India in depth: Budget must ease credit crunch says Andy Mukherjee
15 percent of restructured loans would eventually default, triggering large write-downs. A recent stress test scenario, conducted by the IMF, assumes that the default rate this time around will be higher. If it was three times the normal level, 90 percent of India's state-controlled banks would see their Tier 1 capital ratio dip below the 8 percent minimum required by Basel bank rules - forcing a government bailout.
- Even if these losses do not materialise, state banks will require more capital. According to central bank estimates, the government will need to inject as much as 1.5 trillion rupees - equivalent to 1.5 percent of India's annual GDP - into the banks it controls in order to prepare them for new Basel III rules by 2018. That's 12 times the amount the government is expected to inject into banks in the financial year that ends on March 31.
- The fiscal implications of recapitalization are unwelcome, considering that Chidambaram wants to reduce the federal government's annual budget deficit to 3 percent of GDP by 2017 from an estimated 5.3 percent in the current financial year. Nevertheless, restoring vitality to the banking system is something the finance minister should not shy away from. Putting Indian taxpayers on the hook will not be popular, but is necessary because no government has the political will to dilute its ownership of state-controlled financial institutions.
- Yet recapitalising state-owned banks is only the first step. The second part of the solution is to hand out new banking licences
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