Crisis of slowdown in economy linked with NPA of Banks

The International Monetary Fund (IMF) has lowered its economic forecast for India for the 2017 and 2018 financial years  to 6.7% and 7.4% respectively from the one made earlier this year as India’s economy is slowing down despite the global economy picking up steam.

The IMF forecast has downgraded India’s GDP growth rate by 0.5% for 2017 and 0.3% for 2018 from the forecast it made earlier this year in the latest World Economic Outlook report released recently. The report echoed the popular views of many an Indian economist that the syndrome of demonetisation and implementation of GST as being responsible for the economic slowdown.

India’s own government agencies had predicted that the country’s economy would chug at 5.7% for the 2nd quarter of Financial Year 2017-18 against the record 7.9% recorded by the Modi government months before demonetisation and  GST were introduced in FY 2016-17. So what ails the Indian economy? What are the reasons for the slow growth? Banks are flush with money about a trillion rupees, foreign exchange is touching a record 400 billion USD with a record inflow of about 32 billion USD in one single month in September this year, inflation is under control, manufacturers are holding back investments, small economy is yet to recover from the crushing effects of demonetisation of rendering them cashless, and India still remains the favourite destination for foreign investors.

So why this paradox? Let’s delve into short economic history a bit. First let’s look at some basic facts of India’s economy. India’s GDP  as of 2017 is US$ 2.454 trillion which in economic terms is nominal figure and real GDP is US$ 9.489 trillion (PPP). India holds the sixth position in the world as per its GDP growth though described as the fastest growing economy in the world beating China to 2nd place. Agriculture share in GDP is about 47%, industry is about 22% and services sector mainly dominated by IT sector is 31%. Compare this with 2016 when agriculture was 17.32%, industry 29.02% and services sector 53.66%.

In 2016 inward remittances reached US$ 318.50 billion and is set to cross US$400 billion before March 2018 with record inflow of US$38.2 billion in September 2017. Outward remittances amounted to US$144.3 billion in 2016. United States, European Union, and UAE emerged as India’s top trading partners with India’s export to these countries amounting to 17.6%, 16.1% and 11.5% of the total export basket. China accounted for 8% of which Hong Kong alone accounted for 5%.

In terms of imports, India got most of its stuff from China first at 17% of the country’s import basket, mainly steel, 11.3% from the European Union and USA 5.7%. UAE accounted for 5.4%. If the UPA government of Sonia Gandhi- Dr Manmohan Singh was accused of “Policy Paralysis “, the Modi-Shah government is being accused of “Investment paralysis” since the onset of demonetisation and GST.

Banks are flush with over one trillion rupees and yet the economy is slowing down, manufacturers don’t want to invest, don’t want to borrow internally or externally and banks too are reluctant to lend despite sitting on a huge cash pile. Government has shrunk public expenditure considerably to help rein in inflation to single digit figures and keep it there which explains why RBI does not want to drop lending rates by making only small adjustments like changing the repo rate , the rate at which the banks borrow from RBI or RBI lends to commercial banks.

Lending rates are still high with commercial banks. What ails the banking industry exactly? What do agencies tracking growth think of the slow motion growth slow motion banking crisis? Both internally and externally. US based Bloomberg which tracks more or less accurately say“India’s slow-moving banking crisis continues to drag on, as ponderous and unstoppable as the state-controlled banking sector itself. A recent study found that the gross “non-performing assets” of state banks rose 56 per cent in 2016, and 135 per cent in the last two years. They now account for 11 per cent of all state bank loans.”

Whiles it’s easy to do number crunching, these figures are hardly reassuring. Yet the government — which, after all, owns these banks and thus dominates the Indian financial sector — appears relatively unconcerned. In the most recent budget, the government set aside barely $1.5 billion to recapitalize the banks, the Bloomberg report says. Banking circles claim that the over Rs 75,000 crore announced for recap of banks is yet to take place fully to handle the NPA crisis.

