In the words of Dirk Gently of Dirk Gently’s Holistic Detective Agency, “Everything is connected”.

Last year, India witnessed perhaps the most disruptive policy move the world has seen in recent times: demonetisation. The policy affected each and every citizen and its effects are still being felt. It has resulted in an intense reverse-migration from urban to rural areas as labourers went “They took our jobs!” Demand for Mahatma Gandhi National Rural Employment Guarantee Scheme (MNREGS) has gone through the roof (prompting the Finance Minister to allocate Rs 48,000 crore to the scheme in Budget 2017) since labourers went, “Oi Gormint, now give us jobs!” It has also had some positive effects like a sharp spike in advance taxes collected last year. The Income Tax department now has a motherload of data to play around with and lakhs of people to prosecute for being shady all these years.

But all of this is, to put it carefully, is “collateral damage”.

The real aims of demonetisation are still unclear. The Prime Minister announced on November 8 that demonetisation would eradicate corruption, hit terror funding, bring back black money and counter counterfeit currency. After that, he started promoting a cashless India while companies like PayTM went bonkers as their business exploded. Recently, our Chief Economic Advisor said that demonetisation was done to reduce real-estate prices. Many say that they are changing their goalposts again and again, but I beg to differ. Since the note ban policy affected each and every citizen’s pocket, it’s might be case of hitting multiple targets with one bullet.

While the after-effects are for everyone to see and are still being measured, it becomes even more important to zoom out and trace out the events that happened before November 8, 2016.

In the beginning…

Back in February 2016 when the country was losing its mind over the Jawaharlal Nehru University controversy, dark clouds were looming over our banking system. In December 2015, Raghuram Rajan had ordered a cleanup of bank balance sheets by declaring Non-Performing Assets, aka “I took a loan but I am not going to pay it back. Whatchya gonna do about it, Bank?”

A lot of skeletons started falling out of the closet. Our banks declared Rs 4 lakh crore worth of loans are not recoverable. Even in the Parliament, the government admitted that the situation is not exactly peachy.

As you can see, they also said that the NPAs in Public Sector Banks are set to see a spike. The Economic Survey this year minced no words though and said that bad loans for Public Sector Banks have doubled since last year and reached almost 12 percent of total advances.

If you assume that every loan given out is of equal value, it means 1 out of every 10 loans given out by PSBs has now gone bad and become non-recoverable. The actual figure is way more than that because stressed companies (failing companies that cause their owners a lot of stress) owe more than 40 percent of total debt to banks!

(For more on the NPA phenomenon, I present to you an year old post I had written on Reddit India: “Our Banks are in trouble & we need to talk about it”)

The obvious pitfall of these massive bad loan declarations was that the Bank Balance sheets looked terrible. They couldn’t lend out more money anymore. For our industries to grow, they need available credit. This government came to power promising development and much economic prosperity. Even before demonetisation happened, our manufacturing index had tanked. This bad loan crisis was cited as one of the major reasons.

You can blame this government all you want, but to be perfectly honest, the situation seems to have gone beyond their control. These bad loans had been accumulating for decades, over successive governments. The fact that banks were forced to declare them now is what caused the insanity. (Thanks Rajan!)

Something needed to be done and fast. A series of policy decisions followed.

Incoming: brainwave!

In the Finance Act, 2015, there is a provision that creates the Monetary Policy Committee (MPC).

Before this change was made, the governor of the Reserve Bank of India (RBI) was the one authority to decide interest rates. They could veto anything they thought didn’t benefit the Indian economy. Now, there’s a seven-member MPC that sets rates and makes fiscal policies for the country. The Committee has been put into action and there has been a steady decline in interest rates since 2015, from eight percent to 6.25 percent currently.

Loans are becoming cheaper! Industry can borrow MOAR and spur investment!

But but but, the old bad loans are still there like a blot of dark ink thrown on a politician’s face. Time to clean it up!

