Banking on Indian economy

In October 2017, Indian government announced a capital infusion plan of $32.43 billion into public sector banks over the next two years.

Will this be enough to revive the India’s struggling state-banks and boost the economy?

Background

A bad loan is one where repayments do not get made as originally agreed between the borrower and the lender. Indian banks have been struggling under high percentage of bad loans in the recent years. In fact, the bad loans (or non performing assets) incurred by Indian banks had hit an all-time high by the end of June 2017. The bad loans now amount to $145.56 billion.

NPAs result in affecting all facets of a nation’s economy. When the NPAs continue to grow, they will begin affecting a bank’s profits. Thus, banks in turn will not be able to serve the obligations they have towards their customers. During the first quarter of 2016, such as Bank of Baroda, Bank of India and Punjab National Bank posted significant losses. When a bank goes into loss, then it will not be able to offer any rate cut for their customers. Thus, all loans including car loans and home loans will become more expensive and affect the customers. India has 21 state-owned banks.

The Indian economy has significantly slowed down in 2017. Growth in Asia's third-largest economy slowed to a three-year low of 5.7 percent in the April-to-June period, according to official data. The roll-out of demonetization as well as the introduction of the new Goods and Services Tax have been blamed for it.

Analysis

In October 2017, Indian government announced a capital infusion plan of $32.43 billion into public sector banks over the next two years. Finance Minister Arun Jaitley said, “The decision to recapitalise public sector banks with 2.11 trillion rupees will address the bank balance sheet problem and push growth forward. Once you strengthen banks, markets' appetite for the stock will improve. For bank recapitalization, Rs. 1.35 lakh crore will be raised through recap bonds and Rs. 76,000 crore via budgetary support and equity issuance.”

Analysts estimate that Indian banks need an additional $40 billion to $65 billion to clean up bad loans on their balance sheets. This will help these banks meet the stricter capital requirements set forth in an international regulatory framework called Basel lll.

"Fitch believes the government will have to pump in significantly more even on a bare minimum basis (excluding buffers) if it is to address the system-related risks of a huge NPL (non-performing loan) stock, weak provision cover and poor loan growth," the agency said in a report.

"Like most banking systems in Asia, India is also seen as possessing strong government support but this view has recently come under some uncertainty," CreditSights analysts wrote in a recent report. "We think the government will continue to support the public sector banks and its reluctance to recapitalize them to stronger levels in part reflects a desire to impose more discipline on the banks."

India must sustain an annual economic growth rate of about 8 per cent if it is to stand any chance of creating the 8 million new jobs it needs each year to employ its rapidly growing young workforce. Economic consultancy Gavekal Research estimates India’s infrastructure funding needs at about 12 trillion rupees a year over the coming years. The Indian government will be highly reliant on state-banks to fund such projects, thus the health of these banks is imperative.

There are fears that the government’s efforts will not be enough. Apart from the fact, more money is needed to recapitalize the economy, if the government attempts to save money by paying only a low rate of interest on the bonds, then the earnings of the banks that hold them will suffer. Recapitalization bonds may crowd out genuine borrowers. If the government pays a competitive rate of interest, it risks encouraging the banks to hold its bonds in preference to making potentially risky loans to the real economy.

Ultimately there is no guarantee that injecting fresh capital will achieve little if the state banks do not change their ways.

Assessment

Our assessment is that it is too early to say whether the Indian government’s plans to recapitalize public-sector banks will be successful or not. It is possible that the Indian economy will recover from the current slowdown and the banks will be reinvigorated.