Massive debt write-offs required to rescue large corporates: Eco Survey

Economic Survey 2016-17 says even after eight years the bad debt problem remains unresolved

The Economic Survey 2016-17 has painted a grim picture of the state of public banks and indebted corporates in India. The annual survey says that 57% of the top 100 debtors would need debt reductions of more than 75%. At least 13 public sector banks accounting for 40% of the loans are severely stressed. More than 20% of their loans are unrecoverable.   

This Survey predicts that India may be unable to grow out of its debt problem and that it would soon take a toll on economic growth. That’s because stressed corporates are reducing their new investments while stressed banks have been unable to take new lending risks. Private investment in India has been dipping at an alarming rate. In 2010-11, the growth in private investment touched a low of 5% after a boom in the early 2000s. In 2015-16, private investment started to shrink for the first time. By 2016-17, it had contracted by almost 7%. The government meanwhile hasn’t increased its investment commensurately to compensate for a fall in private investment.

The Survey states that large amounts of the banks stressed debt are owed by only a few corporations. 50 companies account for 71% of the total stressed debts. While just 10 of them owe more than Rs 40,000 crore in stressed debts to banks.

Given the scale of the problem, the Economic Survey notes: "Large write-offs will be required to restore viability to the large IC1 companies (those companies whose earnings do not even cover their interest obligations). For the big firms the road is not littered with obstacles. It seems to be positively blocked.” It says that despite the need for large debt write-downs, public banks are reluctant to do so for fear of being prosecuted by investigative agencies.

The Survey provides a solution that suggests that the government is left with little option except to prepare a massive bailout mechanism for indebted corporates. This would be achieved through the establishment of a Public Asset Rehabilitation Agency (PARA) which could be tasked with the responsibility of resolving big and complex bad debt cases. PARA would work in several stages.

First it would buy big bad loans from the banks. Once the loans are off the books of the banks, the government would reimburse them for losses (or recapitalise them). The Survey notes: “All of this will come at a price, namely accepting and paying for the losses. But this cost is inevitable. Loans have already been made, losses have already occurred, and because public sector banks are the major creditors, the bulk of the burden will necessarily fall on the government.”

So will the tax-payer be used to bail out big corporates by writing off their loans to ensure the survival of certain public banks? The survey further outlines what the government could do once the biggest bad debts are written off. The government could compensate banks for their losses by selling them government securities. The government could recover its money if PARA manages to recover some of the bad loans it has purchased from banks. But the experience of Asset Reconstruction Companies and other schemes launched at bad debt resolution haven’t proved to be effective even though they are founded on similar principles.

For instance, the Stressed Debt Restructuring (SDR) scheme launched in 2015 has been a limited success. The Survey notes that while around 24 companies have entered into negotiations under this scheme, only two resolutions have been possible till December 2016. Under SDR, creditors could take over firms that were unable to pay and sell them to new owners. The Sustainable Structuring of Stressed Assets (S4A) scheme launched in 2016 has seen only one case resolved so far. Under S4A, banks were allowed to provide 50% debt reductions to corporations under certain terms and conditions.

Alternatively, the Survey suggests that the Reserve Bank of India (RBI) could transfer some of the government securities it holds to public banks and PARA. This wouldn’t have any monetary policy implication as no new money would have to be printed. The net effect would be a reduction in RBI’s capital and a corresponding rise in the banks’ capital.

But doing all of this could be a potential political landmine. The survey notes, “If loans are written off, there could be accusations of favouritism; if defaulting companies are taken over and sold, this could be seen as excessively strong government.”