A V Rajwade: Seeing the NPA hurdle for what it is

India's aggregate NPA as a percentage of GDP is far lower than that in Italy, Greece. This doesn't mean complacency, but exaggeration of the problem should also be avoided

Earlier this week, the Centre offered recapitalisation funds of Rs 23,000 crore to public sector banks. The aggregate amount needed to meet Basel III capital would be much higher, partly because, as the Reserve Bank of India’s latest Financial Stability Report evidences, the proportion of non-performing assets (NPA) is much higher for public sector banks than private sector banks. The report also emphasises that most of the high leverage, low interest cover, non-government listed companies are in the iron and steel, construction, power, telecom and transport industries: these sectors also account for a significant proportion of the problem assets.

Gross NPAs as a percentage of total assets of banks have risen sharply in the second half of fiscal 2015-16, after the banking regulator tightened the approach to the classification. What this indicates is that there has been no sudden worsening of the asset quality, as the headline numbers seem to suggest. This apart, the aggregate amount as a percentage of gross domestic product (GDP) is far lower than in Italy and Greece, which I discussed in the last article — no wonder, given that Indian GDP growth has been quite strong in the last few years, unlike in Europe. This does not mean we should be complacent, but we shouldn’t exaggerate the problem either.

The other side is that the nature of businesses, which represent a disproportionate share of bad assets, confirms my view, argued in this column earlier as well, that at least part of the reason underlying NPAs is the very high real interest rates and the overvalued currency, both of which have repercussions, particularly on capital-intensive industries such as power and telecom, and tradeables sector businesses such as steel. Both are the result of monetary policy over which neither borrowers nor lenders have any control. Another reason emphasised by State Bank of India Chairperson Arundhati Bhattacharya in New York recently is the “stalling of projects… between 2011-13”. (Was she being “politically correct” in choosing the period?) Stalled projects mean time and cost overruns stretching the resources of the promoter/borrower and creating NPAs for the lender. Another problem highlighted by an industrialist in the construction business is the delay in the receipt of moneys due from the government. He claimed that his company, now facing major problems, would be debt-free if all his pending bills were cleared by the government. It is a fact that one way of meeting the deficit target, often adopted by the government, is to postpone the liability to the next year, which obviously affects the recipient’s cash flow.

This apart, the publicity that has been given to the problem of the banking system’s asset quality has already had several side effects. For one thing, lending growth has slowed significantly; so has private sector investments in expansion or new businesses: None of this bodes well for the growth of the economy, at a time when there are severe constraints on public funds. Fiscal pressures would surely increase with the recent wage hike for government employees. Whatever the positive effects in the long run, it seems that at least immediately the central government’s expenditure would go up. It is anybody’s guess how much money this will leave for recapitalisation of the banking system to meet the Basel III capital ratios, after a clean-up of the balance sheets of public sector banks. “Creative accounting” like a bank holding company controlled by the government but in which private investors also hold significant equity; a similarly owned asset reconstruction company (“bad bank”), etc would still require large commitment of public resources, if any of those are to have the intended result. (It is worth reminding ourselves that Italy’s Atlas fund got exhausted, taking over the bad assets of two small banks, thus leaving the overall problem where it was.)

It seems the details of the inflation targeting regime are currently under discussion. One thought is that, if the Consumer Price Index is to be the target measure, should core inflation (which excludes food and fuel) be the determining factor and not the headline number? Again, the N K Singh Committee is looking at a review of the Fiscal Responsibility and Budget Management Act, which mandates the ceilings on fiscal deficits. Perhaps, it should look at different approaches towards deficits arising from expenditure and investments. The reason is simple: broadly speaking, the former does not increase future growth; the latter does.

The author is chairman, A V Rajwade & Co Pvt Ltd; avrajwade@gmail.com