Prioritise fixing financial markets

Prioritise fixing financial markets

Rebooting growth has to begin with finance.

On Tuesday, this newspaper reported that downgrades on largely corporate debt overtook upgrades by a factor of 2:1 between January and March. This is the first time in three years that downgrades have outnumbered upgrades. Meanwhile, the Reserve Bank of India (RBI) reports that bad debt, especially of State-owned banks, is coming down, thanks to a crackdown by the central bank and a crisis in India’s shadow banking system. Cleaning out mud choking the plumbing of banks and financial institutions is an obvious first step. Next, many banks will need to be recapitalised: for State-owned banks, the government will have to pour in cash in return for equity, to ensure lenders are in good health. However, policymakers cannot afford to rest easy after these steps. Many wrinkles in our financial markets need to be ironed out.

Real reform will have to target two things. One is perceived high risk in the corporate debt market: interest rates on five-year deposits range from 9.25% for borrowers like Shriram Transport Finance to 7.78% for blue-chip HDFC. Two, India needs to develop a liquid and low-cost market for long-term finance, typically for large projects. Bank lending horizons are too short; quick-fixes like government special purpose vehicles, or shadow banks to bridge the gap between short-term lenders and long-term borrowers, have patchy records. There is no shortcut: government, insurers, banks and companies must get together to build a large and safe market for long-term bonds. These reforms will cut risks and repair India’s financial sector. Tinkering with policy rates to create a gusher of money is no medicine for our sputtering finance markets.

The problem lies more in mediating liquidity to those who would use it as capital, than in the availability of liquidity per se. The market does not have a source of longterm funds of the kind that infrastructure calls for. Bad loan-burdened banks are chary of lending and, in any case, cannot lend for long tenors. Nor can para-banks. A thriving bond market is the only solution to fix the asset liability mismatch that crimps infrastructure.