“There you go again.” That was former US president Ronald Reagan’s famous one-liner during the 1980 presidential election campaign trail.
If one reacted – upon hearing the Narendra Modi government’s new bank rescue plan, where Rs 1.36 lakh crore will be injected into the public sector banking system – with Reagan’s favourite comeback, it shouldn’t be a surprise. After all, we only need remind ourselves of the past half-hearted and hence ineffective efforts over the last three years to dig our way out of the public sector banks’ pile of bad loans.
Dominating the Indian banking scene since 1969 bank nationalisation intiative, public sector banks holding around 70% of the market are saddled with 80% of bad loans of the entire banking sector. In technical parlance, these are called non-performing assets (NPAs).
The NPAs are the result of the ceaseless operation of the two forces on the Indian scene: “imperatives of societal concerns and thus torn between the dilemmas of efficiency and equity”, so aptly summed up by a former Deputy Governor of Reserve Bank of India (RBI), Rakesh Mohan, and Professor Partha Ray of IIM Calcutta in their study on Indian financial sector.
An unenviable world record
The NPAs of all commercial banks, according to the first Economic Survey for 2016-17, stood at 12% of GDP, as of January 2017. This is officially acknowledged by the survey to be higher than in any emerging market and with the sole exception of Russia in the developed world.
This week, the government announced yet another rescue plan of Rs 2.11 lakh crore. It comprises recapitalisation bonds, accounting for Rs 1.35 lakh crore; Rs 580 billion from share sales by banks; and Rs 180 billion from budgeted recapitalisation fund.
Enthusiastic financial institutions and share market pundits hailed the effort as the ultimate remedy – Kotak Institutional Equities has even referred to it as a bazooka.
From alphabet soup to bazooka
Economic commentator and journalist Manas Chakravarty, in a comprehensive analysis, has dubbed the various initiatives of past years as alphabet-soup of initiatives. They carry “the difficult-to-remember” abbreviations. These include AQR (Asset Quality Review), ARC (Asset Reconstruction Companies), SDR (Strategic Debt Restructuring (SDR), and the S4A (Scheme for Sustainable Structuring of Stressed Assets) and so on.
Citing the Economic Survey for fiscal year 2016-17, Chakravarty has argued that such past initiatives have not been successful since (i) banks are unwilling to recognize losses; (ii) there is no coordination between consortium lenders; (iii) bankers want to avoid any investigations and inquiries, resulting in writing down losses; and (iv) bankers fear that banks’ capital position, already strained will be further eroded , if large write-offs are required.
The latest on bad loans
The unofficial, but assuredly the latest were the data released a week ago by RBI through a right-to-information request. They revealed banks’ total stressed loans – including non-performing and restructured or rolled over loans stood on October 11, 2017 at Rs 9.5 lakh crores (Rs 9.5 trillion or $145.6 billion); they were as a percentage of total loans at 12.6%; they were at end-June, the highest level in 15 years; and they rose by 4.5%in the six months to end-June. In the previous six months they had risen by 5.8%.
The deteriorating quality of assets has been causing concerns regarding stability of the financial system. Aside from long term stability concerns, the immediate concerns are about the observed steady fall in credit to private sector, which is affecting private sector investment and economic growth. A major proportion of non-recoverable loans are the public sector banks, notably State Bank of India and its associates; most of them are due from large conglomerates, in steel and infrastructure. The banks are now required to make higher provisions to account for more defaulters being pushed into bankruptcy. Under the strict provisioning regime introduced in August 2017, RBI requires the banks to provide for at least 50% of the secured loans to companies taken to bankruptcy proceedings, and 100% for the unsecured part.
It has also been reported that a dozen of the biggest such cases account for nearly 1.78 trillion rupees, or a quarter of total NPAs; and hence more than 20 other sizeable companies are at risk of being taken to bankruptcy court. Since banks have been the main source of financing private sector credit needs, the growing bad loans problem has reduced bank profits; and fear of new debts has further discouraged new lending, especially to smaller firms.
Growth rate of new loans during Jan-March quarter of 2017 is 5%. That is the lowest growth rate in more than six decades. The decline is also steady, which is of great concern at a time when India’s growth rate, though positive, has been falling for the last few quarters. Economic growth rates for the past four quarters are: 2.4% for 2016 Jan-March; 1.5% for July-Sept 1.5%; Oct-Dec: 1.6%’; 2017 Jan-march 1.5%; April-June: 1.3%; and July-Sep 1.4%.
