Government should, to begin with, offer PSBs bonds in return for equivalent equity

There is general agreement that tepid growth in bank credit has been a major obstacle to launching the economy into a 8% plus growth trajectory. Bringing credit growth back on track in turn requires restoration of the health of Public Sector Banks (PSBs).

Before I turn to the issue of how we might restore the health of PSBs, let us get the facts on the slowdown in credit growth right.  Today, it is universally believed that the annual growth of credit advanced by the Scheduled Commercial Banks (SCBs) in 2016-17 fell to 5.1%, the lowest in six decades. This is the figure in a widely quoted April 2017 PTI story.

The latest data in the Reserve Bank of India (RBI) Handbook on Statistics show, however, that SCB credit has actually grown 9% in 2016-17.  This is far from the lowest in the past six decades.  For example, at 5.7%, credit growth in 1993-94 was more than 3 percentage points lower.

It deserves noting that the 9% figure represents continuity rather than a sharp break from the recent trend.  For the corresponding figures for 2014-15 and 2015-16 were 9.3% and 10.9%, respectively. Recalling that the economy grew 7.5% in 2014-15 and 8% in 2015-16, predictions of impending economic collapse based on a collapse of credit growth must be taken with a pinch of salt.

It is nobody’s case that all is well with credit growth.  On the contrary, two worrying features of credit growth in recent years must be highlighted.  First, on a longer-term basis, total SCB credit growth has been in steady decline. After registering 19% average annual growth for three years from 2008-09 to 2010-11, the growth rate fell to 15% during immediately following three years (the last three years of UPA) and to 10% during the subsequent three years (the first three years of the present government).

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Second, contrary to popular claims that sluggish demand is behind the slowdown in credit growth, differences in the performance of PSB and private banks point to supply side factors as the culprit.  Hamstrung by large and rising volume of non-performing assets (NPAs), PSBs have seen their credit growth decline from 20.5% during three years from 2008-09 to 2010-11 to 14.2% during the last three years of the UPA and then to 5.9% during the first three years of the present government. With their healthy balance sheets, private banks have exhibited exactly the opposite trend with credit growth rates at 15.8%, 17.7% and 21% in that order during the three periods.

Rapid growth in corporate bond market raises further doubts about the claims of weak credit demand. Net value of outstanding corporate bonds has grown at the average rate of 17.9% during the past three financial years followed by 18.2% average growth during the preceding three years. Remarkably, in value terms, outstanding corporate bonds have come to grow to 31% of the total bank credit at the end of March 2017.

Therefore, the main corrective measure we need is restoration of the health of PSBs.  With disproportionately large bank deposits, these banks offer the greatest scope for accelerating credit growth. Among other things, this requires infusion of fresh equity into them.

One way to accomplish this with minimal crowding out of private investment would be for the government to offer PSBs bonds in return for equivalent equity.  In this manner, the government will be able to infuse equity without having to borrow from the private market. To my knowledge, under the accounting practices approved by the International Monetary Fund, such recapitalisation does not add to fiscal deficit.  Unfortunately, under our accounting practices, it does.

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Therefore, while the exchange of equity for debt would minimise crowding out of private investment, it would not get around the fiscal constraint implied by the deficit target.  The government will need to generate extra revenues beyond those currently estimated in the Budget.

The principal avenue available for extra revenue, which also coincides with the government’s commitment to reforms, is accelerated disinvestment. It has been nearly a year since the Cabinet Committee on Economic Affairs (CCEA) approved the first tranche of enterprises that the NITI Aayog had recommended for strategic disinvestment.  In the meantime, Air India has also been identified for strategic sale.

Yet, to date, not a single public sector enterprise has been sold.  It is time that the government directed the Department of Investment and Public Asset Management to translate the CCEA resolution into action.

In addition, the government may consider selling or leasing to private players on a long term basis infrastructure projects that it has built and currently operates.  Private players have been hesitant to enter Build, Operate and Transfer (BOT) contracts due to risks associated with land acquisition and other unanticipated sources of cost overruns.  But they would face no such risks with buying or leasing already completed projects.

Once markets recognise the government’s resolve to restore the health of the banks, value of bank equity would rise.  This would allow banks to raise additional equity from the market and the government to raise additional revenue through sales of its bank equity up to 50%.  A virtuous cycle would emerge.

DISCLAIMER : Views expressed above are the author’s own.

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