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Size-based incentives should not stop companies from growing big, says CEA

We need to respect wealth creators but the wealth creation has to happen in the right way.

ET Now|
Updated: Aug 22, 2019, 10.38 AM IST
 Krishnamurthy Subramanian- CEA-1200
Whenever we keep size-based restrictions, the incentive should be for those that are young and are still finding their feet. But if you have someone who has basically been 40 years in business and yet continues to be very small, then maybe it is something to think about, says Krishnamurthy Subramanian, Chief Economic Adviser. The CEA and Ajay Kanwal, MD & CEO, Jana Small Finance Bank, were in conversation with Nikunj Dalmia of ETNOW at the Jana Small Finance Bank - Financial Inclusion Conclave. Excerpts:

Is growth the need of the hour?
Krishnamurthy Subramanian: There is absolutely no doubt in our minds that we really need to focus on growth. There has been a phase in the last five years when we have come out with some very important reforms including the bankruptcy code. There cannot be a credit culture in a country without a bankruptcy code. So, there has been a clean up because starting around 2008, till 2014, excessive leverage was built up which got reflected in the corporate balance sheets and found reflection in the banks’ balance sheets as well.

The ramp-up and some of the difficulties that were created at that time, happened over a seven, eight-year period and one cannot expect that the unwinding will happen in a jiffy. It is important for that process to continue. Again, in the Independence Day speech, the Prime Minister very clearly mentioned that wealth creation is very important.

Wealth creation is important. Think about an industrialist who actually has wealth, it is not as if that person is sticking the wealth in notes under his pillow. That person is employing that in the form of capital assets which are creating jobs and that is a perspective that should be kept in mind.

We clearly need to respect wealth creators but at the same time, the wealth creators also must understand that wealth creation has to happen in the right way and emphasising that is important. This is a process that we should wait for it to come to a logical conclusion.

As economists, we always say there are no benign options. The cleanup will have some difficulties in the short run, but let us acknowledge that in a world that is struggling to grow at even 2-2.5%, if we are able to put things in place even while growing a little lower, that is something very important and we should let that process continue.

In the process, we have to get rid of some of the habits that we may have gotten used to, not only as an individual but also for the economy, we need to move into more salutary habits and that is really critical. So, this is what I would emphasise on. Don’t have a crystal ball but I can have a reasonable guess that within six to eight months, this process may run its course and will actually have growth.

What is important is if these sort of checks and balances are not put in place, then you have to put your foot on the accelerator and then hit a speed bump and and then you have to really pull back. You really need to be f pushing the accelerator in a sustained manner. It is really important to fix these aspects. That is the way I would actually explain what we are going through. There is absolutely no reason for us to be pessimistic about it.

In order to be a $5-trillion economy, we need a vibrant financial sector. What role do you think PSU banks will play? How committed is the government to reform and recapitalise the entire PSU banking sector?
An important change happened from 2014 onwards which is that the commercial decisions that the banks basically had to make was left to them. Nowhere in the world do commercial banks go and lend to infrastructure and there are two very good reasons why that does not happen; one, it creates a huge asset liability mismatch. Second, the ability to judge a good infrastructure project. It is really a long gestation project that needs very specialised expertise and banks do not specialise in that.

While it may seem now as something that we take for granted, the fact is banks get to take commercial decisions on their own. We keep talking about how there is not enough transmission of the rate cuts. But that is the decision banks are making on their own. I think that is an important piece of reform that has happened.

Overall, whenever across the world, we look at any crisis -- be it the Asian financial crisis or the global financial crisis -- eventually when the verdict comes out, there is actually a huge element of governance in it. Even our own experience from 2008 onwards, the ramp-up in credit when quantity happened without the quality, also had to do with governance.

The emphasis on governance is very important in the context of public sector banks. But let me take a more big picture view and not just focus on the public sector banks. We do need more banks catering to the credit needs of the country. I think for instance many countries now you have actually there is talk about a Netflix model of banking. These are disruptions that are happening. Fintech is here and the emphasis on the use of technology is something that is really critical and needs to happen across the board. Our banks need to take that on board and run with it.

