Vivek Kaul is the author of the Easy Money trilogy of books on the history of banking and money and, most recently, of Bad Money: Inside the NPA Mess and How it Threatens the Banking System. In lucid prose, Kaul draws out the history of India’s banking sector and how we got to a place where the challenge of fixing it seems nearly intractable. spoke to Kaul about the current government’s economic policies, the hidden costs of the Atmanirbhar Bharat package and what everyone gets wrong about India’s beleagured banking sector.

A major point of the book is that there are no free lunches in economics. Yet the 20 lakh crore package comes with a tiny percentage of actual fiscal spend. If you had to draw it out then, what is the hidden cost of a liquidity heavy package?
If you go through item by item, much of the package essentially depends on banks giving out loans to small and medium enterprises, to small borrowers and so on. The point here in a situation like this is a lot can go wrong.

I’ll go back a little in history. When the 2008 financial crisis struck, one of the reasons India managed to avoid going into a recession or even a slow growth environment was because Public Sector Banks were encouraged to go easy on lending, which means that they were pushed to give more loans than they would otherwise have. That was one of the factors which helped India continue to grow.

And in 2011, in fact, India grew at more than 10%. That’s the only time on record when the country has grown in double digits.

While all that easy lending essentially helped the economy for three years, after 2011 the situation started to turn, because banks had given out loans to a lot of corporate borrowers who were not in a position to repay. Now if a situation like that were to replay all over again, and I see no reason as to why it wouldn’t, then you are putting your banking system in danger all over again.

What we also need to realise here is that, other than banks being asked to go easy on lending, there are going to be a huge amount of defaults because of the negative impact of Covid-19. So once you put it all together you have a deadly cocktail, which is dangerous for the overall state of the economy.

One way of looking at this is that the government sees not spending money fiscally now, and relying on lots of liquidity and banks, even if they don’t end up being as crony as they were in the past, will still end up with loans going bad in a year’s time because demand will not have gone up. And then the government will have to spend money anyway?
I have a straightforward view on this. I don’t think it is the responsibility of any bank to revive the economy. The bank’s responsibilities are towards depositors and the responsibility is to ensure that they lend money to borrowers who are in a position to repay that loan. That is the basic responsibility of the bank and banking system.

Now, of course, the problem in the Indian case is that a bulk of the banking system is run by the government, and hence we end up in a situation like this.

So what are they hoping to do with a package that focuses on liquidity. Is there an argument for what they did?
If you expect banks to do the heavy lifting, I think that’s wrong. What you essentially need to do is, and I’ve said this over and over again, that, the government has a huge amount of assets and this is the time to sell.

I stay in central Mumbai. Within a 5 km radius, within a reasonable distance of where I am, there are so many of these government buildings. Why does an MTNL building need to be in Cumbala Hill? They can very well be outside the city, or you can just rent a few floors, there’s so much commercial space around.

The point at the end of the day: The government needs to be smart about how it raises money and then decides how to spend it where you can. Instead it puts public sector banks and the banking system at risk every few years, when the economy doesn’t do well. I don’t think that’s the right way to go about it.

The book goes over the history of the banking system, with a focus on what happened in the mid-2000s and then the excess of loans in the stimulus after the 2008 crash. This government came to power speaking against crony capitalism and complaining about a legacy of bad loans. Do you think they’re approaching this new crisis in a substantively different tone?
Crony capitalism is something that one figures out in retrospect. It is difficult to say whether Covid-19 will lead to an increase in crony capitalism. That time alone will tell.

Beyond that, if you look at how the government and the RBI reacted post 2011, and how they are likely to react, now, I think it’s along similar lines.

If you look at the history of RBI between 2011 and late 2014, there was barely any recognition of all the bad loans going around in the system. In fact, banks were encouraged to kick the can down the road. The terminology they use for it over and over again was regulatory forbearance, which essentially meant the RBI kept looking the other way, in the hopes that banks would lend their way out of trouble.

The idea being that, in days to come, the banks would lend more, and then these bad loans would become a very small part of the overall loans the banks had given.

