The right remedy

A striking feature of the just-released Financial Stability Report of the Reserve Bank of India is that it paints a discouraging picture of not just the banking sector but the economy as well. The subtext, amidst the reams of data on restructured, stressed and non-performing loans, is hard to miss — the report speaks less of India’s high growth prospects and more of the downside risks. It expects the gross non-performing assets (GNPA) to rise to 8.5 per cent of gross advances in March 2017, from 7.6 per cent at present; “if the macro situation deteriorates in the future, the GNPA ratio may further rise to 9.3 per cent…” it continues. Clearly, the projected rise in NPAs is not entirely due to the new NPA classification norms. The corporate sector, despite signs of “moderation of stress” in 2015-16, continues to face “lower demand and weaker debt servicing capacity”, the report notes. Add to this, the usual global uncertainties (accentuated by Brexit) — weak global recovery and the effects of monetary easing in the US and EU on currency movements and capital flows in emerging economies — and the outlook on Indian banking and industry seems less encouraging for 2016-17 than the Centre would like to believe.

The stress points are evident: there has been a spike in GNPA in advances to industry from 7.3 per cent in March 2015 to 11.9 per cent in March 2016. Within industry, iron and steel, construction and textiles are worst off. As of March 2016, only 6 per cent of advances in the agriculture sector have turned sour. In an indication that medium-scale units are on a downward spiral, loan sizes ranging from ₹20 to ₹100 crore account for most of the standard accounts that turned into NPAs in 2015. From this it is evident that the effects of the debt crisis among big players (which accounted for 86.4 per cent of all NPAs in March 2016) are also being felt by downstream players.

The issue is whether to contain the debt contagion by turning off the tap on loans altogether, or by writing off loans and beginning on a new note so that investment and growth do not suffer. Unfortunately, the report does not indicate its view on this count. While focusing on transparent reporting of NPAs, it appears that the AQR norm has squeezed lending to critical sectors at a time when capital formation needs to pick up. The ‘S4A’, or Scheme for Sustainable Structuring of Stressed Assets, marks a step forward from the so-called 5:25 (stretching an infrastructure loan over 25 years with no provision for write-off) and Strategic Debt Restructuring schemes, allowing banks to move on by writing off a section of the loan and converting it into equity. But the RBI must assess the performance of S4A also in terms of reviving industrial activity, every six months, so that corrective steps can be taken. Perhaps S4A could even have come earlier. Cleaning up the books of banks is a laudable move, but that should not be at the expense of reviving investment.

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