That is enough for international rating agencies ready to mark India “not so safe destination” for foreign investment. The rattled government with one eye on immediate elections in two states and of course the other eye on the next parliamentary elections felt it has to do something, more radical than before.
What is the bazooka rescue plan?
Similar bond sales took place in the 1990s to recapitalise banks, through a route which was considered liquidity neutral. The banks sold their shares to the government, which in turn sold these bonds to the banks in return. The details of Rs 1.35 lakh crore are being finalised. These could play out in several ways. One would be government allowing the banks to sell the bonds and realise proceeds; and government assuring the bond holders of return of principal and regular interest payment.
The other is on the lines of oil bonds: the government will sell the bonds to banks, who will be allowed to sell them for cash. Whatever the way, the sale of bonds for recapitalizing banks will have fiscal implications. This will be a textbook case study of quasi fiscal operations. The interest payment obligation for Rs 1.35 lakh crore would be around Rs 9,000 crore. The government is confident this cost would be “offset by spur in economic activities due to increased credit and private investment”.
The fiscal deficit for the current fiscal year has been targeted at 3.2% of GDP. Pointing out to accounting practice of International Monetary Fund (IMF), India’s chief economic adviser has argued the recapitalisation will be shown below the line, and not part of the fiscal deficit. However, he conceded that that under “our own accounting practices, it is above the line and part of the deficit. The reason it is below the line is because when you recapitalise, you don’t directly add to the demand for goods and services, which is what the deficit measures. So in that sense it is not going to be inflationary”
Indeed, it is good defense of the recapitalisation.
So far, nobody talked about previous bond programmes. While there is some evidence to show that a similar intiative in India in the 1990s was successful, it’s unclear whether the government conducted a thorough study on the matter. Nevertheless, international experiences of similar recapitalisation of the 1990s elsewhere, notably in the former socialistic satellite states of the Soviet Union are available.
In his book, Banking Reforms in Southeast Europe, Professor Zeljko Šević writes about the 1995 Czech banking crisis thus:
“The recapitalisation (substitution of contaminated assets with government bonds) did not prevent a further accrual of NPAs. As a result, a banking crisis could not be avoided in 1995 and particularly in 1996, because the Czech bank could collect hardly any collateral from their debtors”
In a jointly authored work Quasi fiscal operations of Public financial institutions, G. A. Mackenzie and P. Stella, referred to Poland’s case foreign liabilities of were accepted by government. The government in turn issued bonds to compensate the banking system for foreign currency losses on these bonds and interest payments were incorporated in the annual budget. Notwithstanding these, banks continued to incur bad debts because of loans to loss making domestic making enterprises continued.
In a 2005 World Bank publication on Learning from a Decade of Reform, focusing on Indonesia’ s banking crisis, Robert Zaga and Gobind Nankani observed although recapitalisation enabled removal the debris of the old financial system with NPAs, bonds represented much of the system’s assets.
They underlined the need for reforms in governance of all credit institutions. That brings us to discussion of the remaining reforms for consideration and implementation.
Reforms initiated during the mid 1990s under Narasimha Rao first and then continued by Manmohan Singh heralded an era of liberalisation. They have to be pursued with vigour. Bipartisan support between the two major parties and allies is critical, as we saw in recent times in regard to successful introduction and implementation of Aadhaar and GST, regardless of who initiated them.
One more reform is still needed: that will be putting an end to state ownership of banks. Ending the public sector ownership is the ultimate reform: that is the mother of all reform measures.
The reforms of the 1990s ended the phase of Janardhan Poojary’s bank melas with helicopter money of depositors thrown to all and sundry, regardless of their creditworthiness. It ended one extreme but it brought in the beginning of another extreme: crony capitalism with loans to friends and nephews of politicians and industrial conglomerates with blessings of the powers that were in charge.
The pendulum always swings. The present government should end it by completing the reform cycle. That deserves the support of everyone, from across the party lines. We end with another quote from the great communicator: “You can accomplish much if you don’t care who gets the credit”.
T.K. Jayaraman is a research professor at the International Collaborative Partner programme, University of Tunku Abdul Rahman, Kampar, Perak, Malaysia.