There is a consensus today that India is in a sweet spot among Emerging Markets. The India growth story, which went behind clouds for sometime due to a host of issues, is being discussed enthusiastically once again. The huge FPI inflows into Indian capital market YTD in 2017, the third best after Mexico and Taiwan, is a reflection of this renewed interest in the India Growth Story. One major drag on India’s growth prospects, however, has been the “twin balance sheet problem”: the highly leveraged companies and the huge stressed assets that have been chocking the banking system. The decision of the Union Cabinet to issue an ordinance to amend the Banking Regulation Act that can pave the way for the resolution of the NPA crisis is a bold and timely initiative to address this major drag on the Indian economy.

Stressed assets in the banking system have been rising steadily during the last 5 years. Profligate lending by the banks during the boom years of 2003-07, reckless borrowing by some corporates in segments like steel, power and construction, some unexpected developments relating to the price of imported coal, the crash in steel prices following the huge excess capacity in China etc. contributed to the rising NPA burden which has reached around Rs 7 lakh crores presently. The PSU banks are the worst affected. Some private sector banks too are affected, but generally, the private sector performed relatively far better. For the financial year ended March 2016, the public sector banks incurred a combined loss of Rs17446 crores on a combined equity capital base of Rs 18894 crores. Contrast this to the performance of private sector banks, which earned a net profit of Rs 40298 crores on a combined equity capital base of Rs 9376 crores. The huge stressed assets of the PSU banks has reached a stage where meeting the Basel 3 norms has become a big challenge.

The ordinance promulgated by the Government is widely expected to pave the way for the resolution of the crisis. The Prime Minister’s Office, the Finance Ministry and the Reserve Bank of India had recently arrived at a consensus on a new NPA resolution policy. It is likely that the amendment to the Banking Regulation Act will empower the RBI to address the issue. Under the policy, an Oversight Committee to be set by the RBIwill have special powers to resolve NPAs. The Oversight Committee, which is likely have jurisdiction over all resolutions, can remove the fear of investigation by the agencies.

Details will be available only after the President approves the ordinance. But, indications are that the new policy will allow banks to take haircuts within permissible limits. A new formula for haircuts and recasting of loans may be proposed and the OC is likely to recommend the extent of haircuts.  A deadline for the resolution of NPAs with penal provision for non-resolution is likely.

The Government is likely to manage the political fall out of the resolution and haircuts by arguing that the NPAs are a legacy issue inherited from the UPA Government.

The new initiative has come as a shot in the arm for the Indian economy. This is likely to pave the pave for India to emerge as the fastest growing large economy in the world for the next 5 to 7 years.

Posted: October 2017