Now this is a formula that RBI and the financial industry successfully ran between the early 1990s and the early and mid-2000s. When in the early 1990s, bad public sector loans were around 25%. Over a period of time, by kicking the can down the road, this had been brought down to around 3%.

The problem was that in the early 1990s, the Indian banking system was very small in comparison to what it became by 2010-11. Finally, by 2015 they had to crack the whip and start cleaning up the banking system.

Now if you look at the kind of communication that is happening right now, you see that the finance minister has been talking recently about restructuring loans, and she’s been talking about the fact that talks are on with the RBI.

As of now a [loan] moratorium is on, and it was extended, and you had another round. The point is, if a company or an individual is not in a position to repay right now, I don’t see any reason they would be in a position to repay a year from now.

And if these loans are not repaid, then how are banks expected to repay deposits? So, as I said, I think the responsibility of the banks is towards the depositors and not towards anyone else.

Vivek Kaul, author of 'Bad Money: Inside the NPA Mess and How it Threatens the Banking System'

Do you think the government will eventually have to spend more? Do you think it’s inevitable?
People think economics has all the solutions. If spending its way out of trouble was the answer, they would have done it. But the fact of the matter is that they really don’t have the money. And they don’t have the money because post-2016, after demonetisation and a botched up implementation of the GST, the tax collection as a percentage of GDP and as against targets set by the government have come down.

In 2019-20, the government had hoped to collect taxes of around Rs 24.6 lakh crore. They ended up collecting around Rs 20 lakh crore. That is a huge difference of Rs 4.6 lakh crore.

The government has driven itself into a situation where they are really not in a position to spend that extra money, because past tax collections have been down, and future tax collections will be down as well.

So as I said, the only way out is to start selling assets. In this market, obviously, they are not going to get the highest possible price. So unless they go to RBI to print money and hand it over to them, I don’t think there is any other reasonable way out.

One thing we have been trying to figure out over the years is what the economic approach of the government is. There was demonetisation, and GST. There was the IBC. And then last year, even as revenues were falling, there was a corporate tax cut. What do you make of these moves and how they panned out.
I’ll try answering your first question first, which is, what is the economic policy of this government. I find it funny that people don’t understand this basic point that the only policy of this government is narrative. All the policies are built in and around the narrative that has to be promoted.

When the finance minister presented her first budget last year, and given that the government had just been re-elected, you wanted to give out stuff [to the public], and that is what happened. Then in September they could see the economy slowing down.

I don’t know who advised them on that, but someone did and they thought that cutting corporate income tax rates would lead to revival of demand. That was the most bizarre logic I have ever heard on the economy in my life. If the idea is to promote economic growth, you have to put money in the hands of people directly and let them decide what they want to do with it.

You don’t put money in the hands of corporates and hope that they will pass it on to the people of the country. It doesn’t work that way.

What should have actually been cut that way, was the personal income tax rate. Or if you look at the situation right now, the government needs to cut the GST on automobiles by at least 10%, of all kinds – two-wheelers, three-wheelers, four-wheelers.

Now, if you do that there will be a substantial fall in price, and people are then likely to buy. And then the tax you lose out per unit of the vehicle, you are more likely to make up through GST because of volume and other taxes.

You know the auto industry employs a lot of contract workers. These contract workers come into the picture only when there is extra demand. Right now the buying is down 50%. If the demand goes up, these contract workers come into the picture, they get paid, they spend that money, they pay indirect taxes, so it’s an overall picture that needs to be thought of before any decision is made.

But that doesn’t seem to be happening.

I would add in there the question of what you make of fuel prices, which again seem to be a “free lunch’ for the government”. But keeping prices high – even if it earns taxes – has a downstream effect on the economy, right?
In an ideal world, when fuel prices are going up the increase should be passed on to the consumer, and when they are coming down, the fall should also be passed on to them. But in India that has not been the case for a while now.

When prices go up, they go up. But when oil prices come down, petrol and diesel prices don’t seem to follow.

