The State of Stability

THE RESERVE BANK of India’s (RBI) reports seldom make for interesting reading. Couched in “financialese”, the regulator’s reports are strictly for those who have a direct interest in or concern with banks and financial markets. Yet, when the central bank released its bi-annual ‘Financial Stability Report’ at the end of June, the jargon-laden prose made for comforting reading.

The report, among other things, outlined the results of stress-tests on Indian banks and also included a Systemic Risk Survey based on the assessment of experts and market participants. In a world where economic and financial risks and political volatility are rife, these results highlighted India as an oasis of stability in a region beset with economic and political strife. The Systemic Risk Survey in particular highlighted that India’s financial authorities are aware of risks and are unlikely to be caught off-guard.

Till a few years ago, Indian banks were in acute financial distress. Non-Performing Assets (NPAs) had touched alarming levels due to poor lending practices for a decade. Every year, the government had to inject significant amounts of capital to shore them up. Even this was not enough and many said these large dollops of money were at most droplets when it came to the requirement of these stressed banks. All that seems to be a thing of the past.
The RBI report noted: “Stress test results reveal that Scheduled Commercial Banks (SCBs) are well capitalised and capable of absorbing macroeconomic shocks even in the absence of any further capital infusion by stakeholders.”

The central bank carried out these stress tests on two assumptions: a moderate and a severe stress situation for the banks. These situations can emerge for a variety of reasons: unanticipated external events such as war, financial markets in turmoil, and more. RBI noted: “Under the baseline scenario, the aggregate Capital to Risk Weighted Assets Ratio of 46 major banks is projected to slip from 16.5% in March 2022 to 15% by March 2023. It may go down to 14.2% in the medium stress scenario and to 13.3% under the severe stress scenario by March 2023. None of the 46 SCBs would breach the minimum capital requirement of 9% in the next one year, even in a severely stressed situation.”

India has its own macroeconomic troubles: high inflation and a rising current account deficit (CAD), itself a product of a widening trade deficit, pose problems for the government and RBI. But when seen against the backdrop of what is happening in South Asia, India’s troubles are more or less manageable.

On July 13, Sri Lanka’s beleaguered President Gotabaya Rajapaksa finally fled his country and landed in the Maldives. He did so without resigning properly after having promised to quit by July 13. In no time, Sri Lankan authorities imposed an emergency. It was the third time in a span of four months that emergency was imposed. If anything, the latest round only highlights the deep political crisis the country is in and its inability to end it.

Sri Lanka was in trouble long before angry protesters trooped into Rajapaksa’s official residence in Colombo last weekend. The scenes of anarchy and desperation of an entire people had a long gestation. The decade of the 1980s, remembered as a tough time by many due to the separatist conflict in the country’s north, brought its own share of economic troubles. But nothing compared to the present collapse can be found in the island nation’s history since 1948.

The present crisis had its roots in 2012 when Sri Lanka’s economy grew by a record 9.1 per cent. The following year, growth collapsed to 3.4 per cent and then it never really recovered. The secret of that high-growth year lay in the huge infrastructure investment boom that began in 2009, the year the Liberation Tigers of Tamil Eelam (LTTE) were finished. But the trouble was the manner in which that boom was financed: by opaque and high-interest loans from China. The full extent of these loans was never known until much later. Unlike regular external borrowing, say via foreign currency denominated debt—which was availed by Sri Lanka as it does not have sufficiently deep capital markets—bilateral loans from China are structured differently. To compound these problems, the extent of cronyism in these projects was phenomenal. Many were located in Hambantota, the political base of the Rajapaksa clan. Empty stadiums, a swanky airport with no travellers, a port that had to be handed to the Chinese to repay debts, and other vanity projects led Sri Lanka nowhere.

On top of it all, the country made alarming policy missteps from 2019 onwards. These mistakes were cascading: to rectify a prior mistake another one was made. The chain proved to be deleterious for Sri Lanka and brought catastrophe in 2022. First came the massive reductions in indirect taxes in December 2019 that resulted in a collapse of tax revenue by almost 50 per cent. The same year, on Easter, a series of bomb blasts in Colombo by Islamist terrorists led to a precipitous decline in tourists coming to Sri Lanka. The combined effect was a severe economic crunch. To save foreign exchange, the import of fertilisers was banned. This was also due to poor agronomic advice by ‘green experts’ who had urged President Rajapaksa to “go green”. Agricultural production collapsed virtually overnight. Then came the Covid-19 pandemic. In effect, Sri Lanka has witnessed a disaster of biblical proportions. The consensus among economists, both within and outside the country, is that the Lankan economy is crippled and is unlikely to get back on the rails for many years.

