It was just a coincidence that the day the former Reserve Bank Governor, Raghuram Rajan, sent his report to the parliamentary committee of the Bharatiya Janata Party on mounting bad bank loans and slow growth, it happened to be the tenth anniversary of the Lehmann Brothers bankruptcy that has been described as the first financial crisis of this century.
In his report to the panel headed by BJP leader Murli Manohar Joshi, Rajan said over optimistic bankers, government foot-dragging and slow growth were factors behind these mounting bad loans. He pointed out that the size of frauds in the public sector banking system had been increasing, though still small compared to the overall volume of Non-Performing Assets (NPAs).
He said the RBI had set up ‘a fraud monitoring cell’ when he was Governor to coordinate the early reporting of fraud cases to the investigative agencies and he had sent a list of high profile cases to the PMO urging that ‘we coordinate action to bring in at least one or two to book. I am not aware of progress on this front.’
Unfortunately, he said, the system had been ‘singularly ineffective in bringing even a single high profile fraudster to book.’ In his letter Rajan explained in great detail the NPA crisis in the country and prescribed a closer examination of Mudra loans and Kisan Credit Cards to prevent a similar crisis in the future.
A larger number of bad loans originated in the period 2006-2008, said Rajan, when economic growth was strong and previous infrastructure projects such as power plants had been completed on time and within budget. ‘It is at such times that banks make mistakes. They extrapolate past growth and performance to the future. So, they are willing to accept higher leverage in projects, and less promoter equity. Indeed sometimes banks sign up to lend based on project reports by the promoter's investment bank without doing their due diligence work.’
This is the historic phenomenon of irrational exuberance, common across countries at such a phase, said Rajan, who was RBI governor for three years till September 2016. However he could not absolve himself by merely identifying and passing on the problem of hidden toxic liabilities to the PMO, instead of having initiated the process by asking banks to take action and thereby compel the PMO to take coordinated action. By this he could have brought at least a couple of Vijay Mallyas, Nirav Modis or Mehul Choksis to book. Both the RBI and its Governor certainly enjoy considerable autonomy to withstand any undue political pressure against bringing culprits to book.
Rajan's report also suggests, as prevention, ‘Improve governance of public sector banks and distance them from the government. A variety of governance problems such as the suspect allocation of coal mines coupled with the fear of investigation slowed down government decision-making in Delhi, both in the UPA and the subsequent NDA governments.’
Project cost overruns escalated for stalled projects and they became increasingly unable to service debt, he said. ‘The continuing travails of the stranded power plants, even though India is short of power, suggests government decision-making has not picked up sufficient pace to date,’ he pointed out.
The economist who had warned of a financial crisis in 2005 before it hit, is now cautioning that trade wars combined with a build-up in leverage and high asset prices could result in a toxic mix that would be a drag on global growth.
‘We are all very well aware that two things have built up before the previous crisis, leverage and asset prices. Trade is an issue for the world to be concerned about. It is extremely important that we have good outcomes there. By all means negotiate, but don’t pull the nuclear trigger there,’ he said.
The financial crisis that began in the summer of 2007 with the collapse of the US subprime mortgage market and the September 2008 bankruptcy of Lehman Brothers could be regarded as this century’s first crisis of globalized patrimonial capitalism that Rajan had predicted with prescience when everybody else scoffed at it.
The reverberations of it are still being felt across the world as when the US and China returned to the negotiating table after more than two months in 2018 and lack of progress after two days of talks renewed the threat of escalation in the trade war, when the US stock prices hit a new high and the emerging market gauges fell, with the Shanghai Stock Exchange Composite Index dropping by about 17% .
Turkey and Argentina also experienced asset rout, though Rajan says ‘my sense is that it is not a systemic issue yet among emerging markets.’ Tariffs on China, however, have potential ripple effects for other emerging market nations, many of whom are dependent on it for trade and export directly or indirectly.
Emerging countries like India and Brazil heading for elections should focus on maintaining macroeconomic stability, Rajan said. The rupee’s recent fall isn’t too worrying, and is attributable in part to overall ‘dollar strength,’ though the currency hit an all-time low of 70.39 against the greenback in mid-August.
Exactly ten years earlier, the financial crisis affected many Asian countries like Thailand, South Korea, Indonesia, Singapore and the Philippines. These had posted the most impressive growth rates and the ‘Asian tiger economies’ saw their stock markets and currencies plummet to 70 per cent of their value.
That financial crisis, like many others before and after, began with a series of asset bubbles with the growth in the region’s export economies leading to high levels of foreign investment and soaring real estate values, bolder corporate spending and spectacular public infrastructure spending all by heavy bank borrowings.
This was also the time when Palaniappan Chidambaram presented his ‘dream budget’ when none expected bold fiscal reforms from a weak and minority United Front Government. But with daring and panache he introduced these measures to put the country on the world map. He lowered income tax rate for individuals, reduced customs duty and simplified excise duty structure. His argument was that lower tax rates would boost tax compliance and more people would pay corporate taxes. It was also the time he had quit the Congress and joined the Tamil Manila Congress which was part of the coalition government and he called himself the ‘Finance Minister of the genuine coalition government at the Centre.’ He also introduced the Voluntary Disclosure of Income Scheme that has been one of the most innovative of reforms.
