The massive Rs 2.11 lakh crore capital infusion in public sector banks may make the 3.2 per cent fiscal deficit target for 2017-18 difficult to achieve if two-thirds of the planned recapitalisation bonds are issued by the government, Fitch Ratings said today.
The announcement made on Tuesday "is a significant change from the drip-feed approach pursued over the last few years and should help address the capital shortages that are a major negative influence on the viability ratings of the banks," it said.
Of the total Rs 2.11 lakh crore, Rs 1.35 lakh crore would be in the form of recapitalisation bonds, while the rest would involve a combination of already announced budgetary support and capital raisings by the banks themselves from the capital markets.
"The recapitalisation plans could make this target more difficult to achieve if recapitalisation bonds are to be issued by the central government, which might mean expenditure cuts elsewhere.
The $21 billion of planned issuance is equivalent to 0.9 per cent of GDP," it said.
The rating agency however said the additional pressure on fiscal balances could be more than offset by the beneficial impact recapitalisation may have in eventually helping to return the banking sector to health, which would support the longer-term economic outlook and reduce uncertainty.
Out of the total recapitalisation plan, the government will provide Rs 76,000 crore.
Banks are expected to raise the rest through, for example, fresh equity issuance, with the government willing to accept a dilution of its ownership share to 52 per cent.
Fitch had last month estimated that the Indian banks would require around USD 65 billion of additional capital to fully meet new Basel III capital standards that will be implemented by end-March 2019.
Also, that the state banks, which account for 95 per cent of the shortfall, would be dependent on the government to meet these requirements.
"The latest planned injections will go a long way in plugging the total capital gap.
They also exceed the $6-7 billion that we estimated the government would need to pump in on a bare minimum basis (excluding buffers) to address weak provision cover and aid in effective NPA resolution," Fitch said today.
Lending growth, however, is still likely to remain weak, at least in the short term, as banks will prioritise asset resolution and provisioning over expansion, it said.
The government's plan is to provide capital to all banks that need it, which carries some risk of encouraging moral hazard.
"However, the size of capital allocations is to be determined by performance, which suggests the largest share will go to stronger banks, while some banks - particularly smaller, struggling ones - could still be swept up into the government's consolidation agenda," Fitch said.
The government is also planning structural changes to governance and underwriting standards at state banks to guard against future systemic asset-quality problems - although this reform process is likely to be slow and vulnerable to implementation risks.
State banks will now receive Rs 2.11 lakh crore (USD 32 billion) in new capital over the next two years, with the government providing USD 24 billion.
The government had already budgeted USD 3 billion for capital infusions under a previous plan. The other USD 21 billion will be raised by issuing bonds earmarked specifically for recapitalisation.
The government plans to begin issuing these recapitalisation bonds within the ongoing fiscal and has said it will front-load injections.
Details on the programme, such as which entities will issue the recapitalisation bonds and who will subscribe to them, are still to be announced, Fitch said.
"Finance Minister (while announcing the plan on Tuesday) has hinted that the recapitalisation bonds could be sold directly to the banks, with the proceeds returned as equity.
Effectively, this would mean converting banks' excess liquidity into equity.
Banks' liquidity ratios are healthy, having been given a boost by a surge in deposits after demonetisation," it added.