Prodromal signals do provoke deep thought

12th Jun 2016, ECONOMIC TIMES

By R Gopalakrishnan Financial crises of nations and companies produce prodromal signals, which means advance warnings. The challenge is around how you interpret and respond to those prodromal signals.

12th Jun 2016, ECONOMIC TIMES

By R Gopalakrishnan

Financial crises of nations and companies produce prodromal signals, which means advance warnings. The challenge is around how you interpret and respond to those prodromal signals. If you worry a lot, you are thought to be an alarmist. If you are blasé, you are thought to be not quite a thinking citizen. To think deeply and to act sensibly in the face of prodromal signals, leaders have to act with enough despatch with a sense of positive stress but not with overpowering neurosis. Trust is an important currency in responding to prodromal signals and leaders must earn the trust of their people.

In the business and financial environment around us, we sense multiple prodromal signals. The negative signals arise, no doubt, from the cumulative effect of several decades; some signals are deeply disturbing, but could things deteriorate rapidly? Even if they can, it is not easy to admit it and respond in panic. Without doubt the government is facing up to realities in a measured and thoughtful manner, but is there enough trust, collaboration and urgency? These are vexing questions.

I understand economic and financial matters only as an experienced generalist. I am intrigued by the plethora and texture of bewildering statements about the banking and financial sector. What are these signals?

  1. In the lifting tide of 2003-2009, Indian real estate valuations and the business of lending both ballooned. Expansion of lending was predicated on an expected scintillating growth rate. Subsequent events have been mellow. As a result, gross NPAs of listed banks are reported to have doubled within the last one year exacerbated by the belated recognition of bad loans by the banks. India’s NPAs are now 11% of GDP, amounting to USD 170 billion. Economist Dr Haseeb Drabu, now Finance Minister of J&K, in his recent budget speech, went so far as to use the C-word in his speech, “I have corrected the budget numbers because otherwise, the State finances could head into a crisis” (italics are mine).
  2. Nature demonstrates that animals with fangs do periodically bare them. Other animals should know about the fangs, or else of what use are they? Through the Kingfisher episode, our PSBs demonstrated that they do have fangs. Here I don’t comment on the merits or facts of the Kingfisher case but, for sure, the PSBs went after the bloke, showing that, given the right circumstances, they can bare their fangs. Why don’t they professionally bare their fangs when their business requires them to? Why do they need someone to tell them to do so? The behaviour by
    PSB boards and management is a poor example of corporate governance–they want “protection from CAG/CBI”. Bankers may well need some assurance, but the issue is that the CBI/CAG etc have been so badly misused by successive governments that trust has been lost by even bank chairmen. Think about the common citizen.
  3. RBI Governor’s statements must be taken seriously. On one day, he warned the banks to face up to reality and to provide for their mounting NPAs. Soon after he advised banks not to become excessively risk-averse: lending should not slow down to the point of stifling growth. Shaken by these messages, one after the other, the banks made provisions in a ‘quarter horribilis’. In Q4 15-16, two thousand companies, excluding financial and oil sectors, showed a 20% growth in profits, but add in four hundred financial and oil companies, the profit growth is minus 20%! The “true and fair” financial status of PSBs is a national enigma; there is a more than a decent chance that muck lurks somewhere.
  4. Banking expert, KV Kamath, made what he probably intended as a calming speech; what I understood of his view is that this level of NPAs is part of a growing economy and should not cause alarm! His message produced butterflies in my stomach. I was bothered a bit like a daughter would be, by her elder’s remark that getting stressed about a recalcitrant, adolescent progeny is “unnecessary” because it is all part of growing up. The statement is partly true, but telling the parent not to stress is not helpful!
  5. MoS Jayant Sinha says, “We (the banks) have gone through governance and management reforms, we have gone through asset quality review, and now we are in the consolidation phase, to ensure that at the end of this phase, we have a set of competitive banks.” How long will this consolidation phase be, 3 years, 10 years? Chris Wood, the CLSA managing director, then writes a paper expressing his hope that by April 2017, the “PSBs will be recapitalised so that banks are cleaned.” How dirty are the banks anyway? Who can say how much is needed to sensibly recapitalise our PSBs? Those who make a reasoned estimate, as happened after the recent Union Budget, are
    immediately talked down.
  6. Critics quote the sore example of Air India, which reportedly has borrowings of Rs 30,000 crores from banks with no plausible way to repay. Why is no bank baring its fangs at Air India? Only because the nation stands behind it? Another example relates to the meandering, desultory journey of fertiliser subsidies through issuance of off-balance sheet bonds, inadequate budgetary provisioning and general pain to the industry and farmers.

In the next part of this two piece article, I propose to review the prodromal signals from the power sector.

