Jaitley isn’t getting it; recovery is a mirage as long as banks remain fence-sitters

The budget was a golden chance for Jaitley to keep the economic revival story intact by refuelling the banks. By choosing not to do this, Jaitley seems to be forgetting that someone needs to really fund the India growth story

Dinesh Unnikrishnan March 10, 2015 17:36:15 IST
Jaitley isn’t getting it; recovery is a mirage as long as banks remain fence-sitters

The only element seems to be missing in an otherwise promising India-story scripted by the Narendra Modi government in the first nine months at Centre, is any credible sign of sustainable economic recovery.

True, recovery doesn’t happen overnight. It demands time. But nine months should be sufficient for any government to show the direction. That is what is precisely missing as mirrored by all key macro-indicators that are commonly watched for growth trends—factory output, core sector growth, bank lending and PMI numbers.

A Reuters report, citing a poll of economists, on Tuesday said India’s factory output would have further lost momentum in January, after a disappointing set of numbers in December, signalling persisting weakness in the real economy.

The index of industrial production (IIP) slowed to 0.65 percent in January from December's 1.70 percent, the report said. In December, IIP had slowed to 1.7 per cent from 3.9 per cent in November, with manufacturing, electricity, capital goods segments registering anaemic growth.

Jaitley isnt getting it recovery is a mirage as long as banks remain fencesitters

Reuters

Such a fall in January numbers is quite logical since the core sector growth numbers and the PMI numbers, released in the first week of March, too had painted a grim picture of the economy. Out of the eight core sectors, only two — fertilisers and steel sector — showed some growth. The overall sector growth hit a 13-month low of 1.8 percent.

Growth in all other sectors dropped with natural gas registering the sharpest fall of 6.6 percent in January compared with a fall of 3.5 percent in December.

The Modi government has repeated its commitment to ease the process of doing business, push public investments and bring in private investors to pep up the India growth story. The promises range from removing the hurdles for project implementation, making financing and refinancing more easier for infrastructure projects to encouraging manufacturing on the home soil.

To be sure, some amount of work has already gone into each of these areas in the past nine months. But the real growth on the ground is missing. Why?

The answer is simple. The growth script is ready; but there are no fresh investments coming in to fund the story. The private sector, loaded with debt and faced with poor demand, is not interested in investing, while the government is financially stressed. Banks, which are the lifeline for companies, wouldn’t lend as they are burdened with bad loans and do not have enough capital.

In short, there is no reason to expect government spending and the private sector will act to bring about the revival. In this context, sustained flow of bank credit is something that could have been a near-term trigger to keep the momentum alive.

But that hasn’t happened because state-run banks, which control 70 percent of the banking industry and still the primary financiers to long-gestation infrastructure projects, are helpless due to the combined impact of fund draught and bad loan troubles. Over 90 percent of the total bad loans of the banking system is on the books of these lenders.

Higher bad loans put pressure on the capital situation of banks as they need to set aside more money to provide for such loans. They also need funds to meet the Basel-III requirements. But, on the other hand, capital support from the government, which is the majority owner in these entities, is notably absent.

As Firstpost has highlighted before, the Rs 7,940 crore capital infusion announced in the budget for public sector banks is only half of what they originally require and lower than what the government committed for 2014-15.

Even for fiscal year 2015, the government has so far infused only about Rs 6,990 crore out of the promised Rs 11,200 crore, based on performance.

Except for a few large banks, other government banks do not have the ability to raise funds from the market. This would virtually forcing most of them to shrink their business or merge with other banks.

Already capital shortage is visible in the slow pick-up of bank credit credit, which grew by just 10 percent in the December quarter lagging behind the growth in deposits, with most segments witnessing a slowdown.

Credit to industries grew at a slower pace of 6.6 percent on year compared with 13.6 percent in the year-ago period. This is not surprising since in the absence of the much needed additional capital, banks would rather preserve the existing headroom to meet the mandatory reserve requirements and repay the existing bad loan book, rather than taking fresh exposure.

What makes the finance minister's move particularly disheartening for state-run banks is his decision to set aside Rs 20,000 crore for the creation of a refinancing agency, Micro Units Development Refinance Agency Bank (MUDRA), for small and medium enterprises.

This was unnecessary. Instead of creating a new agency, he could have opted to strengthen the existing ones with similar goals — such as the National Bank of Agriculture and Rural Development, Small Industries Development Bank of India and National Housing Bank — and channelled Rs 20,000 crore into the public sector banks. This would have offered them the much-needed headroom to resume lending to industry.

The budget was a golden chance for Jaitley to keep the economic revival story intact by refuelling the banks. By choosing not to do this, Jaitley seems to be forgetting that someone needs to really fund the India growth story.

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