Bad news from banking sector now taking a toll on Indian economy and Modi

Scandals, bad debts, ATM cash shortages — India’s banking system has experienced them all in recent months and the bad run is starting to have repercussions for both the broader economy and Prime Minister Narendra Modi.

India’s nearly $1.7 trillion formal banking sector is coping with $210 billion of soured or problem loans, and some regional banks have been ensnared in fraud scandals. With a national election slated for April or May, Goldman Sachs Group economists have trimmed their growth projections for the year ending March to 7.6 percent from 8 percent amid concerns that the banking system’s woes are more widespread than previously thought.

On top of that, ATMs in some parts of the country have been reported to be running dry in recent days. There’s an unusually high demand for cash, according to the Finance Ministry. The rupee shortage is being blamed on everything from farm spending to looming elections and hoarding by some families.
 

Yet some roots of the issue may lie in Modi’s 2016 decision to take high-denominated cash out of circulation in a bid to curtail India’s vast and unreported black economy and crack down on illicit financial transactions.

The move initially caused economic mayhem and the disruptive shocks to cash in circulation continue to linger. While government officials have said the banking system is healthy and that there’s adequate cash for the excess demand, the crunch has only further tarnished the public image of banks.

"The problems in India’s banking system are self-inflicted mostly because of lack of due diligence," said N.R. Bhanumurthy, a Delhi-based economist at the National Institute of Public Finance & Policy. "Of course this will affect growth."

The broad uncertainty hovering over the financial sector comes just as the economy was showing early signs of recovering from a disruptive tax system overhaul and the 2016 cash ban. Now there are growing worries that lending, and with it economic activity, will stall.

Bhanumurthy for now forecasts GDP growth of 6.5 percent for the current fiscal year ending March 2019, although he fears the numbers could go even lower. His estimate is already below last year’s 6.6 percent and as well as the most pessimistic forecast of 6.9 percent in a Bloomberg survey.

Indian banks -- the heart of its economy -- have had their image tarnished by a string of scandals that have come to light over the past couple months as companies, saddled with excess capacity and subdued demand, struggle with the aftermath of a borrowing spree following the global financial crisis.
 

Many companies have been unable to pay down their debt as the economy has slowed, especially in the power, steel and telecommunications sectors. At least some of these loans might have been given with insufficient scrutiny, exposing financial institutions to risk.

That coupled with tougher regulatory oversight by the central bank and federal investigators, has skeletons tumbling out of closets.

Last week, Kolkata-based UCO Bank was in the spotlight after India’s federal investigative agency registered a case against its former chairman for cheating the state-run lender. The bank had reported losses for nine straight quarters as it made provisions for soured debt. Calls to him went answered.

Axis Bank CEO, Shikha Sharma, this month said she will quit earlier than expected from the mid-sized lender after failing to rein in about 250 billion rupees in gross non-performing loans.

In one of the most high profile cases of fraud, a billionaire jeweler was accused of masterminding a $2 billion scam at Punjab National Bank, one of the country’s largest public sector banks by using fake guarantees. Punjab National Bank shares have lost almost 40 percent over the past year.

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Business sentiment has soured in the wake of the alleged banking frauds, said Abhishek Gupta, Bloomberg’s India Economist, who cut growth forecasts this week. This is likely to have a negative impact on credit growth, with the banking system burdened by bad loans.

Gupta has lowered his growth forecasts to 7.2 percent from 7.5 percent for the year ending March 2019. That took it below the Bloomberg consensus of 7.4 percent, a pace probably insufficient for Modi to create enough jobs in time for the elections.

Adequate Cash

India’s banks are still reasonably well capitalized according to international Basel-III capital guidelines. A government capital infusion plan should take care of public sector banks, which have a 70 percent share of India’s banking system, said Srikanth Vadlamani, vice president for financial institutions group, Moody’s Investors Service.

The government will make sure that adequate cash is available at ATMs and in banks so that all demand is met, Sanjeev Sanyal, a Modi advisor said earlier this month. “There is no crisis, the banks are in perfectly good shape, we have more than adequate cash and more will be printed if necessary. So there is absolutely no need for anybody to panic about this.”

India announced a $33 billion recapitalization plan in October last year to tackle one of the highest stressed loan ratios in the world. But the latest scandals have raised concerns that most of the capital to be pumped in will go into providing for more losses towards soured loans, leaving very little for fresh lending. That bodes badly for the economy which is already estimated to have slowed to a four-year low in 2018.

"Corporate sentiment is already down," said Madan Sabnavis, Mumbai based chief economist at Care Ratings Ltd. "Demand isn’t there and most sectors are facing excess capacities. So will the investment cycle revive? Unlikely, and these problems in the banking sector are coming at a time when they are already grappling with large non-performing loans."