Exhibit A is the government’s decision to recapitalise banks which lend at lower rates to certain consumer sectors such as two-wheelers and durables. Business Standard reports (4 October) that this decision was taken "in principle" at a meeting between Finance Minister P Chidambaram and Reserve Bank Governor Raghuram Rajan.
R Jagannathan Firstpost.com It does not pay to have a middle class that is sore with the government at election-time. This is why the Finance Minister is trying all kinds of distortive approaches to revive consumer demand. Exhibit A is the government’s decision to recapitalise banks which lend at lower rates to certain consumer sectors such as two-wheelers and durables. Business Standard reports (4 October) that this decision was taken "in principle" at a meeting between Finance Minister P Chidambaram and Reserve Bank Governor Raghuram Rajan. It quotes Chidambaram as saying: "Lower interest rates will depend on the lending capacity of banks. Banks will decide on sectors where lower rates will boost demand. I will meet bankers soon." There are three assumptions being made here all terribly wrong. First, it is the government's job to decide which sectors must be given a fillip by enabling banks to lend to them at lower rates. Wrong. In fact, this is the surest way to build a bad loan portfolio . When rates are cheaper for some sectors, more borrowing will happen there�- and increase the potential for non-performing assets. Cheap loans to homes in the aftermath of Lehman enabled SBI to build a lot of dud loans. Does it make sense to ask consumers to borrow more to buy bikes and TV sets when they should be more worried about jobs and salaries -which is what is under threat in a slowing economy? It is not the government's job to tell banks where to lend and how much. Bankers can decide that for themselves based on their own assessments of creditworthiness. The RBI, in fact, went the other way less than a fortnight ago when it banned zero-interest consumer loans . What's the logic of banning what banks thought made sense and now enticing them to lend cheap to the same sector with promises of recapitalisation? Second, cheap interest rates are the best way to revive demand. Again, a flawed assumption. While cheaper money can indeed stimulate demand, the larger determinants of demand are economic conditions and consumer confidence. Consumers, in fact, are benefited more if companies cut prices to boost demand instead of offering cheaper loans. Ask yourself a simple question: would you prefer to pay less for a car with a smaller loan or pay more for the same car, priced higher, and financed with a larger loan? Third, it seems capitalising banks has no costs. The government glibly says that it will raise the Rs 14,000 crore capital set aside for banks to enable them to lend more. Let us be clear: capitalising banks is no different from borrowing from them. In a situation where there is a huge fiscal deficit, capital for banks will come only by raising the deficit further. And what is the fiscal deficit? The money government borrows. And who does the government borrow from? Banks. In short, recapitalising banks means borrowing money from them and returning the same and calling it share capital. So, when the government says it will capitalise banks if they lend cheap for mobikes, it is saying it will borrow more from banks to give it back to them as share capital which can then be used to expand subsidised lending to two-wheeler and TV buyers. How daft is this? Reducing interest rates artificially in this roundabout way means government is encouraging demand in some sectors at the cost of the others. Credit will be diverted to boost auto sales, while some other credit-starved sector -mostly small scale units that create jobs -will be charged more or not lent money at all. Does all this make sense? Should government be playing favourites with some sectors and starving the rest? Worse, should it be borrowing more to do this kind of artificial pump-priming? In an election year, the government is more eager to finance feel-good buying with cheaper loans instead of focusing on reviving growth the hard and sensible way: reforming regulations and improving the business climate. Giving dollops of cheap money to favoured sectors is the exact opposite of reform.
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