Tuesday, March 22, 2016

Banking distress: containing the damage

FM Arun Jaitley has moved to contain the damage to morale in PSBs by emphasising recently that bad loans at PSBs are substantially the result of larger economic factors, they don't always point to bad decisions:

But there are also some other issues due to which non-performing assets have added up in the banking system," he said, adding that some genuine economic reasons for the delays in repayments to banks needed to be dealt with. In steel, he said, it was dumping by China. In sugar, it was low global prices, while in power, it was indiscriminate moves by some states to sell electricity below cost, forcing distribution companies to resort to borrowing. In highways, it was poor policy implementation that had crippled the sector, Jaitley said, listing the reasons for the rise in bank NPAs.

These observations are welcome. I am inclined to think, however, that much damage has already been done by strong statements made by people at the top and also by the media coverage of the issue. I would imagine that fear psychosis is pervasive and PSB bankers would be reluctant to lend to large corporates and especially for infrastructure. It does not help at all that the CBI has swung into action.Since the NPA position can't be tackled without fresh funds coming and projects moving towards completion, it does look as though the problem is going to stretch out for a while.

What can be done with stressed assets? Well, broadly there are three options:

i. Identify cases where the stress has happened for genuine reasons. In these cases, banks should take a hit and fresh money should come in. But PSBs will be most reluctant to do so in the present atmosphere. I would suggest that the government set up a Settlement Advisory Board comprising ex-bankers, chartered accountants, academics and others to vet loan settlements above a certain value. That would give bankers the courage to move ahead.  Fresh funds can come either from the banks or the National Infrastructure Investment Fund.

ii. Use SDR to convert debt into equity, dislodge existing promoters and management and bring in new promoters. This sounds fine in principle but it hasn't happened in a single instance so far. Borrowers can stymie such moves by approaching courts. Bankers don't have the expertise to find fresh promoters. Again, if new promoters are to come in, valuation issues will arise. I don't think SDR will work/

iii. Government takes over some of the stressed assets, completes the projects and repays banks' loans. So, for example, NHAI could take over road projects, SAIL could acquire steel projects, NTPC could acquire power projects and so on. The key issue is: do they have the ability to complete the projects in their present condition? In some cases at least, this is worth exploring.

While resolving stressed assets, we need to ensure that systems are strengthened so as to avoid a repetition of past mistakes. The Bank Board Bureau must professionalise bank boards and induct high quality people as MDs. The BBB is not as envisaged by the P J Nayak committee. The Nayak committee wanted a BBB without any government representatives. That is completely unrealistic in my view. Government as the owner has to take the lead in making appointments. The job of the BBB Chairman and other members is to ensure that the government gets these appointments right. But much depends on the intentions of the government.

The BBB is no merely the old Appointments Board minus the RBI Governor. The Appointments Board could not prevent wrong appointments. So the onus really is on government to make the right choices. One hopes that the present crisis brings out the best in government as crises typically do.

Thursday, March 10, 2016

Hysteria over NPAs is not helpful

India's banking system, according to media reports, has stressed assets of about Rs 800,000 crore or about 11% of total assets. NPAs are a little over 4% and the rest are restructured assets. A quarter of restructured assets typically turn into NPAs. That means an NPA level of around 6%. That is way below the level of 15% in 1996-96. The NPA situation is challenging but not alarming, as the RBI governor himself has pointed out.

But that's not the impression you would get going by screaming newspaper headlines and raucous discussions on TV. You would also think that all of the NPAs reflect crony capitalism and are the work of crooked politicians and businessmen, aided and abetted by public sector banks (PSBs). Two solutions are being prescribed accordingly. Privatise PSBs- the government has ruled these out. Instead, the government would prefer consolidation of banks: as the FM puts it, we need strong banks, not many banks.

Let me deal with the diagnosis first. It's sheer nonsense to say that all or most of the NPAs are the result of poor judgement or mala fide decisions. Banking is a play on the economy. NPAs at PSBs reflect larger problems in the economy:

i. The global economic crisis is still unfolding and banks the world over are feeling the impact. European banks especially are in poor shape. A large number of banks are trading below their book value- as the papers mention, HDFC Bank is today worth more than global giant, Deutsche Bank.  The Indian economy, like other emerging markets, is facing the lagged impact of the global crisis. Banks are impacted as a result.

ii. More than half the stressed assets arising from five sectors- mining, iron steel, infrastructure, textiles and aviation. It was PSB finance that drove the infrastructure boom of 2004-08. So PSBs are more exposed to these sectors than private banks. They are more impacted as a result.

iii. Maybe PSBs should have been as clever as private banks and take a lower exposure to key sectors of the economy? Maybe they too should have focused on retail assets? Well, we don't have deep enough corporate bond markets. And we wound up development financial institutions years ago. So, if the PSBs don't fund key sectors, who's going to fund them?

iv. The infrastructure and related sectors have been impacted by several factors which could not have been anticipated: delays in land acquisition, problems with environmental clearance, adverse court judgements, a sudden slowdown in the Indian economy, etc. It's not that private banks judged these risks better because they too are exposed to the very groups and companies to which PSBs are exposed. It's just that they had lower exposures because their business focus is on other assets.