The Bloomberg report says; “Who has time for a slow-moving crisis in India, a country where life comes at you fast? Instead of being allowed to focus on bad loans, the state-controlled banking sector has been buffeted by one task after another dealt out by its principal owner. Banks have spent months dealing with the fallout of Prime Minister NarendraModi’s decision to withdraw 86 per cent of India’s currency. There still aren’t enough currency notes in ATMs, as a senior finance ministry official admitted ( as of February this year)  And though forced deposits mean banks’ cash resources have increased, nobody knows for sure how much of that money will remain in bank accounts once withdrawal limits are lifted.” But RBI Governor Urjitpatel has claimed that 99% of the currency withdrawn is back in banks.

India’s biggest commercial bank , The State bank of India is becoming the government’s tool for other plans. Banks, claimed to be the primary conduit for drawing tens of millions of poor Indians into the financial system, are now,being told to solve India’s jobs crisis as well: Officials insist that a government scheme to provide easy loans to small entrepreneurs will help employment recover. So who has time to fix bad loans?

The agency report says government ‘s lack of attention is quite puzzling on the bad loan crisis, better known as the Non-Performing Assets of banks – debts of banks or loans not returned by people or industries who borrowed.  The bad-loan crisis, together with demonetization, has pretty much wrecked the credit pipeline — and, consequently, India’s growth prospects. Recently, credit growth hit 5.1 per cent, and the chief economist of India’s largest state bank, the State Bank of India, said that represented its lowest point since 1960. Most analysts expect credit growth to range between 5 per cent and 6 per cent in the coming months, nowhere near the double-digit numbers needed to get an investment recovery going.

Two things need to happen, the report says pointing out that state-controlled banks need to get these loans resolved; then the system that allowed them to build up needs to be demolished. ”Each of these has an obvious solution. The problem is that the government is simply unwilling to implement either one, “the report claims.

How severe is the bad loan crisis or the NPA problem of banks? To understand this well”We propose a new measure—the ratio of NPAs to bank capital. This measure shows that the crisis is indeed severe, among the worst in India’s history,” claimHarsh Vardhan and RajeswariSengupta, whoare, respectively, with Bain & Co. and Indira Gandhi Institute of Development Research.

According to the report published in a leading economic daily quoting them, “ The ratio of NPAs to GDP measures the potential losses in relation to the size of the economy. This is especially useful in cross-country comparisons, given that countries are at different levels of GDP. The problem with this measure is that it does not indicate whether banks are able to handle the NPAs with their own resources—their capital.”

The NPA to loans ratio suggests that the current crisis is considerably less severe than that of the late 1990s, the experts say adding that however, when NPAs are measured in relation to bank capital, the current crisis looks just as bad. In particular, the deterioration in the balance sheets of banks post-2010 is much sharper when measured using the NPA to capital ratio.

The emphasis on the alternative measure of the NPA problem also highlights the importance of capital in resolving the crisis. If the NPA to capital ratio is to be restored to a level that was prevalent during the high growth years of 2003-2007, the capital base has to roughly quadruple. Even if we assume that roughly 50% of the net NPAs will be recovered by the banking sector, the capital base has to double. This is unlikely to happen through retained profits or sale of real estate or other similar strategies, the experts claim

An attempt to revive the banking sector must include a credible commitment of capital for it to be meaningful. In absence of capital and accompanying structural reforms, any solution will be incomplete and the banking sector may remain in the quagmire for a long time to come.

So what seems to be the need of the hour is that government must implement its recapitalisation programme announced in the union budget as quickly as possible. Banks be allowed to lend at lower rates so that credit off-take takes place, industry is allowed to kick back in with more production and investments to reinvigorate, the economy, while government goes strongly after the defaulters who have contributed to the mounting NPA problem of banks, no matter how big a persona he or she  be, hiding overseas, or within the country and refusing to liquidate his or her  debts.

India’s growth prospects is therefore mainly linked to banking crisis being resolved by the government, manufacturers letting their purse strings loose and invest and massive job creation by both government and private sector in joint venture projects. Let’ s see what the Economic advisory council has to say to the PM even as the CEA Dr Arvind Subramanian outlines measures to restore growth in the economy before the EAC and PM.

T N Ashok is a Corporate Consultant, Resident Editor and Writer of Economic Affairs.