In the current scenario, this is the easiest way for the government to earn money. If you look at tax collections otherwise. GST is down, income tax is down. In this scenario, whatever little movement is happening, the government is trying to make more money out of this.

Having said that, the problem the bureaucrats need to think about is – not as many private vehicles are moving around right now, and a lot of the movement is of government vehicles. Essentially the government is paying itself. It is a little bizarre.

Also, what I think has happened – and this is not just a problem post Covid-19, it has been happening over the past four years – because the tax collections have slowed down, the government has found it easy to just increase the excise duty on petrol and diesel and make money from it.

Essentially this is the cost of the government screwing up on GST and demonetisation. Which the citizens have to pay for. So there is no free lunch. But the institution made the mistake, and individuals are paying for it.

Rupak De Chowdhuri/Reuters

You mentioned earlier that the economic policy of the government is narrative. So I want to get your thoughts on the current narrative. What do you think of Atmanirbhar Bharat (self-reliant India)?
This is convoluted. The Aatmanirbharta that they are talking about is essentially to produce within the country and to encourage people to buy that production. The logic offered is that if you buy local, local industries will benefit, local jobs will be created, the government will earn taxes, and so on.

There are multiple problems with this argument.

  • The first problem is that it stinks of import substitution, which was the norm between 1947 and 1991. And we all know how the government grew in those years.
  • The second point is that import substitution comes with crony capitalism and I don’t think that’s ever a good idea.
  • The third problem is that along with the government talking about self-reliance, it is also talking about the fact that Indian corporations need to export more by becoming a part of the global supply chain. Now the issue is: How do you become a part of any global supply chain without having the ability to compete globally? And how do you compete globally without competing locally?

Even though it’s only been talked about recently, trade protectionism has been on the rise in the last two years. If you read our own Finance Minister’s 2018 Budget speech, it says this very very clearly.

So the way we seem to be promoting self-reliance is not through competition, but through clamping down on imports. Which I don’t think is a great idea. And finally what you’re doing is that you’re reducing the choice for the end consumer and forcing him to buy a product which is more expensive and of inferior quality.

Now ,ultimately, what is the idea behind any economic activity? It’s consumption, right? Is the end consumer, the average Indian, kept in mind while deciding on any policy? That doesn’t seem to be happening here.

So I think it’s just another case of narrative building. And obviously the justification is that many countries around the world seem to be doing it.

This brings me back to the question of economic policy. There are people in this government who insist that protectionism is Nehruvian and outdated (we wrote about it here). There must be people in government who know it doesn’t work. So why are they doing this? Is there a temporary benefit? Is it a holding pattern?
This is just a promotion of a narrative. There is no short-term benefit.

The basic idea that is being sold is that you will end up buying Indian products and the Indian economy will benefit. Any consumer, any individual, makes only a certain amount of money. If you force them to buy an expensive product of inferior quality, they’ll have to cut down on consumption of some other thing, and that some other business will obviously suffer. While we can see the business that is benefiting out of protectionism, we cannot see the businesses that are losing.

An old French economist named Frederic Bastiat called this concept the seen and the unseen. The seen effect here is of a few Indian companies benefiting, but there is a huge unseen effect of companies losing out now.

I’ll give you an example. A few years ago, the tariffs on imported steel were increased to ensure that Indian steel continued to be competitive. Now this was done primarily because Indian steel companies owed a lot of money to the banks.

So if the Chinese companies kept coming into India, the Indian ones wouldn’t be able to compete, and if they didn’t compete, obviously they wouldn’t be able to repay the banks.

So by ensuring that cheap Chinese steel became expensive, you ensured that everyone who used steel, from car manufacturers and scooter manufactures to whoever needed steel, ended up paying more for Indian steel. And ultimately they didn’t pay it out of their own pockets, they passed it on to the end consumer.

So, you can try selling a narrative, but if one were to just dig down a little more, you can easily figure out it is essentially a narrative and nothing more.