Is Direct Tax Code going to be one of the biggest hallmark reforms of the current administration?
Krishnamurthy Subramanian: Let me acknowledge that after submitting the report to the finance minister all of us who are members of the task force made a solemn promise to each other saying that till the report is being considered by the government, we are not going to be talking about it. I am someone who takes these things seriously and therefore I do not want to get calls from my colleagues saying you broke your promise.

But what I can tell you is that even though I joined this I was put into this taskforce just a couple of months back in mid June while the taskforce itself has been working for 21 months. Something that actually is the output of 21 months, needs to be at least given 21 days to be assimilated. I will say sabr ka fal meetha hota hai (It pays to wait).

Ajay, in your case you have been hitting the ground running. You have managed to turn an unknown brand into an unforgettable franchise. How are you dealing with down the pyramid borrowers? Hoe do you paint the current economic picture?
Ajay Kanwal: At that moment we are worried about work for the electrician or the plumber or the maid or the driver. In the segment that we work in, we see the same amount of requirement for credit. There is enough amount of entrepreneurship available and we do not see the pain or the pinch as yet. Where we can see a bit of stress is in the smaller micro enterprises and mainly in the metro cities. So, I am in the same camp which says that it is not as bad as you think but when it is a small problem, we tend to call it a crisis and when it is a crisis, we call it a Tsunami and we address it as such. So, the chance of something not getting addressed is minimalistic.

It is nice that we are really getting panicky about where we are because I think we will over address the issue and it will probably help as we go along. A good point that you made is vis-a-vis the credit culture. In the credit side of any banking, six Cs are important and one of the main Cs is character. Addressing the character of how the banking industry or consumers behave is a co-foundation of the future because you can only have problems for a few years but if you do not address it, it will be a downhill path forever. So, addressing credit culture is crucial.

Then there is the discussion around insolvency code and a fresh start. Why I bring this up is because last time when demonetisation happened, there was a discussion with the Reserve Bank saying for 90 days you do not have to classify it as NPAs. What happened is vested interest came in started collecting people and saying you do not have to pay.

My worry is we may not communicate this well. While we have done a lot on improving the credit culture this insolvency personal core with a fresh start may give the vested interest another chance of spoiling the character. So in the end, while we are trying to help, we may actually move backwards.

It will be nice to hear how you are thinking about f fresh start being important? It is crucial in many ways but how does it not stop or rather make it worse both for banking and of course for customers because in the end they will lose when the banks back out.

Krishnamurthy Subramanian: What you have highlighted is a very good point. It is a nuanced point. We economists use these two Latin terms; ex post and ex ante which is after the event versus before the event. These dynamic effects are the ones that are usually very difficult to communicate but it is really important as a policymaker to try and communicate this. So when once a borrower let us say A is in trouble to possibly make some exceptions is ex post, maybe good but what it does for the credit culture is basically the ex ante effect; that is something which is really important to keep in mind.

It creates dynamism for the credit culture. It is a very difficult question to answer. We looked at bankruptcy codes in 85 countries to see if they give a fresh start to the debtor or are do they give a lot of power to the creditor? We looked at it from the perspective of overall economic growth. An important takeaway for us was that if you make it too friendly towards the debtor, there can be an impact on the credit culture but at the same time, when the debtor gets to say okay I can fail and yet start again. That also enables risk taking, innovation and thereby economic growth and therefore there is basically a clear trade off here.

I will talk about one other margin effect that we must keep in mind. We wrote about that in the economic survey. It is important to recognise that when you say that if you are below a certain threshold, you get this benefit, it may create the perverse incentive for the firm to remain small to continue availing that benefit.

It is important to keep in mind that whenever we keep the size-based restrictions, the incentive should be based on those that are young and therefore are still finding their feet. But if you have someone who has basically been 40 years in business and yet continues to be very small, then maybe it is something to think about.

There is a very nice saying in Hindi; which means the skilful gardener is someone who looks at the leaves and can say this leaf is very, very thin and so this is the tree that is going to become big. Skill is something which is important as well. One should support the infants, nurturing them but not the dwarves and that is another aspect. One has to take into account all these three effects and then arrive at the policy.
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