(For details on the MPC and what it does, do take a peek at a post I had written earlier: “Raghuram Rajan’s Successor Is A Committee”.)

Too big to fail?

According to the Economic Survey 2017, 71 percent of all loan defaults are by 50 companies which owe Rs 20,000 crore each to banks. The top 10 companies owe Rs 40,000 cr each (!!!).

So even if one of these top companies defaults, the bank is in major major trouble. Which means the whole of Indian economy would be in trouble. Which is probably why instead of clearing their debts, our top borrowers seem to be taking extraordinary steps to avoid it.

Take the example of Vijay Mallya. Kingfisher Airlines borrowed an amount of Rs 7000 crore from 17 banks. These loans were declared as NPA and the recoverable amount came to a mere Rs 6 crore. On top of it, Vijay Mallya resigned from United Spirits and got a payout of Rs 515 crore. Good times for him while the 17 banks unitedly struggle to recover the loan amount.

And Mallya is small fish when compared to other big corporates collectively. The companies have found ways to skirt the problem, leaving our banks, especially the Public Sector Banks, with a world of problems. The Economic Survey 2017 wasn’t exactly a bundle of joy when it elaborated this.

Enter the Enforcement of Security Interest and Recovery of Debt Laws and Miscellaneous Provisions (Amendment) Bill, 2016.

Good lord I fall asleep just reading that long title. For the sake of simplicity, let’s call it the “Voldemort Bill”. (The Bill That Cannot Be Named, geddit?)

(I have written about this bill here: “The Voldemort of bills got passed, and you didn’t know”)

Hello loan, bye-bye loan

When a loan goes kaput and the bank is unable to recover the amount, it tries to sell off the security that was guaranteed against the loan in order to recover the loan amount. The security could houses, land, machinery or even company shares. To initiate this process, banks have to go through a tedious process of filing cases and dealing with special courts called Debt Recovery Tribunals.

This is where the Asset Reconstruction Companies (ARCs) enter, wearing a cape and all, looking heroic and stuff.

The ARC tells the bank, “Guys, we’ll buy this loan from you, take it off your books and then fight the tedious court battle for you.”

“Oh alright,” says the Bank. “But what will you get? It’s a bad loan. We don’t even know how much value the security has now. We got only Rs 6 crore from Mallya. SAD.”

The ARC grins and says, “That’s alright. We’ll take a cut out of whatever amount we recover from the loan defaulter. You see, at least you will recover *some* amount of money. We give you a piece of paper that guarantees you 15 per cent of the bad loan value.”

“Promise?”

“Pinky promise.”

Satisfied, the Bank hands over the loan to the ARC and gives it complete charge of the recovery process.

This Voldemort bill gave ARCs super powers. Interestingly enough, this process of selling off risk to ARCs had been started in 2014 itself. Despite all this, banks were starved of monies. The Economic Survey 2017 talks about this extensively.

New lending has practically stopped. There are too many bad old loans.

This phenomenon can be observed across the board, even for Micro-Small-Medium Enterprises (MSMEs). The smaller enterprises have had to bear the brunt of the misadventures of bigger sharks. Banks are unwilling to lend to them either. It’s understandable when stressed companies stop getting new loans, but even lending non-stressed enterprises has tanked to nothing-levels.

The Government needed to step up and do something about this. Recapitalisation was the only option left.

Cue in the Indradhanush Scheme.

The Government launched this scheme in 2015 to help banks deal with the bothersome NPA situation. Under this scheme, they announced a slew of measures including the appointment of a new Bank Boards Bureau and ordered them to hold all bad assets of failing PSUs. They also allotted Rs 70,000 crore to recapitalise the banks, which would be paid in instalments till 2018.