SRI LANKA’S ECONOMIC problems have only mutated into political ones in the last four to six months. The rapid economic crisis not just dented the popularity of the Rajapaksa clan but made it a political pariah overnight. That, however, has not prevented commentators from laying the blame for the economic mess on “authoritarianism”, “hatred”, “divisiveness” and other favourite ‘explanations’. Of these, there is an element of truth only in the case of “authoritarianism”, in reality the extreme concentration of political power in the hands of a single family. The economic mismanagement was linked to this issue. But that is hardly the stuff of authoritarianism.

Something similar is afoot in Pakistan where mismanagement of the economy during the tenure of former Prime Minister Imran Khan has brought the country to the brink of collapse. After he took office in 2018, Pakistan’s economic growth plummeted from a high of 6.2 per cent—its best since 2010—and never really recovered until he left office this year. The high growth of 6 per cent in 2021 was more or less a statistical artefact after the plunge in growth in 2020 due to the pandemic. Along with sputtering growth came high inflation that remained high consistently through Khan’s tenure. From a benign 3.8 per cent in 2018, inflation (as measured by the GDP deflator, based on World Bank data) is now in double digits. The only way to arrest this is by controlling money supply, something the State Bank of Pakistan (SBP) did reluctantly. Pakistan had avoided this, unmindful of the hardship and misery inflicted on ordinary citizens, until the point it became clear that the International Monetary Fund (IMF) would have to be approached for a bailout.

The interesting thing in both cases—Sri Lanka and Pakistan—was the reluctance to approach IMF until they had run out of options. Pakistan had a little more room for manoeuvre as it approached Saudi Arabia for some financial cushion. This took the form of credits for oil, rolling over of its deposits with Pakistan and some more deposits. Pakistan also managed to secure some help from China in the form of a $2.3 billion loan. In contrast, Sri Lanka received no help from China. In both cases, IMF is being careful in dishing out money.

The two countries have a history of multiple IMF bailout programmes over the past decades. In Pakistan’s case, these programmes have never been successful as the country is simply unwilling to undertake the politically difficult reforms that involve a robust system of taxation that includes its elite. At the root of the present crises are structural weaknesses in their economies that were never overcome after they gained independence. In Pakistan’s case, it exploited its strategic location to secure money first from the US and then from China. But it never undertook steps to develop its economy on a sustainable basis. In Sri Lanka’s case, its reliance on primary commodities like rubber and tea as exports and tourism ensured that any external shock would land it in trouble.

In the days after the start of the turmoil in Sri Lanka, a number of Indian commentators, economists and, in general, critics of the government began to assert that India was perilously close to experiencing what Sri Lanka was undergoing. Their criticism was dubious, at best. Sri Lanka’s crisis is economic in nature and has now become a political one as its leaders mismanaged the economy to the point that they had to flee the country. India, given its robust buffers like foreign exchange, careful regulation of the economy, and efforts to push growth after the pandemic-induced stop in growth is nowhere near the two cases of crises in the neighbourhood.

These commentators ignore another factor at work: the use of debt as a political tool by the biggest lender of these countries, China. For them, the crisis is wholly due to authoritarianism and victimisation of minorities. In this context, when a linkage is drawn with India, these commentators studiously avoid mentioning Pakistan. The reason is obvious: if victimisation of minorities is to be held as a reason for economic decline, the fate of Pakistan’s Hindu and Christian minorities will have to be analysed. Doing that is ideologically inconvenient. So the ‘analysis’ just sticks to Sri Lanka and that, too, in vague generalities. The economic reasons for Sri Lanka’s catastrophe and the political reasons for Pakistan’s economic mismanagement are never spoken of.

Yet, as per RBI’s ‘Financial Stability Report’, the steps taken by the Union finance ministry to check inflation and its record on arresting fiscal deficit after big expenditures during the pandemic show that India is far from economic instability. But facts never come in the way of convenient comparisons.

Chinafinancial crisisIndian economyPakistanRBIShaktikanta DasSri Lanka