At a time when the government is facing intense opposition to its farm laws, and when questions were being raised over whether its offer to keep the laws in abeyance for 18 months effectively meant backing off from other critical reforms, some of the financial sector proposals unveiled by Finance Minister Nirmala Sitharaman in the Union budget are bold. For one, Sitharaman has stated her intention to privatise two public sector banks — the first such mention in recent budget speeches. Second, she has proposed setting up a new structure to deal with the vexed issue of bad loans. And third, to help finance long gestation infrastructure projects, a new Development Financial Institution (DFI) will be set up. While the intent behind each of these initiatives is laudable — each is geared towards addressing specific concerns — much will depend upon how they are structured and executed.
Saying that a public sector bank will be privatised in the budget has more than a symbolic value. It is also an acknowledgement that the government simply does not have the resources to keep recapitalising public sector banks. The government may have to bring legislative amendments to go ahead. Accomplishing this, and then expanding the privatisation programme to other public sector banks will also require the government to expend political capital to convince the bank employee unions. Simultaneously, Sitharaman has proposed creating a framework — a bad bank of sorts — for tackling the issue of bad loans that is likely to escalate in the coming months. An asset reconstruction and management company will be set up to take over the bad loans of banks. While this will clear the banks’ balance sheets — the Reserve Bank of India (RBI) expects banks’ non-performing loans to rise to 13.5 per cent at the end of September 2021, up from 7.5 per cent in September 2020 — freeing them up to lend to the broader economy, several issues will need to be addressed: Who will fund the bad bank? At what prices will the transactions between the bad bank and the banks take place? Will the process be transparent? Doesn’t this simply absolve bankers of their past errors, while encouraging them to continue with the same lending practices?
Lastly, with the public sector bank-led model of infrastructure financing broken, Sitharaman has also proposed setting up a Development Financial Institution. The budget has allocated Rs 20,000 crore towards the new institution’s capital base, to enable it to lend Rs 5 lakh crore over the next three years. But this is not a new solution. India has experimented with DFIs before, and the experience has not been encouraging. DFIs like ICICI and IDBI were converted into universal banks. Scaling up may prove to be challenging, and political considerations may affect decisions. Falling back on the DFI model also signals an acknowledgement of the absence of a deep and vibrant bond market which could have facilitated long-term infrastructure financing.