(i) Financial Year 2015 -16 – Rs. 25,000 crore

(ii) Financial Year 2016-17 – Rs. 25,000 crore

(iii) Financial Year 2017-18 – Rs. 10,000 crore

(iv) Financial Year 2018-19 – Rs. 10,000 crore

Total – Rs. 70,000 crore

Till now, Rs 60,000 crore have been given, the remaining will be allotted next year. Given the incredible amount of bad loans, this amount is like a drop in the ocean. The government needed something radical.

All hail demonetisation

To explain demonetisation in simple words: A large number of people deposited money into their bank, but they can’t take it out as quickly because of the set withdrawal limits. Deposits in the banks swell up, giving them more money to loan out to the industry.

(I have written about this ‘in-but-not-out activity’ here: “The Great Indian Demonetisation”)

In a press conference held on November 12, 2016, the Finance Minister said something quite interesting.

When demonetisation was announced, the withdrawal limit for citizens was at Rs 10,000. After two weeks, it was increased to Rs 24,000 per week. That limit is still in place for saving accounts. For current accounts, the limit has been increased from Rs 50,000 to Rs 1,00,000. There is still no sign about when these restrictions would be removed. If I had to guess, I would say this limit is not going away for another six months.

The Finance Minister gave hints that bank lending is set to increase as a result of demonetisation twice in his budget speech.

Voila:

And double voila:

For every Rs 100 crore that gets deposited in the bank, the bank is allowed to loan out Rs 75 crore. The deposits-to-borrowings ratio (both CRR & SLR) is set by the Reserve Bank of India and decides the bank’s capacity to give out loans. At the moment, it’s around 25 percent.

We come to the final step in this chain of events: The Specified Bank Notes (Cessation of Liabilities) Bill, 2017, aka “Note Ban” Bill.

The first order of business for the government after they announced Budget 2017 was to introduce this bill which would wipe out the liabilities of the RBI against un-deposited old demonetised notes. The Attorney General claimed right after November 8 that out of the Rs 15 lakh crore currency they demonetised, only Rs 10-11 lakh will come back into the banks. The remaining 4 lakh crore is all black money, so it won’t come back.

Well, that didn’t go as planned. Oops.

The Government was all excited about a large chunk of old money not coming back because then they could wipe that amount off RBI’s books. Every note you hold in your pocket is a liability for the RBI. It represents a value and our central bank is the ultimate guarantor of that value. If you go all Heath Ledger Joker on a stack of money, it ceases to be a liability.

People did this IRL. Stacks and stacks of old currency was destroyed right after November 8.

It’s become quite clear that the Government and RBI both want to prevent the remaining undeposited old notes from coming back. On December 30, they cleared an ordinance which stopped anyone from depositing old notes into banks, except NRIs who weren’t in the country during the 50 days of note ban. The note ban bill extinguishes the liability of RBI towards these undeposited notes.

If you hold old notes, you might as well do a Joker-inspired bonfire with them now because this bill also makes holding them a criminal offense.

One of the things this extinguished liability will be used for is solving the nightmarish situation our banks are in. I’m not saying this, the Economic Survey 2017 is:

The Note Ban Bill was introduced in the Lok Sabha last Friday before it got abruptly adjourned.

The Specified Bank Notes (Cessation of Liabilities) Bill, 2017 is listed for consideration and passing in Lok Sabha on Tuesday, February 7. There is a high chance that this will be certified as a money bill by the speaker once it is passed and Rajya Sabha will not get a chance to debate/vote on it. Given Bharatiya Janata Party’s majority in Lok Sabha, this bill will easily sail through, extinguishing whatever liabilities RBI has towards old notes. The surplus will then be transferred to banks so that they can continue their merry misadventures.

What would be interesting to see would be exactly *how much* of this liability will be extinguished. Till now, the RBI and government have kept mysteriously silent on how many old notes have come back as a result of demonetisation. Perhaps they will reveal the magical numbers in Lok Sabha since the Note Ban bill is completely and utterly concerned with the benefits derived from that apocalyptic exercise.

The author can be contacted on Twitter @Memeghnad