Monday, September 9, 2013

India's private sector debt induced banking crisis

India's version of crony capitalism ran something like this. Politically connected firms acquired public assets - land, mines, port and airport concessions etc - at extremely favorable terms. They developed these assets mainly through loans taken from the nationalized banks. Massive loans were most often extended without adequate due-diligence, at the behest of the Finance Ministry, which control these banks. Frequent recapitalization of these banks have kept them afloat. Rent-seeking has been pervasive, both at state and central levels.

After nearly a decade of this binge, the chickens have come home to roost. Public sector banks are saddled with large and unsustainably high non-performing assets, window dressed as restructured debt. Morgan Stanley estimates the share of non-performing and restructured loans at 9% in 2013 (up from 4% in 2009) and could reach 15.5%, or Rs 3.5 trillion, in the next two years. Most of the largest infrastructure firms are left with heavily debt-laden balance sheets whose adverse effects have been exacerbated by projects which have been inordinately delayed for various reasons and have undergone large cost over-runs. A recent report by Credit Suisse finds that the combined gross debt of the ten most indebted firms exceeded a staggering $100 bn last year.

The continuing economic weakness and plunging rupee is only worsening the situation. Indian firms hold nearly $225 bn of dollar denominated debt, half of which is estimated to be unhedged, leaving those firms badly vulnerable as rupee depreciates alarmingly.

There are no easy answers. As the new RBI governor announced, it is imperative that action be initiated to clear up the mess at the earliest. Whatever the form of debt restructuring, if we are not to unleash irreparable moral hazard, it is important that two things be borne in mind. One, private firms which borrowed and invested so recklessly should not be allowed to socialize their losses with favorable debt restructuring. India's version of "too big to fail" should be nipped in the bud. Second, this is a great opportunity to introduce greater professionalism into the management of India's public sector banks, especially the Finance Ministry's control over the bank boards. The debt restructuring should not be done by unconditional recapitalization of these banks.

Update 1 (14/10/2013)

From Livemint, about the concerns created by India's 10 most indebted corporate groups,
The combined gross debt of these 10 groups was Rs 63.10 trillion at the end of March. They also account for around 13% of the total loans in the books of Indian banks in fiscal 2012, a concentration risk that deserves regulatory attention. These large borrowers also have massive foreign borrowings, and anecdotal evidence suggests that much of it is unhedged. So the financial health of these 10 borrowers should concern not just their shareholders but also policymakers given the potential risks to financial stability.

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