India Legal – July 13, 2019

| INDIA LEGAL |July 22, 2019 21

This is what India needs—quick
intervention to clean up all the NPAs so
that credit can start flowing and for pri-
vate investment to rise quickly. Coupled
with a sensible fiscal policy, which
includes a substantial one-time reduc-
tion in both corporate taxes and capital
gains (I have called for an elimination of
both), would create an environment con-
ducive for Indian companies to start
making profits and expanding capacity.
That will reduce future NPAs and get the
Indian economy out of this cycle of poor
lending, insufficient investment and
weak growth to a virtuous cycle of credit
expansion, investment growth, increased
levels of income, consumption and jobs.
Let me suggest a way to clean up the
logjam of NPAs. It mirrors the approach
taken by the US Federal Reserve bank
after the 2008 economic crisis. The gen-
esis of that crisis was an increasing vol-
ume of bad loans in the US mortgage

sector which forced banks to reduce

lending to the real estate sector. This, in

turn, put downward pressure on home

prices and further perpetuated the bad

loan problem. The US central bank

responded quickly with what is known

as quantitative easing (QE). It created

vast amounts of new money electroni-

cally (almost $3 trillion) to buy bad

loans from the banks. As a result, the

balance sheets of banks became stronger

and more liquid and they were able to

start lending again. This resumption in

the flow of credit due to QE prevented a

major economic disaster. Domain

experts run key departments in the US

government and the Federal Reserve

and they were quick to recognise that

clearing the logjam of bad loans was

imperative to reducing systemic risk and

getting the economy moving again.

I

ndia too needs a quick and substan-

tial quantitative easing programme

engineered by the Reserve Bank.

The Bank should create `8 lakh crore of

new money electronically and use it to

buy all the existing bad loans from the

banks at their face value. It will provide

immediate recapitalisation to banks,

strengthen their balance sheets and

allow them to start lending again.

But won’t this substantial increase in

money supply create inflation? It will if

the banks are allowed to release this

money into the real economy for con-

sumption purposes. Instead, if they were

required to lend this money to the gov-

ernment at zero interest rates, to be

used only for investment in high-return

infrastructure projects, the impact on

inflation would be minimal as there

would be a corresponding increase in

production to offset the rise in con-

sumption. The experience of the US

shows that the impact of QE on core

inflation was very minimal.

This QE will also help the govern-

ment meet its infrastructure targets

without issuing bonds and reducing

credit availability for the private sector.

This “crowding out” effect is very pro-

found in a country like India where

CONTROLLING CHAOS
The Reserve Bank of India must play a lead-
ing role to ward off the NPA crisis; (below)
many real estate projects have been badly hit

Anil Shakya