Sunday, September 14, 2014

India's biggest immediate public policy challenge

I am surprised why the problems facing our banking sector does not get the attention it deserves. It is arguably the biggest short to medium-term problem demanding the attention of the Government of India. Its resolution is central to realizing the massive infrastructure investments that are necessary to ease important supply side constraints and sustain a reasonable economic growth rate.

ET puts India's corporate debt restructuring challenge faced by its predominantly public sector banks in perspective,
The total of banking system's net owned funds is under Rs 7,10,000 crore as of March-end 2014. The stated non-performing loans (NPLs) are around Rs 3,00,000 crore and the estimated level of NPLs, including restructured assets, is around Rs 10,00,000 crore. 
It is no hyperbole to say that India's banking sector is in a crisis. This "negative equity" situation is compounded by the additional capital requirements placed due to the Basel III norms which are due for implementation by March 31, 2019. There is no substitute for massive capital infusions, either directly from budget resources or through divestment of government equity. The RBI appointed PJ Nayak Committee estimated an additional equity capital requirement of Rs 3.1 lakh Cr over the next four years for public sector banks to comply with Basel III norms, sustain a credit growth of 16%, and provision for 30% restructured assets turning bad.

It is abundantly clear that government does not have the fiscal resources for direct recapitalization. Raising this capital through divestment cannot happen without lowering government stakes below 51%. In any case, without additional capital infusion, the ambitious infrastructure investment plans will remain still-born.

There is no way we can wish away a problem of this magnitude or hope that economic recovery will generate the resources required to tide over. A sustainable economic recovery itself is contingent on supply of infrastructure resources or atleast an expectation of it.

Clearly, any solution has to embrace a mix of both options, coupled with strong commitment to recover impaired loans from corporate defaulters. But immediate action is required since kicking the can down the road will not only increase the cost but also postpone the green-shoots of sustainable economic recovery.

Update 1 (23/9/2014)

Moody's says that the 11 Public Sector Banks rated by it, representing 62% of total loans in Indian banking system, will need to raise additional equity of upto $37 bn (Rs 2.2 lakh Cr) by March 2019 to meet the Basel III requirements. 

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