Former Reserve Bank of India Governor Raghuram Rajan said India needs a functional out-of-court restructuring process for stressed assets so that most of the cases are resolved out of bankruptcy code.

The National Company Law Tribunal can act as a court of last resort if no agreement is possible, he said. “The NCLT will help restructure debt for the largest firms and projects under the bankruptcy code,” Rajan said while releasing the report, 'An Economic Strategy for India'. “The tribunal will be overwhelmed if every stressed firm or project is filed before it.”

The report -- authored by 13 senior economists -- outlined a host of economic priorities for India over the next five years and comes ahead of the general election next year. Among the priorities highlighted by the economists is the continuing need to clean up banks’ balance sheets.

As a part of this, Rajan said the both the out-of-court restructuring and bankruptcy processes, according to him, need to be strengthened and made speedy. “The out-of-court restructuring process requires protecting the ability of bankers to make commercial decisions without subjecting them to inquiry,” Rajan said. “The Insolvency and Bankruptcy Code requires steady modifications to make it effective, transparent, and not gamed by unscrupulous promoters.”

But for many projects, he said, financial restructuring is of little use if the project cannot proceed for other reasons such as lack of land or permissions or input supply. “Any new government will have to give priority to rectify these issues.”

Improving Governance At State-Owned Banks

Public sector bank boards are not adequately professionalised, and the government still decides board appointments, with the “inevitable politicisation”, Rajan said.

Eventually, strong boards should be entrusted with all bank-related decisions, including appointment of chief executive officers, but held responsible for performance, he said. “Strategic investors could help improve governance.”

Reduce Government’s Mandates For PSBs

Capitalising banks through budgetary resources is against the interest of minority shareholders, according to Rajan.

The requirement for banks to mandatorily invest in government bonds—statutory liquidity ratio requirement—should continue to be reduced, he said, adding it should be substituted with liquidity coverage and net stable funding ratios set by Basel.

Key Highlights From The Report

Macroeconomic Stability

Stressing on the importance to maintain macroeconomic stability, the economists suggest sticking to fiscal consolidation and finding ways to ensure that off-balance sheet liabilities don’t build up.

Some of suggestions include:

• Sticking to the path laid out by the Fiscal Responsibility and Budget Management Review Committee such that the consolidated fiscal deficit is brought down to 5 percent and general government debt to 60 percent of gross domestic product.
• Formulating a “grand bargain” between the centre and states, giving states incentives to be aligned with the centre’s fiscal goals—something that is almost entirely missing.
• Better accounting for contingent and off-balance sheet liabilities of the states and the centre, so as to estimate overall government financing needs, and therefore its claim on savings. This is especially important when we add necessary healthcare and pension schemes that will last well into the future. Such entitlements have to be costed based on long-term use and growth, not on current costs, especially since entitlements are virtually impossible to withdraw.

Banking System

The economists also suggest persisting with the banking clean-up which began when Rajan was RBI governor. His successor Urjit Patel continued with many of the policies but stepped down after a stand-off with the government on issues which included the RBI’s tough banking regulations.

According to the economists, key measures needed include:

• Cleaning up bank balance sheets by reviving projects that can be revived after restructuring debt.
• Improving governance and management at the public sector banks and then recapitalising them.
• De-risking banking by encouraging risk transfers to non-banks and the market; and reducing the number and weight of government mandates for PSBs, and banks more generally.

Non-Bank Lenders

The economists noted that the non-bank financial sector needs a strong banking system as well as deep equity and bond markets, supported by liquid secondary markets and a robust regulatory and legal infrastructure.

Key priorities include:

• Developing a liquid and deep corporate bond market through policies to encourage institutional investor participation.
• Enhancing liquidity in the government debt market and making it more attractive to institutional and retail investors.
• Developing missing (or nascent) markets like fixed income derivatives to hedge the credit and interest rate risk of fixed income securities.