India’s Bad Loans Problem

By: Utkarsh Shalla

As Modi’s first term comes to an end, this longstanding banking crisis comes as an economic test of his Prime Ministership

A week before Finance Minister Arun Jaitley presented his Union Budget to parliament, his government announced its plan to infuse $13.8 billion of its $32 billion recapitalization plan into twenty of India’s public sector banks in exchange for reforms. The plan bears 1.3% of the country’s GDP and is the largest “bank bailout” in the past thirty one years. First and foremost, the plan does sufficiently address the immediate problem of the banking industry; the majority of the country’s financial institutions are government owned, with almost every public bank holding overwhelming percentages of NPAs(Non-Performing Assets). That being said, if these public sector banks faced bankruptcy it would mean a nationwide credit crunch worth 70% of the entire banking system. The government needs to tackle the long standing duality of over-indebted private firms and under-capitalized public banks, called the “twin-balance-sheet problem.”

Unfortunately, historically bank recapitalization in India has almost always been ad-hoc and piecemeal. Credit crunches have occurred before, and the government has always opted for the traditional Keynesian recourse, much like the current administration’s efforts, but what remains interesting to watch is the efficiency with which the Modi government enforces banking sector reforms. India’s infamous crony socialism has seen the federal government repeatedly bail out irresponsible, yet politically connected, industry giants after every cycle of bankruptcy, only to again recapitalize them later on.

Although recapitalization of this magnitude will bring at least temporary financial confidence, it isn’t just the lack of money that is the concern as much as its management. This credit crunch traces its origin in the previous administration’s careless decade- long distribution of credit to unreliable and unscrutinized portfolios. The usual tradition of large public sector banks lending to equally large monopolistic industry giants has been exposed to be so toxic that the government ownership of banks itself has lost its traditionalist socialist appeal. The Indian federal government owns an overwhelming 21 banks, only increasing the possibilities of red tape in the banking system. However, as part of his program for disinvestment of public assets, FM Jaitley has not yet considered the privatization of these inefficient institutions.

However, the Finance Minister’s worries don’t just end with the plan’s implementation; having crossed its deficit target, and with state treasuries exhausted, the Modi Administration wants to use “recap bonds” to finance the recapitalization plan. Considering the monetary enormity of the plan, such a large influx of supply in the bond market should surely cause bond yields to soar and prices to fall. Higher yields will substantially drain bank’s treasury portfolios, causing Mark to Market losses; furthermore, as corporate banks are the largest buyers of government bonds, the administration can’t afford to try to save public banks from insolvency while depreciating private bank portfolios at the same time.

This recapitalization plan, after years of India’s banking system being ignored, has rightly come to the media and public’s attention; thus making the economic consequences of this plan, and the annual Union budget extremely significant for Modi’s bid for a second term. Even though the BJP has been able to win a majority of seats in the past assembly elections, the opposition has come back strongly from the shambles it was in back in 2014. This only enlarges Modi’s list of obstacles towards a second term in office. Thus this recapitalization plan owes its significance to the fact that it can very well determine the result of the upcoming 2019 national election.

Sources Cited: