value (P/BV) is 0.67. In contrast, private sector lenders’ market cap is 74 per cent with average P/BV at 2.35.

Good friend Neelkanth Mishra of Credit Suisse says that the government has spent thousands of crores every year on bank capital and they make loans to connected individuals and enterprises. This government has put an end to all that. It is a huge step and it is grossly under-appreciated.

In fact, in an interesting note sent to clients, he shows that the gross bond issuance is now 70% of the net new loan issued by banks in 2015.  Bond issuance has picked up since the introduction of the bank base rate in 2011. This is a huge development and again, it has flown largely under the radar.

Now, it makes sense as to why the Reserve Bank of India and the Government of India might be playing a ‘bad cop and good cop’ routine on bank lending rates. The more bank lending rates remain sticky at high levels, the better it is for the diversion of borrowing to the bond market. Bank share of new lending will slowly erode. Hence, I have concluded this morning that the so-called disagreement between RBI and the Government of India on interest rates is one for the optics.

The government is doing quite a few things quietly and hence many are not grasping it, leading to the widespread impression that the government has been slow on reforms. It is taking on many legacy issues left over by previous Congress regimes from more than five decades ago. They are not easy. Hence, the government is going about them slowly and silently. For instance, starving public sector banks of capital is one thing but it does not address the huge staffing that these banks carry. Of course, quite a significant chunk of it would come down through natural attrition and crossover as many employees find placement in the new banks that will be coming up, once licenses are handed over.

Given these subtle manoeuvres, it is hardly surprising that many are still unable to piece together the government’s game plan. There are honourable exceptions, however. Read the piece by Raghav Bahl here and another by Vivek Dehijia in MINT here. My piece in ‘Manushi’ is here.

Now, if the government can get the Land Acquisition Ordinance through and repeal a whole bunch of outdated laws. That would be quite impressive. Then, let us see how they tackle the behemoth of Indian Railways. Shankkar Aiyar has done an admirable job of summarising the recommendations of the Bibek Debroy Committee report here. All of these would be huge achievements.

Undoing the mess left behind by Congress-run governments since 1947 and particularly that of the UPA over the last ten years is never going to be easy. But, this government is gamely taking the issues head on and in quite interesting ways too. All strength to them.

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