Higher economic growth, a big ask now

RK Pattnaik Jagdish Rattanani | Updated on January 11, 2018

Creaky wheels Economic growth is now dependent on banks which are snarled in NPAs Lightspring/shutterstock.com   -  Lightspring/shutterstock.com

A highly leveraged corporate sector and an alarmingly stressed banking sector imperil the economy

The Indian economy is going through an interesting phase with a temperate economic growth rate, benign observed inflation and GST being described as a game-changer with the idea of “one tax and one nation”. There is the hope, as the RBI put it in its statement on the latest Financial Stability Report (FSR), that domestic political stability will bring “accelerated reforms, overall positive business sentiment and macroeconomic stability”. Furthermore, a perception has been building up very strongly that lower CPI inflation than that of the average target level of four per cent makes a case for policy repo rate reduction which would help break the investment pessimism and thereby nudge the economy to a higher growth trajectory.

But a sustained increase in economic growth at this juncture is critically dependent on credit intermediation of banks, which are caught in the vortex of NPAs and so cannot lend effectively to corporates, which are themselves struggling and stretched. Given the predominance of this twin balance sheet problem manifested in the surfacing of a leveraged corporate sector and stressed banking sector, the move to a higher growth trajectory apparently looks difficult.

It is the last one that is the focus of the FSR released on June 30, and offers some insights that should be worrying. As the report noted, the tail risk in corporate leverage increased to as much as 47 per cent, up from 39.6 per cent in March 2016 for select non-government non-financial companies described as “leveraged” or “highly leveraged”. These are companies with negative net worth or a debt-equity ratio of two or above.

The telecommunication industry has the largest debt with negative profitability and relatively high leverage. The other infrastructure industries such as power, construction and iron and steel not only witnessed relatively high leverage but also recorded a high interest burden. The significant increase in the share of debt at risk in respect of weak and leveraged companies, particularly in the infrastructure sector, poses potential challenges for credit pick-up from the banking sector and potential pressures on asset quality of the banking sector.

Imminent danger

The FSR report raised concerns of the continuous negative returns on the assets of public sector banks, reflecting the weak asset quality. The worrisome aspect in this regard is the rising trend in the stressed advance ratio (stressed advances are defined as gross non-performing advances plus restructured standard advances), particularly in the critical sectors such as cement, mining and quarrying, basic metals and vehicles. The deterioration in the credit quality of large borrowers (exposure of ₹50 million or more and accounting for 86.5 per cent of gross NPAs of the banking sector) has potential for a financial sector burst sooner or later which is already being reflected in the deteriorating banking stability indicators of asset quality and profitability.

It is important to mention that the macro stress test undertaken by RBI and disseminated in the FSR report indicated potential threats to asset quality as there are indications of increase in credit risk, credit concentration risks, and sectoral credit risk. For example, the stress test results showed that 25 banks having a share of 44.4 per cent of the banking sector’s total assets would fail to maintain the required capital to risk weighted assets ratio (CRAR). The concern is further aggravated because there is a likelihood that the CRAR of as many as 22 public sector banks might not be maintained at or would drop below nine per cent. Furthermore, sectoral credit risks emanating from the infrastructure sectors have not only a potential threat to profitability of banks but also for economic growth.

The sectoral analysis gives the impression that the issue of leverage is cyclical in nature but the reality is that the sectors are incidental whereas the problems that have led to this near collapse are perennial. The bubbles of sectoral leverage will shift but the problems will remain. That is the lens through which the FSR should be read and understood. Time and again, RBI has mentioned that it has tightened the supervisory and enforcement framework but the net results have not been very encouraging. Even the tightening of disclosure and standard assets provisioning requirement have not impacted to a desirable extent as the phenomenon of stressed assets is only getting worse.

Unwilling spirit

Much has been made about the amendment to the Banking Regulation Act ostensibly to empower the RBI to intervene and push for resolving large NPA accounts. This new push, it is said, will make a huge impact and speedily resolve the issue of stressed assets in some key, large accounts. However, what is less understood is that the RBI already had not only the powers but also the duty and the responsibility to act even before any such amendment. The age-old section 35A of the Banking Regulation Act empowered the RBI in public interest “to issue directions to banking companies generally or to any banking company in particular and (they) shall be bound to comply with such directions.” So the lack was not in the empowerment but in the will and the diligence to act with fairness, promptness and to call out early enough if matters were getting out of hand.

What is unfolding before us is a result of larger structural issues, including governance, due diligence, monitoring and the undue influence of the big ticket borrower. Credit inherently has a cycle that is made up of allocation, disbursement, monitoring and repayment. The big borrowers are seen to be taking advantage at each level of the cycle, particularly in the public sector banks. What happens here is often a toxic mix of political patronage and bureaucratic crookedness. Former RBI Governor YV Reddy wrote in his memoir Advice and Dissent: “Influence peddling was also not uncommon in the appointment of chairmen and managing directors of banks and development financial institutions. These appointments were normally based on the recommendations of a selection committee … On paper, the process appeared reasonable. Yet, there were cases when the process was manipulated.” These are structural problems that show up on the balance sheet only long after the damage is done.

Pattnaik is a professor and Rattanani is an editor at SPJIMR, Mumbai. The views are personal. Via The Billion Press

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Published on July 16, 2017
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