‘The idea of bad bank has merit’

Chief Economic Advisor Krishnamurthy Subramanian said the idea of ‘bad bank’ has some merit. His statement assumes significance as there is a possibility of an announcement on these lines in the Budget.

“The idea of bad bank has merit. The design of the bad bank must also be carefully done. If it is in the private sector, it can be more efficient because restructured asset, which bad bank deals with, requires quick decision-making. This does not happen very well in the public sector. So, designing in the private sector is something useful,” he said, while talking to a select group of journalists, a day after the Economic Survey was tabled in Parliament.

Rising NPAs

The idea of a bad bank is to buy bad loans and other illiquid holdings of another financial institution.

The entity holding significant non-performing assets will sell these holdings to the bad bank at market price. By transferring such assets, the original institution can clear its balance sheet, although it will still be forced to take write-downs.

RBI report

The idea of a bad bank gathered momentum after the RBI, in latest Financial Stability Report, said macro stress tests incorporating the first advance estimates of GDP for 2020-21 indicate that the GNPA ratio of all scheduled commercial banks may increase from 7.5 per cent in September 2020 to 13.5 per cent by September 2021 under the baseline scenario.

“The ratio may escalate to 14.8 per cent under a severe stress scenario. This highlights the need for proactive building up of adequate capital to withstand possible asset quality deterioration,” it said.

Governor’s stance

Another strong indication on the bad bank came from the RBI Governor Shaktikanta Das’ remarks; he said if there’s a proposal to set up a bad bank, the RBI will look at it.

“We have regulatory guidelines for asset reconstruction companies,” Das had said. When asked what would be the right time to consolidate fiscal expansion, the Chief Economic Advisor said it would be after two years.

Effects of reforms

“For India, the potential growth rate is between 6.5 and 7.5 per cent. So, by FY23, many of the effects of reforms, supply-side reforms, especially, and measures taken on the demand side, should start giving results and the growth in the coming year will lift a lot of firms. So, by FY23, we should be back to pre-Covid growth path. So, that might actually be the right time to start consolidation,” he said.

Fiscal expansion

The Economic Survey has pitched for fiscal expansion to continue till the pre-Covid growth path is achieved. This indicates that India will go for higher fiscal deficit in the upcoming Budget.

Subramanian doesn’t think fiscal expansion will lead to higher inflation as was seen during the 2008 global financial crisis when the government focussed more on expenditure. “When you do fiscal spending, it actually affects demand and not supply. When demand comes back, if supply has not responded, you will have an inflationary phenomenon,” he said, while adding that the present phase of reforms focusses on both demand and supply. “Anticipating when demand comes back, supply also needs to respond, which is what we've done. I actually do reckon that given the supply-side response that the reforms will bring in, there should be no worry, because we've taken that into account and have actually taken measures for the supply side,” he said.

‘Lot of liquidity’

Commenting on the recent bull run in the stock market, Subramanian said there is a lot of liquidity that is actually looking for returns which is, in turn, increasing the valuation. Now, this may not sustain for a decade. The situation is likely to unwind slowly, maybe around FY24 or so,” he said.