If Arun Jaitley is not able to do this, expect crisis ahead
Though each segment of the investing community will be focussed on different aspects of the budget, perhaps the most important will be how the government plans to deal with the rising NPA cycle. Bond traders will be sharply focussed on just the fiscal deficit number in the budget later today, and for good reason. A higher deficit means higher borrowings — especially with the states borrowing a lot more than in the past, and large volumes of UDAY bonds in the offing — and with very little appetite in the market from either banks or FIIs, yields can spurt.
Paradoxically, since this will keep interest rates high, the contractionary impact may just cancel the expansionary impact of a higher deficit, though the chief economic advisor has made a very strong case for reviewing the fiscal responsibility Act. Stock markets, on the other hand, will look to see whether there is any tax change in the treatment of capital gains, an unnecessary controversy triggered by the prime minister’s ill-advised comments on how the rich never paid taxes on capital gains — interestingly, if the markets tank, as they probably will if the holding limit is raised to 3 years, there will be more losses than gains, so tax collections from the stock markets will fall further. And though the government has ducked the issue of the retrospective tax for two years, it has no option but to address this today if it wishes to regain the trust of global firms who have been badly hit — not just by the tax itself but also the duplicity with the government talking of letting courts resolve it, but at the same time delaying the process of international arbitration and, in the case of Vodafone, even threatening attachment of assets as was done in the case of Cairn Energy.
How the government deals with rising NPAs is most critical, though, since this is linked to both the ability of banks to lend as well as to a largely debt-stressed India Inc’s ability to invest. RBI is right in asking for early recognition since delays have only made loans worse and higher GDP growth in itself isn’t going to help fix the problem — from 5.6% in FY13, GDP growth rose to 6.6% in FY14, 7.2% in FY15 and is projected at 7.6% in FY16, yet gross NPAs of PSU banks rose from 3.8% of advances in the March 2013 quarter to 6.2% in September 2015 and 8.1% in December. The problem, however, with aggressive recognition of NPAs — from R40,000 crore in the September quarter, NPAs jumped by a whopping R99,000 crore in the December quarter — is that this chokes off India Inc’s ability to borrow for stressed projects and worsens their viability, and also that it hurts the ability of banks to raise capital. Which means it is critical that the recapitalisation cycle match the NPA-recognition one — a continuing mismatch of the type we’re seeing right now can lead to a more serious problem down the line. A bad bank takes care of much of the problem since funding (https://goo.gl/JcX9gv) is done through government paper and, once deeply discounted assets are available — and they will be, once promoters and banks take a haircut — there will be buyers. The concern about the bad bank is that bad promoters will still find a way to retain good assets while leaving the bad ones for banks — the finance minister has to demonstrate how this time will be different.