India’s “Bad Loans” Problem

By: Utkarsh Shalla

Will the Modi Government be successful in bringing promised growth? Or is it actually ignoring a more significant structural problem in the economy?

When the Narendra Modi led Bharatiya Janata Party (BJP) came into power in April 2014, it was elected in the hopes that the new PM would bring desperately needed economic change to the precarious condition the Indian economy was suffering through. A free falling Rupee, decreasing economic growth and a long list of corruption scandals spurred enough anti-incumbency sentiment for the development and growth focused Modi campaign to sweep into power. However, although the economy has performed well since the past three years, a series of disruptions to led by the controversial November 8th currency ban (or demonetization) and the highly publicized GST (Goods and Services Tax) have changed the national tone about the economy.

During the second quarter (April-June) of this year, India grew at 5.7%, the lowest its growth rate has been since the government came into power in 2014. Soon after the RBI, India’s central bank, revealed that Demonetization didn’t quite meet its objective of clearing the economy of “black money” , the government came under pressure as the nation started questioning disappointing growth numbers. Manufacturing, Agriculture, small scale industries, domestic consumption, and investment demand all have taken a hit. The government has faced a national backlash; with the next general elections only two years away, and several key state elections falling in place even before, the Modi administration realises it cannot fall prey to the same anti-incumbency that brought it into power in the first place. The same government that came into power with the slogans “Sabka Saath, sabka vikas” (“Everyone’s support, Everyone’s development”) is now being questioned of its ability to deliver jobs to the roughly one million workers that enter the labour force each month.

However, while GST and Demonetization certainly were disruptive forces that structurally changed the economy, there is little evidence that they are the central reasons for this sudden fall in growth. I argue, that the source of this stagnation is the underperforming banking system, which has been clogged due to the long list of Non-Performing Assets (NPAs) in the public banking sector’s balance sheets. NPAs are the toxic assets, or loans, wherein the borrower has defaulted and thus the bank is unable to receive repayment. Stressed loans have reached a record 12.6%, about $153 billion, of the total share of loans, with most being owned by the government controlled public sector banks, which actually form over 70% of the entire banking system of the country. That being said, to ignore how formidable an obstacle the NPA crisis is to India’s growth would be to overlook an impending financial meltdown and credit crunch, of unimaginable severity in the history of Indian economic crises.

The government has responded by two major plans; one, a very traditionally Keynesian fiscal stimulus in the form of $107 billion in infrastructure spending and two, a major $32 billion bank recapitalization plan. Perhaps inspired from the former PM Atal Bihari Vajpayee’s central India highway plan, the government plans to invest in a large network of roads connecting several industrial cities with each other, and there’s no denying that India’s infrastructure could sure benefit from an upgrade. The recapitalization plan is much like the US Troubled Asset Relief Program (TARP), implemented to prevent a credit collapse after the financial crisis. While, such may seem as an ideal solution to the problem, it raises the question of who will pay for these programs. Uptil now, the government has only vaguely mentioned that two thirds will be raised by recapitalization bonds and the rest by “budgetary support”; moreover, state treasuries are exhausted and deficit spending can lead to crowding out for the private sector in the long run. Although the government desperately needs to unclog the banking system to see long term growth, it cannot ignore its commitment to fiscal responsibility. Moreover, it isn’t just the current presence of NPAs that are the central problem, it actually is the irresponsible lending that public banks undergo due to political pressure; once these troubled banks are stabilized, the government must then look towards privatization of its unnecessarily large ownership of the country’s banking system.

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