Ever since the charismatic former governor of the Reserve Bank of India (RBI) Raghuram Rajan left office, the central bank’s policies during his tenure have been blamed for slowing down economic growth under the Prime Minister Narendra Modi regime.

Last week, the current Katherine Dusak Miller distinguished service professor of finance at the University of Chicago Booth School of Business, submitted a 17-page deposition to the Parliament Estimates Committee explaining why RBI policies cannot be held responsible for a slowdown. The deposition was prepared at the request of Murli Manohar Joshi, the chairman of the committee.

The criticism pointed at Rajan has been called unfair and politically motivated, and a way to deflect from the conversation about the effect of demonetisation on the economy. Most recently, Rajiv Kumar, vice chairman of the NITI Aayog, suggested in an interview with news agency ANI that it was Rajan and his move to initiate Asset Quality Review (AQR) in 2015 which led to the slowdown in economic growth.

In the interview, Kumar alludes to the rise in non-performing assets (NPA) of the banks to Rs 10.5 lakh crore by mid-2017 from Rs 4 lakh crore in 2014. Kumar told ANI, “Under the former RBI Governor Raghuram Rajan, they had instituted new mechanisms to identify stressed and non-performing assets. This is why the banking sector stopped giving credit to the industry.”

His comments had sparked a fresh round of debate on what crippled growth post 2016, and whether Rajan was really to blame for it.

In his deposition, Rajan tackles the question on NPAs and builds a case for why the policies on AQR and NPAs were needed at the time.

“The RBI has been accused of slowing the economy by forcing NPA recognition….Simply eye-balling the evidence suggests the claim is ludicrous, and made by people who have not done their homework,” Rajan writes.

The deposition explains, how the slowdown in credit growth in the public sector banks had already started in early 2014. The same, Rajan writes, is true for the industry and micro, small and medium enterprises (MSMEs).

“The fact that public sector bank credit slowdown dates from early 2014, suggests that the bank cleanup,  which started in earnest in the second half of fiscal year 2015, was not the cause [for slowdown in economic growth],” he writes, pointing to the increasing aversion of public sector bankers to lend to industrial projects. He describes the behaviour of the banking system as one that was plagued by balance sheet problems.

“The obvious remedy to anyone with an open mind would be to tackle the source of the problem – to clean the balance sheets of public sector banks, a remedy that has worked well in other countries where it has been implemented,” he writes.

Most of the bad loans had originated between 2006 and 2008, according to Rajan. The period was marked by a phase of the highest economic growth in post-liberalisation India. Naturally, there was a bull run in the stock markets and credit was readily available.

It led to an environment of Indian banks lending large amounts of money to corporate houses without much in-house due diligence and often depended on reports by investment banks or the likes of SBI Caps and IDBI, writes Rajan.

“It is at such times that banks make mistakes,”he writes, adding that, “They extrapolate past growth and performance to the future. So they are willing to accept higher leverage in projects, and less promoter equity.”

Rajan, who predicted the global economic crisis of 2008, finds a similar aggressiveness to lend in the banking sector today but for completely different reasons. Within the credit growth targets under the central government’s schemes like Pradhan Mantri MUDRA Yojana and Kisan Credit Cards, Rajan finds the possible roots of the next crisis in the banking system.

He terms the targets as ambitious and says that sometimes, these are achieved by ‘abandoning appropriate due diligence, creating the environment for future NPAs’. He even calls for greater examination of potential credit risk when loans under the two schemes are sanctioned and calls the Credit Guarantee Scheme for MSME run by SIDBI, a growing contingent liability.

While defending the RBI and its policies under his tenure, Rajan has been non-partisan in New Delhi’s role over the years in contributing to the large NPA levels in the Indian banking system.

“A variety of governance problems such as the suspect allocation of coal mines coupled with the fear of investigation slowed down government decision making in Delhi, both in the UPA and the subsequent NDA governments. Project cost overruns escalated for stalled projects and they became increasingly unable to service debt,” he writes.

“The continuing travails of the stranded power plants, even though India is short of power, suggests government decision making has not picked up sufficient pace to date,” he adds.

Further, about the period when the UPA government was in power Rajan writes, ‘there was obviously some amount of corruption’. He adds that there were also instances of promoters who were inflating the cost of capital equipment through over-invoicing and well-connected promoters were granted loans despite a history of defaults.

His disclaimer when writing about corruption is that it is hard to distinguish between banker exuberance, incompetence and corruption without an investigation into unaccounted wealth of bank CEOs. In the absence of such an investigation, Rajan writes it would be difficult to ascertain whether significant element of the NPA mess was due to corruption.

Rajan is more worried about the frauds in the banking system. He writes that the size of frauds is still small relative to the size of NPAs, the problem has been increasing. He also points to the system’s failure in bringing even a single high profile fraudster to justice. A list of high profile cases, he mentions, was sent to the Prime Minister’s Office for a coordinated action. Though he doesn’t mention when he sent such a letter, media reports on Tuesday said it was during Modi’s tenure in 2015.

“I am not aware of progress on this front. This is a matter that should be addressed with urgency,” he writes.

Interestingly, the steps that the government has announced in the last few months suggest that fundamentally it does not totally disagree with Rajan’s views.

For example, Rajan’s suggestions on greater due diligence and improving the process of evaluation of project risks was something that the government said will need to be done for public sector banks under the prompt corrective action of the RBI before they get recapitalised.

Similarly, the government has also tried to strengthen the recovery process through the introduction of the Insolvency and Bankruptcy Code, and by amending it in a quick and timely manner.

Sure, NPAs did rise during the time that Rajan occupied the position of the RBI governor. But, his decision to conduct the AQR did not create the NPAs, it simply uncovered the ones hiding in the system. Rajan may or may not be perfect, but surely he cannot be blamed for anything more than the man who fed Indian banking the bitter pill of truth.

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