Expert Speak India Matters
Published on Feb 19, 2018
Not all of the bad loan problem that Indian banks are going through is because of fraud
How PNB fraud will affect govt's ability to mobilise big money

The magnitude of the fraud that apparently took place in a Mumbai branch of Punjab National Bank, allegedly to benefit companies controlled by diamond trader Nirav Modi and associates, is staggering. The ease with which processes were subverted, and the length of time for which this subversion happened, suggests that other such stories probably exist, but have not yet been revealed. Naturally, not all of the bad loan problem that Indian banks are going through is because of fraud — in some cases, repayment problems is the natural product of a prolonged slowdown. But it is clear nevertheless that risk management in Indian banks, particularly public sector banks, has severely impaired their ability to lend. They are relying on public funds for sustainability.

Meanwhile, public funds themselves are tight. Spending is having to be squeezed. After some years of using the oil price bonanza on government expenditure, particularly capital spending, the government has hit the bottom of the barrel. Many hopes were attached to the introduction of the goods and services tax; it was hoped it would lead to a revolution in government revenue. Unfortunately, while tax receipts do indeed appear to have increased, this increase has not so far been commensurate with India’s needs.

These two developments take place at a time in which India desperately needs to spend money: on carbon adaptation and mitigation in keeping with its climate-change goals as enunciated in the Paris Agreement; on the social sector, particularly health and education, in order to benefit from a demographic dividend; and on “hard” infrastructure, if we are not to completely miss the manufacturing bus. The finance minister has said in the past that India needs $1.5 trillion to be spent on infrastructure in the next decade. Add the costs of health and education, as well as the additional costs that come from climate-proofing Indian livelihoods and doing our bit towards carbon mitigation, and you come up with a truly daunting figure.

It is clear that these trillions cannot come from the government, given its inability to mobilise such resources — an inability plainly visible in the Union Budget presented two weeks ago.

It is also clear that the banking sector is not working as a competent pipeline for funds at this scale — leakages such as the PNB fraud should be viewed as part of a larger complex of failures in this respect that mean Indian banks are simply unable to do their job of evaluating and pricing risk and allocating funds properly.

What this means is that, in the end, India will have to do without these trillions of dollars unless it finds alternative sources of funds. Fortunately, such pools of capital do in fact exist. The aging populations of the West and Japan are sitting on giant stocks of savings that are not earning enough of a return. Low interest rates and growth prospects in mature economies mean these pools of long-term capital are largely unproductive. There are needs that mirror each other: these countries and societies need a better return on their savings, and developing countries like India need to mobilise long-term capital in order to invest in their own futures.

When there is such a match of demand and supply, a market should logically develop. In other words, we should see far more inflows into social and physical infrastructure in India from global pools of capital than we currently do. Just the vast task of creating a remunerative renewable energy infrastructure, for example, in order to meet the government's ambitious targets, should see money inflows in an order of magnitude than are presently being observed. While some tentative interest has been observed from such pools of capital in transport infrastructure — pension funds have invested in roads, for example — the numbers are paltry compared to the funding deficit in infrastructure, particularly since the Indian private sector is currently unable to spend.

Supply connects to demand; in the connection so created, money flows. Yet long-term money isn’t coming in to these sectors of the Indian economy; short-term cash flows into the equity markets and start-ups and so on instead. This is a signal that somewhere a constraint has been introduced into the normal working of the markets.

In other words, the government's priority has to be to mobilise these pools of capital, and to identify the constraints inhibiting the flow of capital into long-term development, particularly of climate-sensitive infrastructure, transport systems, and renewable energy. Many such bottlenecks exist: a lack of confidence in the policy environment; poor domain knowledge among the relevant government departments; confusions between state and central policies; restrictive land and labour policies; fears about state-induced capital loss. Instead of trying futilely to improve the operation of nationalised banks that, precisely because of their ownership, are unlikely to improve, or trying to squeeze the Indian taxpayer yet further, the government should aim instead at making it easier to invest and earn a secure return in the sectors that have the biggest funding gaps.

The views expressed above belong to the author(s). ORF research and analyses now available on Telegram! Click here to access our curated content — blogs, longforms and interviews.


Mihir Swarup Sharma

Mihir Swarup Sharma

Mihir Swarup Sharma is the Director Centre for Economy and Growth Programme at the Observer Research Foundation. He was trained as an economist and political scientist ...

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