When Chidambaram presented the budget in 1997 he was also fully aware of the political and economic uncertainties. Dr. Manmohan Singh, his predecessor, had presented a path-breaking budget of 1991, but that government had been voted out of power in 1996 as these reforms were increasingly perceived as anti-poor. The ‘genuine coalition government’ he described was an alliance of 13 parties with a relatively unknown Karnataka leader HD Deve Gowda, as prime minister.
Though India’s GDP was consistently above 5 percent, it paled in comparison to the buoyancy of many smaller South East Asian countries. The corporate world was lobbying for more growth enablers, including rationalised taxes. However, by the time Chidambaram finished his Budget speech, the Sensex had risen by 6.5 percent, a vindication second only to Dr.Singh’s 1991 Budget. One of the biggest long-term impacts of the ‘Dream Budget’ has been on income tax collections, which grew from Rs. 18,700 crore in 1997 to over Rs. 2 lakh crore in 2013.
However, these crises and bubbles had been in the coming for some time now. Beginning with the stagflation of the 1970s that exposed the limits of Keynesian economics and the end of the euphoria of the World War II victory and sense of fulfilment, the discontent led to the duo of Ronald Reagan and Margaret Thatcher explaining that ‘the government was the problem and not the solution’. The fall of the Soviet Union and the failure of that experiment left capitalism without an enemy and thus began the new era that was variously called ‘the end of history’ and ‘new economy’ This was based on permanent stock market euphoria. That was also the end of ‘the twenty five glorious years from 1945 to 1970’ that also coincided with the Nehru era.
This was the time when West European households’ financial and real estate wealth reached 9.5 billion pounds. This was the era when the wealthy in the rich countries did very well while production and incomes grew very slowly. In these post-war years they believed they were going to a new stage of capitalism, a kind of capitalism without capital. When the Infosys founder says that agriculture is nonviable and that the service sector is the one with the future and that the country should be urbanised, he has no clue to what is the ground reality. The new world he envisaged is the one, for the first time in history that managed to create a currency without a state and a central bank without a government.
The basic error was to imagine that we could have a currency without a state, a central bank without a government, and a common monetary policy without a common fiscal policy. These were the kind of policies that were followed that helped the rich grow richer with the help of the intra-European trade transfer of their neighbours’ tax base that has nothing to do with free markets. It was just theft.The ones who suffered were the poor countries like Greece for no fault of theirs, because in financial matters the biggest players are often better informed and get rid of their toxic investments in time. Even the loftiest of measures have this angle. The abolition of slavery in Britain in 1833, for instance, led to the passing of generous compensation packages to slave owners.
The alternative that was prescribed in the socialist bloc included Chinese-style capital control, Russian style authoritarian oligarchy and perpetual demographic growth. Thus each regional block had its solution.
It is here that the role of the International Monetary Fund becomes relevant. For decades the IMF had done everything possible to undermine the very principle of progressive taxation and wherever it had intervened, it had favoured taxes on consumption or even a flat tax and a tax with the same rate on all incomes. And everywhere it had explained that levying higher rates to the higher brackets was harmful for the growth and should be abandoned. Understandably the IMF executives who drew hefty tax-free emoluments have always been glued to this ideology. The severance pay row that the two honchos of India’s biggest companies, Infosys and Tatas had been engaged is a stark reminder of where their priorities lay.
One of the effects of globalisation is the shift, the macro-economic paradigm that has predominated from the1970s to 2008, of which three features can be distinguished, a) its American-ness and their policies that are described as international, b) the enemies like the social democrats and post-war settlement and state socialism, and c) the success of neoliberalism. The outcome has been expropriation of existing structures and goods, privatisation of utilities, de-unionisation of labour, means testing of universal benefits, and freeing of tariffs and controls. The positive side has been less spectacular, the World Trade Organisation and shadow banking.
Since the 1990s the liberalised American economy with the Treasury- Wall Street as its heart has been the paradigm for the world. The American destination for most of the primary commodities ensured that the chain of price deflations, stock liquidations and bankruptcies would assume global proportions.
There were other factors as well. The feminisation of the labour force in the West in the 1970s was part of the service sector expansion. That also brought about a lowering of wages. This service sector expansion that Narayanamurthy extolled broke up traditional households of working class communities and generations of crafts and farming practises. These threw millions of people into wage labour and that was not a great leap from living on subsistence labour and close society cohesion. The total decimation of the rich variety of subsistence farming to the vastly higher productivity of the agri-business was hastened by the wizards of the IMF. From the close-knit communities to the factories was no great leap.
Just as the full recovery from the Depression of 1929 came with the rearmament for World War II which led to a boom in the US, the breakthroughs now would shape the future, like the plastics, cathode-ray tube. These seem to be heading for the slowdown due to greying societies,shift towards low-productivity service economies. Containerisation and post-Ford production and supply chains are bound not to show up statistically. The alternative is a China-centred phase of accumulation that is merely a broader dissemination of existing plants. This decade might be the ‘end of the line’ or growth based on accounting balances, asset bubbles and debt creation. The brave new world seems to drift toward a ‘stationary state.’ Synthetic silicon breakthroughs and green-gold de salinisation transforming rising oceans into sweet water irrigation supplies are some other options. For the millions trapped in chawls of Mumbai or favelas of Rio with no sewerage and no jobs this is going to be a bleak world. Rajan might have found an answer to the bad loans that banks have accumulated and their impact on the Indian economy and Chidambaram night have presented one dream budget, but the rot is much deeper and it needs some other innovative way of handling it.