Why Ruchir Sharma' s caution on an unbalanced banking system is unlikely to find any takers in the Modi govt

Ruchir Sharma, the head of emerging markets and the chief global strategist at Morgan Stanley Investment Management, is a man whose observations on economies and financial markets typically carry sufficient weight. Those observations compel the heads of nations to ponder over their approach to economic issues. That's because Sharma manages assets worth over $20 billion (figure as on March, 2016) across the world including in key emerging markets.

Sharma, speaking at the Rising India summit on Saturday, said that he wouldn't advise Indian Prime Minister Narendra Modi on how the economy can grow more. Sharma was quoted as saying, "I will not advise on anything regarding India. I love the country and want to come back,” Sharma said. Why wouldn't he do so? Sharma recalls a time when he was heavily criticised and asked to leave Russia after he made some observations on President Vladimir Putin’s approach to economic reforms. Apparently, learning from this, he wouldn't want to repeat the same mistake with India.

Ruchir Sharma's book 'The Rise and Fall of Nations' lays out 10 rules of change in the post-crisis world.

Sharma is referring to the not-so-covert tendencies of governments and pro-government media to reject even genuine constructive criticism and rubbish critics. The Narendra Modi government too has not been fond of criticism on its policies or on its approach to reforms, and has often hit back on even international rating agencies and multilateral agencies that were reluctant to acknowledge the government's work in a positive manner. Did this prompt Sharma to recollect the Russian episode at the summit on Saturday?

But the reluctant adviser in Sharma did push out an important piece of advise at the same session. He spoke about the imbalance in the Indian banking system. “Every country needs a public sector but no country is as unbalanced as India," said Sharma.

What Sharma highlights here is an old, but still prevalent, problem in the Indian economy-- a banking sector problematically dominated by government banks, which operate above a level-playing field, compared with private and foreign banks, because these state-run banks are backed by the Centre.

Many government banks, sans government ownership, would have shut shop long back. Some of them continue to stay afloat like a critically I'll patient surviving only on life support. Sharma summarises the problem well. "PSU banks hold 2/3rd of the assets, while private banks are involved in more transactions. This is choking the Indian banking sector. There is regulatory overkill in the Indian banking sector because private banks will keep lending, but central banks are still holding assets.”

What Sharma is implying here isn't difficult to understand: privatisation of PSBs and the transfer of ownership of a majority of all state-run banks to the private sector. This is perhaps the only idea left to be experimented to address the asset imbalance in the banking sector.

Interestingly, despite its stated pro-reform approach, privatisation has never figured on the Narendra Modi government’s priority list, despite the PM stating in the beginning that the government has no business to be in business. This, despite state-run banks proving time and again their inefficiency with respect to governance and asset recovery. Over 90 percent of the NPAs in the banking system are on the books of state-run banks. Particularly in the light of the Punjab National Bank fraud (PNB) and a series of fraud cases involving PSBs, it does make a lot of sense to give a serious rethink on privatisation, given that private sector banks have better record of being accountable to their shareholders. Recently, Adi Godrej pitched for the privatisation of PSU banks. "I don't think so many banks needed ( in the public sector). I think we are too big a public sector in our country and I think they should privatise it.” Godrej isn't the only one to have advocated PSU privatisation of late. There have been quite a few noted experts such as Uday Kotak, who have opined on similar lines.

In 2014, an expert panel under PJ Nayak recommended bringing down government holding in these banks below a controlling stake and letting private parties run these banks. But nothing much has happened so far, except for cosmetic reforms such as splitting chairman and CEO posts and bringing private sector CEOs.

In fact, the government doesn't need to privatise all banks. As PSU bankers such as SBI chairman Rajnish Kumar have pointed out, PSI banks have indeed played a significant role in spreading banking services to India's villages since nationalisation and hence these institutions deserves to have their own space in the country. But even then it doesn't make sense to have too many PSBs in an ambitious economy. The government can retain, perhaps, five to six PSBs and transfer the rest to the private sector. Right now, there are 21 of these banks post internal mergers in SBI group.

In the context of the Vijay Mallya-Kingfisher episode, the PNB fraud and several other cases of wrong credit decisions and careless approach, it is safe to say that PSBs have not acquired the efficiency to manage their own house despite post nationalisation. Like this writer argued in an earlier column, it doesn't make sense to put the entire banking system at risk to protect certain state-run banks.

But going by signals from the government so far, it is very unlikely that the Modi government will have a rethink on the PSB privatisation. The response from Union Finance Minister, Arun Jaitley, to a question on bank privatisation at the Economist India Summit in New Delhi in September, 2016, shows how this government thinks as far as radical, but unpopular economic reform steps. “I don't think that public or political opinion has converged to the point where we can think of privatisation in the banking sector," a Reuters report quoted Jaitley as saying.

Ruchir Sharma's words of caution on an unbalanced banking sector is not new. But it is very likely that this too will go unheard when it comes to PSB privatisation. It is unlikely that there will be any takers for his observations in the Modi government.