Most economists would agree that India’s growth story has taken a pause – a rather long pause. The past two quarters have been a washout, largely because of demonetisation, and the outlook for the remaining part of this calendar year is overshadowed by disruptions caused by the introduction of the goods and services tax (GST). There has been some improvement in broader economic indicators, such as industrial production and exports, but not enough to suggest the worst is behind us.
More than the impact of demonetisation and GST, what keeps the economy from turning around fast is the sharp erosion in the ability of the banks in the country to lend for growth. A sustained accumulation of bad loans, or non-performing assets, which now stand at an alarming 9.6 per cent of total lending, has left most banks, especially in the public sector, shy of financing new projects.
Underscoring the seriousness of the situation, the government brought an ordinance in May to empower the Reserve Bank of India (RBI) to intervene and initiate insolvency process on “specific stressed assets”. Last week, the lower house of Parliament replaced the ordinance with an amendment to the Banking Regulation Act, in a move seen as providing political cover to the central bank in its actions against erring lenders and loan defaulters. The RBI has already asked banks to initiate bankruptcy proceedings against 12 large loan defaulters, accounting for a quarter of nearly `9 lakh-crore that the banking system has piled up in bad loans. More cases will follow in the months to come.
These actions have raised hopes that the NPA-hit banks, mostly state owned, will return to good health and provide the impetus that the economy needs to climb back to a high growth trajectory. It will be a long haul, however. And there are many imponderables.
Although the RBI is empowered to initiate insolvency resolution, there is nothing that stops a defaulter from going to court to challenge the central bank’s action. It will take some time before the ongoing bankruptcy proceedings set some precedents that can help pre-empt any defaulter from challenging the lender’s actions.
It is also imperative that the central bank and the lenders move fast in initiating insolvency resolution. Banks run the risk of recovering less and less of their money as the value of the assets created with their loans falls with every passing day.
The other challenge facing the PSU banks relates to the capital they have. As they get down to cleaning up their balance sheets, some of their capital will get depleted. Already, the capital adequacy ratio in the case of several PSU banks has fallen below the internationally prescribed norms. The government has indicated it would infuse new capital, but has yet to make a firm commitment on the quantum and timing.
That said, the current actions are tailored to address the stock of bad debt, but not the causes behind the generation of bad loans. A three-part series in Hindustan Times, beginning Monday, offers a broader explanation on how India’s banking system ended up with such a big pile of bad loans. Why did the companies borrow so heavily? Why did the banks keep lending to defaulters? Where and how borrowers over-leveraged and lenders made wrong calls? Answers to these questions put the spotlight on issues of governance and credit discipline at banks that must be addressed to find a more sustainable solution to the current crisis.
Last, but not the least, as the central bank works to put the banking system back on track, the government needs to act on reviving fortunes of those sectors where most of the bad loans accumulated – power, telecom, construction, textiles and steel. These sectors are crucial to fuelling economic growth and creating jobs, and, at this point, these are no-go zones for bankers. That must change. Otherwise, when the banks eventually return to good health they won’t have enough borrowers to lend to.