I wrote earlier this week that this approach, narrative above all, may lead to emperor-has-no-clothes situations, where no one in the government is able to say that the demonetisation or protectionism doesn’t make sense.
That has already been happening. You can look at the fact that this government hardly has any professionals working for it. So any professional who has a mind of his own – why would he want to bother working for the current government, unless they have some other agenda? If you are a professional and if you understand public policy, there is no way you would want to work for this government.

Do you think in your lifetime you will see the Department of Financial Services shut down? [Ed: This is a reference to former RBI governor Raghuram Rajan identifying political control of public sector banks, under this department, as one of the main reasons for the banking sector malaise].
Now if Raghuram Rajan doesn’t see that happening, I certainly don’t think I will see that happening.

More than that, though, it will not matter. I’ll explain why. Even though public sector banks may not get privatised, the banking sector in India will get privatised. In fact, it is already getting privatised.

In March 2011, public sector banks had about 74%-75% of the loans in the overall financial system. Currently it’s down to 58%-60%. Over a period of nine years, private banks have majorly eaten into the share of public sector banks. And this is likely to continue.

What will happen in the next 5-6 years is that the difference will get even more significant. In the next 10 years, my guess is that the difference between the share that public sector banks have in the Indian banking system and what private banks have will be very, very low.

So it doesn’t matter whether the Department of Financial Services is around. The market is at work, and it will sort this out. If you look at what happened with the telecom industry in India, you look at what happened with the airline sector, it will play out in the banking sector as well.


As you say, the committee reports and lots of analysts point to what needs to be done, particularly with the government reducing its holdings in public sector banks. But the question is not just economic but political too. So two questions – is there an example from anywhere for how that combination can be managed? How do you think say an actual government pullback from a PSB can be managed?
India has by far the largest public sector banking system. Obviously what that tells you is that countries all over the world have successfully sold off public sector banks, or the sector has been privatised on its own.

I think the economists can do all the thinking but at the end of the day, unless you have a politician who is willing to take the risk, it is difficult to push these things. In February 2000, when Yashwant Sinha was Finance Minister, one of his proposals in the Budget speech was to reduce the government holding in public sector banks to 33%. And obviously he had the blessings of the prime minister, because he wouldn’t have said that in the speech otherwise.

But despite the fact that he made that statement, the government couldn’t implement it. It wasn’t just that the Opposition was against it. The Opposition was definitely against it, but people in government were also against it.

There is this tendency to look at all the PSBs as jewels, but they are not jewels. You have driven down the value of these jewels so much over the years. The market cap of all public sector banks put together is less than that of HDFC.

Kotak Mahindra Bank, which is very, very small, has a larger market cap than the State Bank of India. Let’s say if the government had run SBI professionally, the market cap of SBI would have been much much more than it would have been.

And for all the social policies that the government wanted to promote, all it had to do was to sell a certain portion of its holding in SBI every year and use that money to push its social sector agenda.

The question is: why can’t the government run these banks as proper businesses and look at them from the point of view of an investor, rather than as an owner? The answer is that if you look at a lot of these ministries, if you take away the public sector company away from that ministry, there is nothing really left in the ministry.

If you take away air India, you don’t really need a Civil Aviation ministry. You already have a regulator in DGCA. If you look at the Ministry of Steel, if you took away the Steel Authority of India, what are they going to do?

Along similar lines, every ministry and bureaucrats running the ministry have some value because there is a public sector unit attached to the ministry.

On that note, one of the recommendations is that industrial banking should be limited to a few big public sector banks, while the small ones can concentrate on retail. But right now they are merging small with big.
The reason I say that smaller public sector banks should concentrate on retail lending is because they don’t have the expertise on industrial lending, and the chances of political meddling in retail are limited.

If you look at the data, while public sectors have very high corporate non-performing assets, on the retail NPA front, they are not much worse than private banks. What is the reason for that?

When a public sector banker is giving out a retail loan, they can do proper due diligence. And once they have done that, he can commission the loan or not commission it. So the guy who has knowledge of the situation also has the power to take a decision. This is not always possible when you’re giving out a corporate loan.

