RBI, Centre see leap in economy

Finance ministry is working on structure of recapitalisation bonds, announcements likely over next few weeks

Reserve Bank of India (RBI) Governor Urjit Patel on Wednesday hailed the government’s bank recapitalisation plan, terming it a “monumental step forward in safeguarding the country’s economic future”. 

Analysts said the plan could boost credit growth by 10 percentage points over the next 12 months.

In an unusual communique on the central bank’s website early in the day, Patel said the plan would front-load capital injection while staggering the attendant fiscal implications over a period of time. “As such, the recapitalisation bonds will be liquidity neutral for the government except for the interest expense that will contribute to the annual fiscal deficit numbers,” he said. 

Chief Economic Advisor Arvind Subramanian also said in a speech that the “true fiscal cost of issuing the Rs 1.35-lakh-crore recapitalisation bonds is the interest payment of about Rs 8,000-9,000 crore”. The impact was unlikely to be inflationary, he said. “It is likely that the recap bonds will be placed with the banks, for which the government will get an equivalent holding of equity in the banks. This will strengthen the capital base of the PSBs and allow them to strengthen and increase their lending.” He added if the Centre issued the bonds, its debt would rise but whether that would add to the fiscal deficit would depend on the accounting. Under standard international accounting, such bonds did not increase deficit as they were “below-the-line” financing, but in India, these bonds would add to the deficit, he said.

In his effusive statement, Patel said that “for the first time in the last decade, we now have a real chance that all the policy pieces of the jigsaw puzzle will be in place for a comprehensive and coherent, rather than piecemeal, strategy to address the banking sector challenges”. 

The calibrated capitalisation would allow banks with better balance sheets to use fresh capital for immediate credit creation as the others shaped up, Patel said. Analysts said the move had the potential to prop up economic growth. “If the banking system leverage ratio remains constant, the capital infusion could lower the drag on bank credit growth by up to 10 percentage points and boost GDP growth by up to five percentage points,” said Goldman Sachs in a report. 

Morgan Stanley said aggressive recapitalisation was needed to fight the bad loan mess. “Now banks can take the required hits, make proper provisions and move ahead. The insolvency code was helping NPL resolution, now this will accelerate,” it said while advising its clients for the first time since 2011 to go “overweight” on SBI and PNB. The finance ministry is working on the structure of the recapitalisation bonds and announcements are likely over the next few weeks. While an improvement in the growth outlook was likely to be bullish for equities and supportive of the rupee in the medium term, there was a potential for deterioration of the fiscal position, Goldman Sachs said. 

It, however, added “medium-term fiscal fundamentals could actually improve, should private sector growth and private corporate investment spending rebound meaningfully following the easing of credit conditions”. An official said the finance ministry was looking at either the Centre issuing the bonds and paying the interest and principal upon maturity or a government-owned company or agency issuing these bonds with the Centre providing a sovereign guarantee and paying the interest.

“If the Centre issues these bonds in lieu of equity, then it will pay the annual interest to banks. Upon maturity, the principal can be repaid by the Centre by selling the stake,” said an official. The finance ministry is deciding on the coupon rate for the bonds and whether these securities will be marketable and count toward the statutory liquidity ratio. Another official said like recapitalisation bonds issued in the mid-1990s, these bonds might not be held till maturity. Banks would initially not be allowed to trade them on the secondary markets but would be permitted later, the official added.

On Tuesday, Finance Minister Arun Jaitley had said banking sector reforms would continue alongside their recapitalisation. 

The second official said this meant stricter monitoring of steps banks had taken. 

“What have they done with the capital infused so far, how have they dealt with non-performing assets, what is the progress in cases that have been referred under the insolvency and bankruptcy code, how effective has their provisioning been? These are the issues we will look at,” the official added. These parameters will also decide which bank receives how much capital.