India in depth: Budget must ease credit crunch says Andy Mukherjee
March 2010 and October 2011 was occasioned by the government's pathological refusal to do anything about the expansion of its own spending, which is estimated to have more than doubled in six years.
- The supply side of the credit equation is problematic because a bank-dominated financial system in which state-controlled lenders account for 74 percent of total assets has all sorts of bad incentives to stretch out corporate deleveraging. Loans that have gone sour aren't written off but are "restructured" to give borrowers easier terms. And although the monetary authority wants banks to set aside more of their future income to offset potential losses, the current rate of provision is just 2.75 percent of the value of the restructured loans.
- In a typical business-cycle slowdown, the strategy works out. Most debtors see a recovery after a short blip and start servicing loans again. Demand for new credit picks up, and state-run banks are spared the trouble of making large capital calls on the Indian taxpayer, via their nominal owner, the government.
- This time, it's different. The challenge in India is not the business cycle, but the credit cycle. In January, the cyclical component of commercial bank credit - after stripping out trend growth and seasonality - was at its weakest level in almost eight years, according to Breakingviews calculations.
- Given the severity of the downturn, it's quite likely that banks' restructured loans will turn bad at a faster pace than before. In the past, the rule of thumb was that
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