The over-all economic situation has given most observers within and outside the government cause for satisfaction, as well it should. However, the critical constraint that continues to face the government, when it considers how to accelerate economic growth, is excessive debt — in its twin manifestations. Bloated corporate debt still weighs down balance sheets and leaves little wiggle room for many large companies to undertake fresh investment; asset sales to repay loans have made slow progress, with many deals that made news not (or not yet) materialising. The flip side of this are the problematic loans that weigh heavily on bank books — forcing some of the more challenged ones to scale down fresh lending, if not virtually freeze it. The result is that fresh corporate debt has been growing at barely half the nominal GDP growth. But rapid growth is not sustainable without fresh credit.
The Narendra Modi government has wrestled with this issue from the beginning, and the question is whether there is light at the end of the tunnel. The Reserve Bank’s half-yearly Financial Stability Report, released this past week, provides some answers. The Report strikes a hopeful note when it says that “stress in the corporate sector showed some signs of moderation in 2015-16”, especially for the most debt-ridden companies. However, it adds that the risks of lower demand and weaker debt servicing capacity continue, and therefore that “corporate leverage levels continue to cause concern”. Indeed, when one looks at the corporate sector as a whole, the key financial ratios show little change, or mild deterioration since the first half of 2014-15. This is true on the ratio of profit to interest payments for private non-financial companies, the ratio of debt to equity, and the ratio of interest payments to loans. In such a scenario, it is unrealistic to expect the quick investment revival that will mark a true return to rapid growth.
That is the corporate picture. From the banks’ perspective, the Report makes an important point ignored in much of the current commentary on the subject — that while there has been a deterioration in asset quality and profitability, the sharp spurt in non-performing assets (NPAs) is the result of more accurate classification mandated by the Reserve Bank, not a sudden deterioration in the underlying situation. So while the gross NPAs rose sharply from 5.1 per cent of gross advances in September 2015 to 7.6 per cent in March 2016, the overall total of stressed assets (which includes restructured loans) rose only marginally, from 11.3 per cent to 11.5 per cent.
The key question is how much more of the problem still remains hidden, and what that might mean for the health and functioning of banks. The risk-weighted capital adequacy ratio (CAR) is still a healthy 13.2 per cent, against the requirement of 9 per cent. However, as bank accounting continues to become more transparent through 2016-17, this ratio will certainly fall — sharply in some cases. Indeed, 13.2 per cent is an average figure that hides within it some wide variations. Two government banks’ ratios are already less than 10 per cent, and for 10 other banks the ratio is between 10 and 11. They will need fresh capital if they are to keep lending, but estimates vary widely on how much is required; the government’s own estimates have fluctuated. If the required money is not found, new lending will continue to be slow.
The outgoing Reserve Bank governor has forced the banks to start cleaning up their books. Almost certainly, there is still more dirt under the carpet; will the new governor continue to insist on a clean-up, or chicken out? Also, the dire scenario has prompted the government to consider merging weak banks with stronger ones, and using Reserve Bank money to shore up bank capital. This latter idea was first aired in this year’s Economic Survey, but criticised publicly by Dr Rajan. Watch for what happens once a new governor is in place.
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