One cliché of major crises like these is that they accelerate trends rather than upending them. What trends do you think we’re going to see accelerate?
The government is trying to push through a few reforms. One cannot deny it. How that will work out, and whether they are serious about it will...we’ll get a clearer idea only in times to come.

Some are a case of too little too late, so you have private commercial mining of coal. This should have happened many many years ago. India has huge reserves of coal, but there is largely only one company, Coal India, which digs for coal and sells it. It has never really been able to produce as much as the country requires.

And because of that we have imports. It’s tragic given the fact that we have huge reserves.

The other thing that I see is thar the narrative wielding thing will only get stronger. Yesterday, Piyush Goyal tweeted that India has a trade surplus, which he has portrayed as a good thing.

Now why does India have a surplus? Because imports have fallen much faster than exports. I found that quite tragic, because if you look at non-gold, non-oil imports, which are crashing, what that is telling you is that consumer demand has crashed big time.

That is one of the best indicators of how consumer demand is crashing, which the minister has spun into a positive scenario. That is narrative-building. I’m sure the minister understands what he’s doing.

So I think narrative-building will only go up in the days to come.

What do you think everyone – the media, analysts, experts – regularly gets wrong about India’s banking sector?
One misconception that I see all the time, and this includes everyone from senior editors to economists who have worked or not worked for the government is that they continue to believe that the government runs a major part of the banking space in India. I still see that people saying that public sector banks have 70%-75% of the banking system in India. Which is no longer true.

That was true 10 years ago. As of now, the number is down to less than 60%. What this tells us is that we clearly cannot see this huge change in the trend where private banks are gradually taking over the banking system.

Is there one thing that surprised you during the research for Bad Money, something that you didn’t expect to find?
There were lots of small surprises, like this privatisation of the banking sector, though I had an inkling that one would end up with that.

More than a surprise, it was a realisation when I was writing the chapter on Vijay Mallya, I started feeling sorry for the guy. I’m not justifying what he did, and the fact that he ran away from the country. But if you read the book you would know that there were a whole host of people who have defaulted on banking loans and have disappeared.

The list has almost 50 people. I sort of felt sorry for that guy – there were so many others who have disappeared, but he is the one everyone’s after. That comes from the fact that he had a very flashy life. And he used to say he had a flashy life, because he wanted to promote his brands through his lifestyle, because you cannot really advertise beer in a direct way.

There was another thing I realised and that was quite surprising, which was that there were many bigger defaulters than Vijay Mallya. The biggest was Bhushan Steel, whose default was more than Rs 56,000 crore. Then the Ruia brothers of Essar – their default was close to Rs 49,000 crore.

But when I google for an image of Brij Singhal, of Bhushan Steel, I could barely find anything. Even the Ruias, though they were a little better covered, I could barely find any images of these guys, and also very few articles in the media on these guys defaulting on these huge loans. Whereas everyone went after Vijay Mallya.

That was by far my biggest surprise. One the few occasions I have got to talk on this topic in the public domain, a question I put to the audience is: Who is the largest defaulter? People are also so fixated on Nirav Modi and Mallya that they don’t know that there are much bigger defaulters, or who they are. And for that I think the media is responsible.

What three books / podcasts / papers would you recommend people read / listen to if they want to dig into this some more?

  • The speeches made by former RBI governors, who include YV Reddy, D Subbarao, Raghuram Rajan and Urjit Patel. Other than these guys, I would recommend the speeches of Deputy Governors R Gandhi, Viral Acharya and NS Vishwanathan. These are great sources. One thing that one realised while reading these speeches is that they’re very well written and they’re written largely in a way that lets the common man understand what is being said.
  • If you want to understand how central banking works in India, Who Moved My Interest Rate by D Subbarao is a fine book.
  • The autobiography of YV Reddy, Advice & Dissent. The second half is about central banking.
  • Also, Raghuram Rajan’s Saving Capitalism from the Capitalists, [written with Luigi Zingales]. I don’t think I have directly referred to it in my book, but the core idea runs throughout my book.

Besides the book, how can people follow your work?