Let me now address the prescriptions.
  •  Privatising PSBs is no insurance that the tax payer will not have to foot the bill arising from failed banks. Just look at the recurrent bouts of banking crises in over 100 economies worldwide. The media cost of recapitalising banks has been 6.8% of GDP. In India, the total recapitalisation cost over a two decade period of 0.5% of GDP. The cost of recapitalisation is not the real cost of banking failure. The real cost is lost economic growth. This cost can amount to 3% of GDP every year. India has not had a banking crisis. The cost of recapitalising PSBs is thus miniscule in relation to the larger cost arising from a banking crisis.
  • Consolidation does not necessarily lead to a stronger bank. It's hard to make a success of mergers even in economies where the labour market has flexibility. Here, the HR issues would be very difficult to surmount. Since almost all PSBs are in a stressed state, it is not meaningful to add to the stress of an SBI or BoB by merging an even weaker bank with it. We must first rationalise and restructure all the weak banks. Then, we can take a view on which can continue on its own, which can be merged and which may be privatised.
 There is more to the banking sector than Kingfisher and Mr Mallya. The problems are fundamental and require addressing with a cool head. Hysteria will take us nowhere.

More in a couple of pieces I wrote recently:



Thursday, March 03, 2016

Will the budget boost growth?

Well, it certainly doesn't attempt to do so through fiscal stimulus. We have a fiscal contraction. The point is missed by commentators who have been salivating over various items of expenditure, especially the huge jump in investment in roads. These increases are fine. But, leaving aside the fiscal deficit shrinkage, even public investment doesn't show a rise- M Govinda Rao points out in an article today that capital expenditure as a proportion of GDP actually declines from 1.8% in 2015-16 to 1.6% in the coming year.

The question is whether private investment can compensate through a drop in interest rates. Govinda Rao points out that looking at government borrowings alone is deceptive.We need to look at public sector borrowings. This would include central and state deficits and borrowings of the Railways and the special purpose vehicles for infrastructure. When we put these together and compare with total household saving of 7.6 per cent, there's very little room for lending to the private sector. The implication is that a cut in interest rates by the RBI is not going to help a great deal. I would add: banks' capital position is under stress, despite the move by RBI to let them count various items (such as revaluation of property and translation from foreign exposures) as capital.

The bottom line: since neither public nor private investment will rise and exports have been going downhill, we can't expect the growth rate in the coming year to be any different from that in 2015-16. And that's if the world economy doesn't go downhill. The decision to stick to the 3.5% target may well prove a mistake- unless, as I said earlier, the government will allow the deficit to slide up later in the year.

Tuesday, March 01, 2016

Definitely a Modi budget

The budget for 2016-17 bears the stamp of prime minister Modi. There is a philosophy and a political direction to it, which could have come only from the PM himself. 

There's a shift in focus- from industry to agriculture, from the urban middle classes to the rural poor. This is reflected in increased in allocations for a variety of rural schemes and the attempts to boost rural consumption. It also shows in a willingness to tax the rich (higher surcharge on incomes over a certain limit, taxation of dividend in the hands of the shareholder) and in the attempt to move PF contributions to EEE, that is, to tax withdrawals. (It appears this may be partially rolled back).
What has caused this shift? Several things, I guess:
  •  The realisation that not much can be done to boost private investment and industry at a time when the global crisis seems to be worsening, large Indian companies face a debt overhang and the banking sector is bogged down by high NPAs.
  • The recognition that if agriculture can be strengthened and made to grow faster, we can raise the overall growth rate without being dependent on the vagaries of the global economy. Also, that a turnaround in agriculture can translate into significant votes. That was Modi's achievement in Gujarat- to reach electricity and water to the rural areas. That was also Nitish Kumar's achievement in Bihar. 
  • Once agriculture is improved, a revival in the world economy will help push India's growth rate into the 8-9% range, perhaps in time for the 2019 elections.
At the same time, there is a concern not to rock the boat where foreign investors are concerned, to shore up badly won macro-economic stability at a time when investors are pulling out of emerging markets. Hence, the focus on achieving the fiscal deficit target of 3.5%. Modi doesn't want foreign investors to mess up things for India by fleeing at this time.

The big negative in this strategy is inadequate recapitalisation of public sector banks- Rs 25,000 crore just isn't enough. I am inclined to believe the government when it says this isn't the entire figure they have in mind- more could be forthcoming. Perhaps, the government will get a clearer view of the capital requirement once consolidation of some sort is firmed up. They can then top up the sum of Rs 25,000 crore later in the year. If international conditions are a little calmer, they can afford to give the fiscal deficit target of 3.5% a miss and settle for, say, 3.7%.

As commentators have pointed out, there is a contradiction between sticking to the fiscal consolidation roadmap and then seeking a review of FRBM targets. Perhaps, the FM hopes that the promise review will give him leeway to relax the deficit by the time he presents the next budget.

What could go wrong? Well, what we have is a continuation of fiscal compression along with a little monetary loosening. This won't do much for growth. It's no use bringing down interest rates when banks lack the capital to be able to lend. This means growth is likely to be closer to the lower end of 7-7.5% band indicated in the Economic Survey.

One can live with that - provided the global economy doesn't get into worse shape. If it does, then growth could slip below 7%, foreign investors might yet flee and the banking sector's situation will become perilous.

Secondly, the allocations for agriculture, while higher than in previous years, may not be adequate to dramatically change the situation on the ground. Politically, then, Modi may not reap the expected dividend.

Clearly, there are risks to the budgetary strategy that the Modi government is pursuing. But this is clearly the strategy of a consummate politician- I can't see that any economic advisor could have crafted a budget of this sort.