RBI Monetary Policy
By Shivaji Sarkar
The RBI’s change in monetary stance is terribly hawkish. It has shocked the stock market and heavily pounded banks stocks. The industry, which was expecting an interest cut to come out of the difficult situation of non-payment of their large debts, is left in the lurch.
The Central bank reasoning is that it has already reduced 1.75 per cent repo rate. However, the banks have passed only 0.75 to 0.9 per cent. Further it says that a shift to a neutral stance and a hold on rates was called for to assess how the transitory effects of demonetisation played on the output gap. The statement is extremely modest as the RBI knows that the situation is a lot worse.
It now appears that the currency note ban is virtually not the devil and neither is it black money. The culprit is the critical condition of public sector banks owing to high stressed funds thanks to non-repayment by large debtors. Just 50 companies account for 71 per cent of the debt. And this is affecting investments in the private sector.
The Economic Survey 2016-17 (ES) quoting Credit Suisse data says that the top 10 stressed corporate groups owe Rs 7.52 lakh crore in 2016, which was Rs 45,400 crore in 2006. The total non-performing assets are estimated at about Rs 12 lakh crore, part of which has been restructured – repayment officially delayed.
Apparently, at least 13 of the public sector banks accounting for approximately 40 per cent of total loans are severely stressed. Further, the situation is worsening as the stress on corporate and the banks continues to intensify. This in turn is taking a miserable toll on investment and credit. The picture, the survey portrays, is grave. The recovery process is complicated and time consuming. “The underlying debt problem has to be addressed lest it derails India’s growth trajectory”, warns the ES.
This in indeed a pointer to a severe crisis, the economy is heading for. The banks in February 2016 revealed their NPAs had soared to such an extent that provisioning had overwhelmed operating earnings. As a result, net income had plunged deeply into the red. It led to crash of their shares to such low levels that at one point the medium-sized private sector bank, HDFC, was valued as much as 24 public sector banks put together.
The RBI prescription of asset quality review (AQR) – cleaning up bank books – did not work. As 2016 proceeded, NPAs soared to 9 per cent of total advances by September – double their level a year ago. More than four-fifths of the NPAs were in State-owned banks and had reached 12 per cent.
The ES attributes this to “twin balance-sheet (TBS) problem”, where both the banking and corporate sectors were under one of the highest degrees of stress in the world. “At its current level, India’s NPA is higher than any other major emerging market, except Russia, higher even than the peak levels seen in Korea during the East Asian Crisis in 2000. (Korea had 8.9 per cent NPA)”.
Credit Suisse reported that 40 per cent of Indian corporate debt it monitored was owed by companies, which had interest rate coverage ratio less than one. This means they did not earn enough to pay the interest obligations on their loans.
In countries with TBS, corporations over-expand during a boom, leaving them with obligations they can’t repay. This proves devastating for growth, warns the ES, as neither stressed companies nor the sound ones can invest as fragile banks are not in a position to lend them.
The crisis started with India’s attaining high growth between 2004-05 to 2008-09 as amount of non-food credit doubled both from banks and large inflows from overseas. Foreign inflows or external borrowings reached 9 per cent of GDP. But as companies were taking on more risk, global financial crisis or Lehman Brothers meltdown happened. Costs soared and the rupee tumbled forcing them to repay their debts at exchange rates closer to Rs 60-70, whereas firms had borrowed when the rupee was 40 to a dollar.
Thus higher costs, lower revenues, greater financing costs squeezed corporate cash flow quickly, leading to debt servicing problems. However, unlike the US and Europe, TBS did not lead to economic stagnation in India. A strong domestic demand maintained growth despite very weak exports and moderate to high inflation. Despite supply constraints and fall in manufacturing, trade and transport, new power plants, new roads, airports, and ports “helped” India grow. But most infrastructure investments did not prove financially viable.
In other countries, creditors in such situation would have triggered bankruptcies. Instead, in India, the ES notes, the strategy was to allow more time to corporate wounds to heal. Companies sought principal payments to be postponed so that they could become viable. Accordingly, banks restructured loans by 2014-15 and extended fresh funding to stressed firms. “As a result total stressed assets far exceeded the headline figure on NPAs. To that amount one needs to add the restructured loans and other bad assets”.
Market analysts estimate that unrecognized debts are four per cent of gross loans and perhaps five per cent of public sector banks. The ES states: “total stressed assets (actual NPA) would amount to about 16.6 per cent of bank loans and nearly 20 per cent of loans at State banks”. The model is similar to that of China. Both India and China spurred growth with liberal bank loans.
However, the Survey questions its sustainability. Indian large companies saw earning diminishing to Rs 20,000 crore per company per quarter at the end of 2015 from Rs 25,000 crore in early 2015 and by September 2016 to Rs 15,000 crore per quarter. This means the aggregate cash flow has reduced by 40 per cent in less than two years, which has severely hit their repayment capability. Obviously, if the banks write off loans it would deplete capital cushions.
Debts of top ten companies are rising rapidly. In short, stress on corporate sector is not only deepening, it is also widening. This is hitting the Indian economy. Private investments have contracted to over 7 per cent in 2016-17. State-run banks see a drop in loan demand. The Government’s promise of Rs 70,000 crore capital infusion into banks is touted as a partial solution. A bad bank is also not the way out. That India is heading towards an abyss cannot be ruled out. Sadly, the key elements needed for resolution and taming the corporate are still not in place.—INFA