Column: Banking on Modi

Written by Sunil Jain | Updated: Mar 19 2014, 08:36am hrs
Whether it is Mukesh Ambani or Mukesh, the neighbourhood car cleaner, all have taken huge bets on India, bets that require India to grow at 9-10%, not the anaemic rates it has been growing at for the last two years. Thats what the pent-up anger against the government really boils down to.

Though it is fashionable, and perhaps even correct, to blame crony capitalist India for borrowing huge amounts from banks with little worthwhile collateral (at least, in retrospect), the fact is all the borrowers envisaged India continuing to grow rapidly, to make good all the investments they had made. And since it hasnt, all those that have borrowed are in deep trouble. The problem is that even if growth was to pick up, moving beyond 5.5-6% will be difficult in the next 2-3 years, and thats not anywhere near good enough to make their investments wholethat, in turn, will bankrupt the banks, the subject of this column.

While total loans from the banking system are up from R50.7 lakh crore in FY12 to R58.8 lakh crore in FY13, NPAs + restructured assets are up from 7.63% to 9.25% for all banksthis was up to 10.2% in September 2013and from 8.9% to 11.1% for PSU banks.

There is also middle-class India that borrowed aggressively, to fund not just its purchases of new mobile phones, but also college education for its children, often overseas. Education loans are up from R43,000 crore in FY11 to just under R70,000 crore in January 2014. To repay these loans, the salaries these students need are the type that require India to be growing at 9-10%, not half that.

Nor is this angst restricted to just middle-class India. There are the poor, the Mukeshs and others who are, from their miserable salaries, taking out R300-500 per month to pay for the school fees of their children, or tuition in case they send them to the free government schools, so that they can get good jobs once they graduate. For rural India, according to Pratham, while 19% of 6-14-year-olds were enrolled in private schools in 2006, this is up to a whopping 29% today. It gets worse since even those enrolled in government schools are spending money on private tuition. Add this, and 46% of kids in rural India are getting private schooling of some sortthe number is a high 35% even among the non-affluent. For urban India, the numbers are far higher.Whether a BJP is able to cash in on this latent anger, or whether the

Congress is able to convince people that it should get another chance at fixing things is the stuff of political punditry. This column focuses on some of the tough choices the next PM will have to take, and pretty soon at that.

Sooner, rather than later, the next prime minister will be confronted by the rising bad loans in not just corporate India, but in middle-income India as welland, more important, their impact on the country as a whole.

How serious the problem is depends upon whose version you choose to believe. According to Uday Kotak, a man you may wish to take seriously given his banks track record, if 40% of restructured assets turn badand he thinks that is a distinct possibilityaround 40% of the net worth of the banking system could get wiped out.

There are other numbers as well, all of which point to a serious problem. RBI Deputy Governor KC Chakrabartys presentation at Bancon 2013 suggested that 10% of banking capital could get wiped out if 30% of restructured advances turned into NPAs. RBIs Financial Stability Report of December 2013 does some simulations and talks of the direct impact as well as the one caused by contagionif 30% of restructured standard assets are written off, RBI says the initial loss will be 11% of capital and this can rise to 35% if there is contagion.

Wont a general economic revival take care of the problem, as many suggest it will Probably not. For one, as Chakrabarty points out, the problem started getting aggravated before the slowdown started. More important, the kind of revival required is too large to be funded out of the 30.1% savings-level India has at the moment.

The Tata and the Adani power projects are a good example what needs to be done to revive projects, as are the clutch of road projects seeking succour at C Rangarajans door. The Tata/Adani projects needed the electricity regulator to hike their tariffs significantly for them to become viable. And only a few of the big projects before the Rangarajan panel are looking at restarting given the low level of restructuring help provided. That is, for the majority of stuck projects to take off, a significant restructuring will be required as they just dont make economic sense at current levels of growth.

If you go by Chakrabartys 10% figure, that means the government needs to pump in R70,000 crore of equity into banks; this goes up to R2 lakh crore if you take RBIs contagion-figure.

According to RBI, just to meet the Basel III norms, banks need another R4.2 lakh crore till 2018, around R1.5 lakh crore of which will have to be equity capital. That, however, is just to take care of the loans that will go bad. Banks need extra capital to grow. According to Credit Suisse, banks are likely to require between $35-80 billion (R2.1-4.8 lakh crore) over the next 3 years$35 billion to be able to grow lending at 18% a year and another $45 billion to be able to raise their impaired assets coverage to 70%.

Cut it anyway you like, the first constraint the new PM will face will be with respect to PSU banks. The choices are (a) to let PSU banks lower their lending targets, (b) recapitalise them from the budget or, (c) reduce government equity in the banks to 26% and essentially privatise them, to allow the better-run ones to raise capital from the markets.

None of this is to say the government doesnt have the wherewithal to recapitalise the banks. Of course it does. The question is of priorities. The government spends R2.57 lakh crore annually on subsidies today, most of which doesnt reach the target audience. So, the money is there. The question is whether the new PM will take that decision.Dramatic restructuring of government finances is a decision the PM needs to take anyway. Growth cannot pick up unless savings and investments do, and one of the big reasons for overall savings falling is the collapse of government savings.

Between FY08 and FY13, overall savings fell from 36.8% of GDP to 30.1%while household savings remained unchanged at around 22%, India Incs savings fell from 9.4% to 7.1% and the public sectors from 5% to 1.2%.

How quickly, if at all, the new PM is able to move on these issues will determine the pace at which the economy recovers.