Glide path to solve NPA maths? RBI can give it a try

Glide paths were used by central banks of Chile and Czech Republic to lower inflation levels gradually over a period of time, like a glide so that economy can adjust to the shocks. The Czech National Bank switched to inflation targeting in 1997 with a medium-term inflation goal of 3.5-5.5 percent by 2000. To realise the same, it kept higher inflation target of 5.5-6.5 percent for end-1998, and 4 – 5 percent for end-1999. As these goals were achieved, it announced a long-term objective of 1-3 percent range by 2005 and finally moved to a point target of 2 percent in 2010.

India also adopted a glide path at the start of 2014 – to reach 8 per cent by January 2015 and 6 per cent by January 2016 and moving towards a flexible inflation targeting framework. Interestingly, the actual inflation was much lower than the glide path. Now, whether this decline was because of this forward-looking policy or a decline in food and oil prices is part of the discussion doing the rounds today.

While India was defusing its inflation crisis, another in the form of rising NPAs brewed in the banking sector. The NPA scourge, which started developing in 2013-14, has become one of the foremost problems facing Indian economy. The share of NPAs continued to rise to hit 11.2 percent of gross advances in 2018, with public banks registering a higher NPA of 14.6 percent of their gross advances. The RBI and the government have been grappling with the disease with no end in sight.

With the new government coming to power, attention has again shifted to resolving the NPA mess. The government and the Reserve Bank (RBI) could take insights from the glide inflation path to solve the NPA maths. Taking a cue, after estimating the true nature of NPAs, the RBI should pledge to bring the NPA level lower as it did for inflation over time.

The apex bank could start by making a glide path for NPAs by adopting a medium term target of lowering bad loans to, say 4 percent by 2022. Then, it could look to bring down the NPA level each year by a certain percentage to achieve the target of 4 percent. This could imply NPA target of 9 percent by 2020, 6 percent by 2021 and finally, 4 percent by 2022.

Once the medium target is achieved, the central bank could announce even a lower target of around 2 percent levels, which was the pre-crisis level, to be achieved over a period. The RBI should also impose stiff penalties on individual banks if the targets are not achieved and reward those that achieve their targets.

This approach is an important missing weapon in RBI’s armoury. So far, the words of the regulator have not been backed by action in a strong manner on the NPA front. By providing a glide path with numeric forward-looking targets, the action will guide and signal markets that the regulator is serious about the debt resolution. The stick-and-carrot approach will hopefully push banks to being on the right side of the policy.

The RBI should also take a leaf from the Reserve Bank of New Zealand and design its own Bank Dashboard (discussed in our previous piece). The dashboard ought to include the basic trends related to banking, particularly NPA related, for viewing by the general public. The policies which lead to lower NPAs such as Prompt Corrective Action (PCA) should also be part of the Dashboard. RBI may also bring out a concise document every quarter informing people over the progress being made on the glide path.

The NPA crisis is resolvable and is hardly rocket science. But if it drags on, Indian economy will continue to putter at below par growth levels. The NPA crisis of 1990s was also fixed paving for high growth rates in early 2000s. By using the newer ideas of glide path and dashboard, RBI could signal and communicate its resolve in a firmer manner.

Amol Agrawal is faculty at Ahmedabad University. Views expressed are personal.