In the first part published last week, I had reviewed the prodromal signals in the banking and financial sectors. In this second part, I write about the power sector.

In November last year, the Union Cabinet approved an imaginative UDAY scheme (Ujwal DISCOM Assurance Yojana) to resolve the electricity discoms mess. It has an operational improvement part, and a financial engineering part. All citizens must accept UDAY as a scheme worth the try, and they must pray to the Lord that sense will prevail among elected State governments. I have no quarrel with the UDAY scheme in this respect of pushing State discoms to improve operational efficiency.

The crisis in the power sector is the product of years of muddling and obfuscating by successive governments, both at the State and the Centre. To cut through the muddle, an important sine qua non is that the Centre has to find a way to work collaboratively with the States—as is true for agriculture, GST and many other next generation reforms. The fractious politics of State-Centre relations is not helpful in focussed and speedy correction of the lectricity situation. The absence of collaboration with the States is a definite risk factor.

The accounts of the three PPP electricity distribution companies (discoms) in Delhi reveal ‘regulatory assets’ of a staggering Rs 20,000 crores as of end of March 2016. Put simply, 10 million electricity users in Delhi owe the discoms Rs 20,000 per capita! The Delhi electricity consumers are unlikely to be even aware of their debt, or that they are paying interest on that debt. In the case of the Delhi discoms, the regulator has assured that the debt will be paid by consumers. On that basis, auditors have certified the accounts because anyway there is no way to confirm that the 10 million consumers will pay. This situation has arisen because of the nexus between the Delhi Government and regulator, who failed to award cost-reflective tariffs. The same picture exists in several States. Besides the staggering losses, the ‘regulatory assets’ in all discoms of the country is over Rs 75,000 Crores.

What is this electricity mess and how did we get there? The discoms are, for the large part, companies under the Companies Act. They are supposed to be governed and to behave similarly to any Private Sector Company (actually they should behave in an exemplary manner to set an example to private sector). For many decades, State governments gave away electricity freebies to secure political patronage, the discoms obediently picked up the bill on their balance sheet, and banks subserviently financed the discoms. As of March 2015, the aggregated accumulated losses of the discoms are, hold your breath, Rs 3.8 lakh crores and their outstanding debt is Rs 4.3 lakh crores, approximately USD 65 billion! This is apart from the ‘regulatory assets’ of another Rs 75,000 Crores, approximately USD 11 billion!

Who is responsible and accountable for this mess? The Centre says it is the States, politicians blame industrialists, and they all blame bureaucrats. Attempts were made at least twice in the last fifteen years to devise a remedial scheme; the schemes devised were good as schemes go, but the State governments were busy doing what Milton Friedman derisively termed, “spending other people’s money on other people.” The discom finances got worse because States were undisciplined.

It is also important to note that the politics of the Centre-State relationship becomes very important. UDAY assumes that States will behave better by improving their operations. Bengal and Tamilnadu have not yet signed up for UDAY. As I write, sitting in Tamilnadu, I face unscheduled power cuts four times a day, while the State government has declared that it has surplus power to export to other States! Further, right after the recent elections, the CM of Tamilnadu did the opposite of what UDAY demands—she decided to give free electricity to certain sections (as also waiver of farm loans by cooperative banks).

The official presentation makes no mention whatsoever of the consequences if the States fail to meet targets. What is Plan B for UDAY if the States don’t deliver as their past track record indicates? What are its financial implications since both State and Central deficits will be affected? Are we postponing facing the reality?

It is also a concern as to how the accounting is proposed to be done in UDAY, requiring these loans to be tucked away in the State’s finances, hidden without actually hiding them; they are behind the curtain, and if you know how to part the curtain, they are visible. Would it have been better to account for things as they are? If the facts show up in visible ratios like State/Centre fiscal deficit, all concerned might behave more responsibly. There is also an element of ever-greening the loans by passing the hat from PSBs to PSUs to give the optical effect of there being no NPA.

Imagine if a corporate group came up with such a bond scheme–let us call it CUSY standing for Company Udhaar Sadabahaar Yojana. In essence, the beleaguered company’s parent would issue bonds which are supposed to be bought back by the banks which have given the loans. Technically the answer would be ‘yes’ if the parent company had a solid balance sheet! But does it not stretch credibility?

Much of the financial engineering of UDAY is possible because of the national balance sheet, but is it a bit stretched? The government has a difficult problem to solve, and they are surely trying their best. However the prodromal signals of politics stretching the boundaries of economics and financial planning are deeply worrisome.

The issue may also be one of credibility of government, whether UPA 2 or NDA. Pratap Bhanu Mehta has averred that “the dominant government culture is to spin, so that even truths begin to get doubted.” While governments do have to showcase their achievements, beyond a level, the spin is so intense that the credibility of the government gets eroded. Hopefully we are not at that point with this government.