Modi's one year: Arun Jaitley's all-is-well rant conveniently misses unpleasant part

Finance minister Arun Jailey’s press conference on Friday giving a round-up of the Narendra Modi government’s one-year performance exhibited his mastery of presenting all the good things in a convincing tone, be it the intent to push tax reforms, reining in fiscal situation or pursuing the future divestment plans. Indeed, the prospects of the economy look a lot better than the UPA days. But, the minister has smartly left out the unpleasant part of the story — radical banking sector reforms and recapitalisation of banks — and has depended heavily on certain risky assumptions. [caption id=“attachment_2258302” align=“alignleft” width=“380”]  Finance Minister Arun Jaitley[/caption] Before coming to that, one must surely acknowledge the good work the NDA government has done in its first year. There is indeed more clarity in terms of direction and intent of this government, compared with corruption-ridden, slow-moving regime of the UPA administration. There is progress in law making with some of the key reform bills (insurance, coal, mining) having seen the light of the day despite “obstructionism”. But, big-ticket reforms (Land Bill, GST) are yet to be done. During his hour-long presser, there was no word from Jaitley about the recapitalisation plans for state-run banks, which control 70 percent of the industry, the government’s willingness (or unwillingness thereof) to privatise or overhaul the human resource structure, badly hurting the operations of government banks. Jaitley’s all-good-from-now hypothesis is based on the assumption that resources will be made available for economic recovery. But unless the banking sector reforms are addressed in a radical manner, credit expansion cycle can only get delayed further. Thus, banks would fail to complement the government’s growth push, no matter however hard it tries. Indeed, Jaitley acknowledges that the bad loans are squeezing bank balance sheets, but soon draws comfort from the fact that bank non-performing assets (NPAs) have begun to decline from March quarter by a few basis points. The minister expects that banks would fend for themselves by tapping the market, despite the mammoth disinvestment of other PSUs. Both his assumptions are based on weak premises. First, one of the reasons for less bad loans in the March quarter was that banks rushed to restructure loans in a major way in the January-March quarter just before the Reserve Bank of India (RBI) closed the regulatory forbearance window for restructured loans. What this effectively means is that the actual size of bad loans in the banking system could be much more the Rs 3 lakh crore loans declared so far. Beginning April, banks need to treat any fresh restructuring as bad loans in terms of provisioning. This would mean that if a Rs 100 loan is recast, the bank needs to set side Rs 15 as against Rs 5 before. Hence, banks tried to push maximum cases to restructuring, to minimise the impact. Some of these cases would have, otherwise, become bad loans. Before taking comfort from the NPA decline in the March quarter, Jaitley should have also looked at the restructuring loan numbers. As Firstpost noted yesterday , a significant chunk of the restructured loans are turning NPAs on account of failure to improve their performance. Data sourced from corporate debt restructuring cell (CDR), a forum of banks that takes up cases of large restructuring proposals show that Rs 57,000 crore of restructured assets were tagged as failed loans, accounts that failed to recover despite recasts, at the end of the March quarter, almost double from the year-ago period. Until now, banks have been masquerading their bad loans as rejigged loans to show healthier balance sheets. This Means, the effective size of actual NPAs in the banking system is way higher than the reported numbers. But this hidden stress would come out eventually when the moratorium period given to several stressed companies would get over. Recently, RBI governor Raghuram Rajan too had highlighted the severity of the bad loan problem when he said the quantum of bad loans in the country’s banking industry may not have peaked yet and more pain may be in store. Rating agencies, such as Moody’s and Crisil, too have warned that bad loans are still a potential threat to the overall stability. Crisil has particularly warned about the practice of hiding bad loans. For instance, the agency pointed out the 5/25 scheme for infrastructure project loans. It said this could act as a way for banks and promoters to mask bad loans of at least Rs 80,000 crore in the current financial year. In short, the more banks hide through such methods, the bigger the problem in making. Second, Jaitley was totally silent on bank recapitalisation and privatisation plans. State-run banks must be recapitalised urgently to enable them meet their provisioning requirements and, more importantly, make loans available for an evolving growth story. As Firstpost noted earlier, the Modi government has indeed scored much better than UPA-II in preparing the platform for a growth resurgence, but failed to answer the question on who is going to fund the growth. This should have happened either through a mix of higher government spending plus private sector participation or from the banking system. The government’s obsession with fiscal deficit is a threat for capex expansion. Also, the country doesn’t have deep corporate debt market to take care of the funding needs of corporations, especially when the government is the biggest borrower in the market. Naturally, the onus falls on banks. Jaitley would do well if he shows the willingness to urgently recapitalise banks and initiate the process to privatise some of the smaller banks. The Rs 8,000 crore recapitalisation announced in the 2015 budget is clearly insufficient for state-run banks to push credit to productive sectors. It will be a foolish idea to pin hopes on private banks since they typically play safe by confining to safer retail assets compared with high-risk, long-gestation projects. It may be good time for the government to start thinking about privatisation in the banking sector. Privatisation doesn’t necessarily mean the country’s nationalised banks should be left open to private sector interests. The government can, instead, broad base the holding by giving participation to diversified shareholders. In any case, the government shouldn’t be in the business of doing business — something Modi himself has promised in the past. As far as the banking sector is concerned, still the government is the major participant in the banking industry — be it pushing directed credit to high-risk sectors or forcing banks sell government-sponsored schemes. Clearly, the reason for a change to waning investor sentiments from the days of euphoria is absence of much-needed structural reforms in the economy — the banking sector to begin with. As long as the government turns a blind eye to the issues in this sector, its growth revival agenda will lack a strong, convincing roadmap.