Economy needs the lunch to be served. It doesn’t have to be free. – ET Prime

The Asian crisis had its roots in US commercial banks that had given loans to the private sector in these countries but never got repaid. The three countries– Thailand, Indonesia, and South Korea – were caught between a rock and a hard place because of the huge foreign-currency debts of their domestic banks and corporations. Each of them received the International Monetary Fund (IMF) loans and decided to support the private sector in its struggle to honour debt obligations. The Latin American crisis has a similar tale. US bank loans to the private sector were replaced by sovereign debt, which evolved into the famous Brady bonds.

In short, the US banks were bailed out by the taxpayers of Asian and Latin American countries during crisis periods.

Cut to 2020 , the trend has become more ingrained, notwithstanding the dissent notes from several quarters.

More often than not, private sectors around the world reach out to their governments for fiscal lifelines whenever a crisis hits them. While questions around moral hazards of using public money for a private cause may emerge , the opportunity cost of not intervening is huge as well. The world has experienced it during the 2008 global meltdown, when too-big-to-fail entities were saved a precipitous fall using taxpayer funds.

The US economy, and its ilk, with a much wider tax base, can do a similar rescue operation with much less heartburn. However, in India losses will spread more disproportionately, with a weaker mechanism keeping a tab on failed businesses.

In this article, we make a case for private-sector bailouts and argue that when a corporate recovery happens, the first slice of profit should come to the central exchequer. The concerns of moral hazards shouldn’t paralyse the government’s intent to recapitalise ailing corporates.

Slowdown worsens government finances as tax and non-tax revenues dwindle. For instance, GST collections for March 2020 was a mere INR28,000 crore against an average INR90,000 crore-INR95,000 crore during normal times. Corporate bailouts will help revive firms and when the cycle reverses, tax collections will see a direct positive impact and the fisc will see significant improvement. Hence, while it is true that there are no free lunches, bailouts in the event of exogenous shocks like the present bodes well for future government finances.

Corporate bailout in the Indian context
The governments in India have directly and indirectly acceded to the private-sector demand for fiscal support. There is a long list of largesse that shows how taxpayers have filled in for troubled businesses – the corporate tax cut worth INR40,000 crore, recapitalisation of public-sector banks to the tune of INR3.11 lakh crore, sector-specific packages for the real-estate sector, banks selling assets with large haircuts, waiver of agriculture loans, and bad-debt write-offs.

But remember, bailing out usually helps large entities and the informal sector is invariably left out.

Professor Maitreesh Ghatak of London School of Economics tells ET prime, “In the Indian context, we have to remember that the bulk of the workforce is informally employed. So, the case for supporting businesses to meet their payrolls, which does not include them (the informally employed), is not compelling.”

Although large corporations have no direct link with the informal sector, they are not completely detached either. The formal sector depends on informal players for varied requirements and purposes.

Though losses are socialised using taxpayer-funded bailouts, businesses privatise profits. This moral hazard evokes slow policy responses for an outright bailout of corporations. The informal sector, too, will require direct government intervention. The fear of bailouts can, however, be obviated if these fundings earn a return. Different approaches can be explored to achieve this.

The tools to deliver bailout funding

• Share burden of the costs: To start with, the governments can shoulder a portion of interest and wage costs incurred by the corporations. According to Capitaline data, listed companies in top sectors incur an annualised INR7.76 lakh crore on account of interest expenses and employee costs. Wage costs alone account for INR3.75 lakh crore and even a 20% wage cut ensures a saving of only INR75,000 crore. If the Centre and the states chip in to support with a 50% share, the additional outgo would be close to INR3.85 lakh crore each.

The paycheck-protection programmes adopted by the US, Germany, and Australia can serve as good models for India. This can be accompanied by conditions that wage cuts ought to be bare minimum and retrenchments not resorted to.

According to Karthikeya Naraparaju, assistant professor, economics, IIM Indore, corporates may be offered relief packages with conditions. “A reasonable conditionality to receive a relief package should be to ask the businesses not to engage in retrenchment due to this pandemic and also to have some degree of moratorium on dividend payments, share buybacks, and also caps on executive compensation in the short run.”

• Help for informal-sector workers: This approach involves the government announcing employment guarantees and relief packages. The most effective would be direct money transfers to the Jan Dhan accounts — 380 million as on April 1, 2020. A one-time transfer of an additional INR5,000 to all Jan Dhan account holders would entail an incremental expenditure of INR2 lakh crore.

Both the above measures will increase the fiscal burden by INR7.5 lakh crore which is 3.85% of GDP. Bailouts and relief packages, however, should not be free lunches. Some approaches to generate returns are highlighted below.

Bailout mechanisms that can earn returns for the exchequer

• The Danaharta experiment: Danaharta is an asset management company (AMC) formed in Malaysia backed by a 1998 statute called Danaharta Act. The AMC was formed to buy distressed loans from banks at a discount and also to save distressed companies. The statute gave the Danaharta bank the powers to restructure or allow easier repayment terms to the company. The AMC would buy the stressed asset from the seller banks on the condition that 80% of any excess from recovery, after accounting for costs, would be shared with the sellers and the rest 20% would go to the AMC. Malaysia’s non-performing assets declined significantly from 6.5% of total loans in February 2006 to 1.5% by May 2019. Danaharta can also act as a seller of loans and thus, in essence, would have all the rights available to a buyer and the seller.
• The Troubled Asset Relief programme (TARP) mechanism: TARP was initially signed into a law in 2008 with the objective of providing liquidity to money markets by purchasing mortgage-backed securities from eight troubled US banks. Later it was modified to enable the US Treasury to purchase equities in banks and financial institutions. The Treasury was given approval to invest USD700 billion initially which was later scaled down to USD475 billion. While investing in troubled institutions, the treasury insisted on certain conditions including a 5% annual dividend, foregoing certain tax benefits, and restrictions on executive compensation. By 2010, the initial investment of USD426 billion made in 2008 had grown to USD442 billion generatingUSD16 billion to the exchequer. India, too can develop a similar mechanism and the domestic sovereign wealth fund, National Investment and Infrastructure Fund (NIIF), can take the lead.
• Balloon repayments and subjecting informal sector to tax: The fiscal lifeline to the industry has to be conditional, and it may envisage a balloon repayment back to the government at a risk-free rate, say the 364-day T-Bill (treasury bill) rate after a time period of six months to one year. If this model is applied to finance interest and employee costs of India’s private sector, the Centre and the states will receive INR4.1 lakh crore each after one year at a yield of 6.5%, which is a gain of INR30,000 crore or an eight basis points(bps) reduction in combined fiscal deficit. Similarly, the informal-sector dole needn’t be free either. If informal-sector businesses are taxed at a nominal rate of 5%, it will bring back INR11,500 crore to the central exchequer. So, the returns from the stimulus to the industry and informal sector alone will reduce 5 bps from the Centre’s fiscal deficit. The numbers will look much better if the economy improves due to the stimulus and tax revenue registers decent growth.

The bottom line
Socialisation of losses is inevitable. The moral hazard can be minimised if the bailouts have strings attached and are conditional, enabling the exchequer to generate returns on investments. To be sure, the industry will continue to earn profits when the economic cycle reverses and profits will remain privatised. However, by enabling the government to earn some return on the taxpayer money, it will be a win-win for all.

(Research support by Rochelle Britto)

(Graphics by Sadhana Saxena)

Read the full article now

Become a member

Why Subscribe?