Banking nationalisation continues to cast a long shadow over Indian political economy even 50 years after the fateful day it was signed into a law. Given the political realities of India, it will continue to be relevant even 50 years from now.
Avinash M Tripathi
Exactly 50 years ago, then Prime Minister Indira Gandhi decided to nationalise 14 major private banks. It was a step that changed Indian polity and economy forever. Politically, it enabled the emergence of Gandhi as the foremost Indian leader. Economically, the State acquired the commanding heights of the finance, a position that it has not vacated since then, even after the economic reforms.
The nationalisation plank was more about politics than economics. In her initial years, Gandhi had followed the advice of World Bank and Aid India Consortium (read the United States) to devalue the rupee for managing the Balance of Payments (BoP) difficulties. Despite the marginal respite on the BoP front, the devaluation turned out to be politically costly as most expenditure switching policies tend to be.
In the 1967 general elections, the Congress lost sizeable number of seats, even though it managed to retain a simple majority. In many crucial states first time non-Congress governments were formed. More critically, a clique of veteran congress leaders, popularly known as the syndicate, was breathing down Gandhi’s neck.
Canny politician that she was, Gandhi knew that she needed an issue that could burnish her image as a pro-poor politician, signal her pivot to the left, and as a bonus even help get rid of her finance minister Morarji Desai from the Cabinet. Bank nationalisation ticked all these boxes. It was a masterstroke with few parallels in the political history of India.
So much for the politics, but what about the long-term economic consequence? First, the bank nationalisation made the financial system stable at the cost of accentuating moral hazard. Public Sector Banks (PSBs) enjoy an implicit sovereign guarantee and explicit bailout programmes when their capital base gets eroded. These bailouts are not as fiercely scrutinised as the ones involving private players are. Perceptually, these bailouts are seen as mere transfers from one pocket to another. Consequently, while the banking sector is robust to financial contagion, it also means that the incentives for prudential lendings are weaker.
Second, it distorted the banking regulation in India. Recently, former Reserve Bank of India (RBI) governor Urjit Patel came out with a provocative speech which propounded a trilemma involving dominant government in banking, limited fiscal space and independent regulation. In economics, trilemma refers to three desirable objectives which cannot be simultaneously pursued due to some inconsistency.
Patel was hinting at the peculiar Indian situation where the government is the biggest owner of the public sector banks and also retains a considerable leverage over the financial regulators. When the PSBs are themselves quasi-sovereign, effective regulation is next to impossible. Delayed recognition of bad loans is one symptom of this malaise, opaque accounting system used in the banks which hides contingent liabilities of the kind that led to recent episodes of frauds is another.
Third, there was the institutional aspects of the bank nationalisation. This episode showed that the checks and balances inherent in the parliamentary democracy can be short circuited in the name of faster decision making and secrecy. Going by the testimony of key players, senior bureaucrats were given literally hours to prepare crucial documents. No application of mind was possible. Nationalisation was done through an ordinance even as Parliament was about to meet in a couple of days.
Finally, when the Supreme Court in Rustom Cavasjee Cooper v Union Of India decided that compulsory acquisition of private property required payment of equivalent money as compensation, the Constitution itself was amended to render the judgment null and void. The 25th amendment not only amended the right to property, altering the basis of the said judgment, but also laid down that the judiciary has no power of judicial review over constitutional amendments. A strange formulation in law which mercifully was overturned in the Keshava Bharati judgment.
‘The past is never dead, it is not even past’ said William Faulkner. This is apt for banking nationalisation which continues to cast a long shadow over Indian political economy, even 50 years after the fateful day it was signed into a law. One assumes, given the political realities of India, it will continue to be relevant even 50 years from now.Avinash M Tripathi is associate research fellow (economics), Takshashila Institution. Views are personal.Subscribe to Moneycontrol Pro and gain access to curated markets data, trading recommendations, equity analysis, investment ideas, insights from market gurus and much more. Get Moneycontrol PRO for 1 year at price of 3 months at 289. Use code FREEDOM.