Riskless capitalism leads to NPAs, in India

"Riskless capitalism" is a term first used by Raghuram Rajan in November 2014. The Indian growth story cannot be over-simplistically explained as a result of "market-oriented" reforms. Public sector bank credit-financed investments, particularly in the infrastructure sector, played a significant role in sustaining growth, most crucially after the global economic crisis. Such a growth trajectory, however, proved to be unsustainable with the expansionary phase coming to an end in 2011-12 and bad loans piling up in the banking system.


STYLIZED FACTS

• The Indian economy saw a boom between 2003-08 and a bust in 2008-09 whereas the second boom was for two years between 2009-11 followed by a decline.
• Private corporate investment grew faster than public investment during the booms increased from 6.5% to 10.3%.
• Credit from the public sector banks reached high levels during both the boom periods and a decline in between the two booms during 2008-09. Credit flow from the private sector banks did not follow this trend.
• By the time of the second boom, the banks were recklessly lending to already highly indebted companies.
• In the first boom, the real interest rates fell from 12% to 2.5%. In the second boom real rate of interest was increased.
• The fiscal deficit was reduced drastically during the first boom period. A “pause” button was pushed following the global recession and the fiscal deficit expanded from 2008-09.
• Import intensity of the Indian economy has been steadily rising in the high growth phase and continues to rise today.

GROWTH MODEL

• The internal constraint is the rate of profit should at least be equal to the interest accrued on the debt taken in the past. The external constraint is the Gross External Financing Requirements (GEFR) should be equal to net capital inflows and change in foreign exchange reserves.
• These two constraints are the boundaries for the economic system to function well where neither the domestic financial sector comes under severe strain nor the economy is faced with a balance of payment crisis.
• A developing country faces a foreign exchange constraint arising out of the current account needs as well as the international debt servicing payments accrued in the past.
• Investment decision of a private firm is aggregated to  - first, how much of investment is to be undertaken? Second, how is this investment going to be financed?
• The state-owned banks were made to relax their risk function. And the risk-taking of private investment, was passed on to the public sector banks. High profits of successful investment projects were not shared with the lenders. The losses incurred in failed investments was passed on to the state to clean up. This is being witnessed in India today as increasing NPAs and the clamour for debt write-offs. 
• This is the process of "riskless capitalism” , the former RBI  Governor Raghuram Rajan was alluding.

CONCLUSION

• The promoter enjoys riskless capitalism even in these times of very slow growth, how many large promoters have lost their homes or have had to curb their lifestyles despite offering personal guarantees to lenders? Who pays for this one way bet large promoters enjoy? Clearly, the hard working savers and taxpayers of this country! As just one measure, the total write-offs of loans made by the commercial banks in the last five years is Rs. 1,61,018 crore, which is 1.27% of GDP ... Raghuram Rajan in 1994
• The first boom was triggered by export surge accompanied by public sector bank lending, debt inflows and low real interest rates. The second boom was a result of a more reckless lending by the public sector banks in the face of interest rate hikes by the RBI. Such a “riskless capitalism” could not have thrived without the support, active or otherwise, of the state.
• The second boom was short-lived because of the unstable nature of this growth rate as well as a rise in the domestic real rate of interest from 2010-11 due to RBI’s efforts towards inflation targeting. The effect of this increase in the domestic interest rate was muted because international borrowing costs got lowered due to monetary easing in the US in the aftermath of the global economic crisis.
• While the cost of domestic credit increased, its international counterpart declined causing a change in the composition of corporate credit in favour of higher external commercial borrowings. With increase in domestic interest rates, the growth rate fell on the unstable path. The economy eventually hit the lower constraint implies debt defaults, which manifested in the large-scale accumulation of NPAs of the PSBs.
• Faced with an asymmetry of power, banks are tempted to cave in and take the unfair deal the borrower offers with massive haircuts. The banks debt becomes junior debt and the promoters equity becomes super equity. 

GST is with wrong rules

Among all arms of administration in India, the one dealing with commercial taxes (excise, customs & sales tax) is saddled with corruption of mind boggling proportions. The attitude in the tax administration is that all taxpayers are potential criminals and that subject them to taxation is a matter of identifying and controlling them and catching those who cheat. No modern tax system can function on fear alone. Tax administration requires an environment in which citizens are induced  as a social norm to comply with tax laws or by threat of punishment for non-compliance at minimum cost. Tax administration's task is to prevent pervasive non-compliance. Some taxpayers always comply because they do not have opportunity and are risk-averse. They think it is the right thing to do, and other right-thinking people are also complying.  Efficient services to taxpayers facilitating reporting, filing and paying taxes is a more cost-effective method of securing compliance than countering non-compliance. Since no tax administration is perfect, explicit provision should also be made to deal with mistakes. Tax administration should never be overloaded with impossible tasks and the propensity of governments to alter tax legislation frequently. Both tax officials and taxpayers must know what the tax law is and how it will be applied.The tasks of tax administration consist of identification, assessment, and collection. Due to limited resources tax systems have tended towards ‘self-assessment’ of their tax liability and pay. Inducing citizens to comply with tax laws is difficult with large informal sectors, poor salaries of public servants, ineffective legal systems, and distrust of government. The key to success lies in evolving a strategy, with the available resources, minimize the scope for non-compliance and to maximize the likelihood of detection and punishment of non-compliance. Each country must evolve its own strategy, depending on its own circumstances and background.

Read the detailed analysis  GST: Right intent. Wrong rules

GST: Right intent. Wrong rules (Page 1/8)

GST: Right intent. Wrong rules (Page 2/8)

GST: Right intent. Wrong rules (Page 3/8)

GST: Right intent. Wrong rules (Page 4/8)

GST: Right intent. Wrong rules (Page 5/8)

GST: Right intent. Wrong rules (Page 6/8)

GST: Right intent. Wrong rules (Page 7/8)

GST: Right intent. Wrong rules (Page 8/8)

A fine is a tax for doing something wrong. 
A tax is a fine for doing something right.

The income tax created more criminals than any other 
single act of government ... Barry Goldwater

Collecting more taxes than is absolutely necessary 
is legalized robbery ... Calvin Coolidge

My View:
Theoretically, GST is a very radical reform aimed at improving economy, ease of doing business, etc. But hurried implementation has many pit falls. GST undermines federal freedom of states guaranteed by constitution. Centre will become too strong and the states too weak. USA has not adopted GST not to undermine federal structure, spirit and autonomy of its states. Not good for India with massive population and diversity.

Changing trajectories needs considerable preparation, effort and time. Ignoring any of them is not only detrimental but also catastrophic. The hurriedly rolled out GST with just three months of transition, ignoring the complexities like deficient infrastructure, IT knowledge, creating awareness, training, grievance remedial processes, etc are likely to impact large number MSME exporters with exports share of 45% and could impact exports and economy. GDP likely to come down by few points during first year. While long term benefits are imagination & illusion, short term pain is guaranteed and could even pull down already ailing economy impacted by mindless demonetization, low growth, low inflation, stagnant consumption, high joblessness and distressed agriculture. GST is certain to impact informal sector further, which provides livelihood for 90% of people and already destroyed by demonetization.

A decade ago we were told VAT will resolve all incongruities and corruption that engulfed sales tax but see nothing happened. Tax policy is as good as it is administered, by authorities who are blatantly corrupt.