Road Map to Save India's Cash-Strapped Banks Near Completion

Updated on
  • India may include recapitalization bonds in mandatory reserves
  • Modi to infuse $32 billion to spur lending by state banks

Analyst Hazari Sees India's Bank Rescue Plan as Positive

India is considering all options including making bank recapitalization bonds eligible for inclusion in statutory limits for investment in government securities, a senior government official said.

"Statutory liquidity ratio status allows these bonds to be traded but they may not have an extra interest advantage," Economic Affairs Secretary Subhash Garg said in an interview at his New Delhi office. "That is also being discussed and examined."

Prime Minister Narendra Modi’s administration announced a 2.1 trillion rupees ($32 billion) plan to recapitalize state-run banks on Oct. 24. To spur lending by banks grappling with bad debt in Asia’s third largest economy, the government will sell 1.35 trillion rupees of bonds while banks will get the rest through budgetary support and markets.

"In couple of weeks we will have the entire plan," said Garg, who was formerly at World Bank. He added the government or one of its agencies could issue the bonds which would not have an impact on its "real" budget deficit.

Banks are flush with funds after Indians returned 99 percent of over $15 trillion worth of currency invalidated by Modi on Nov. 8 last year. They will be able to invest the funds in recapitalization bonds which the government will plough back into the banks, Garg said, enabling banks to revive lending growth from a 25-year low.

Why India Is Pumping $32 Billion Into State Banks: QuickTake Q&A

Fitch Ratings Ltd. estimates that India’s state lenders will need about $62 billion in additional funds to meet international capital adequacy requirements by 2019.

Interest Rates

The recapitalization plan would not completely address the problem of bad loans unless it is followed by rate cuts from the central bank, according to Abhishek Gupta at Bloomberg Intelligence.

The industry sees scope for an interest rate reduction but "growth is not an interest rate phenomenon alone, it’s the investment which needs to take place," Garg said.

Read more: Reality Check for India’s Central Bank as Slowdown Deepens

India’s growth plummeted to a three-year low in the June quarter as the cash ban and a nationwide sales tax led to uncertainties and disrupted supply chains. The Central Statistical Organization is scheduled to release September quarter growth estimate on Nov. 30.

"The transitory disruptive effect is over. Now we are on a stable growth path. When the number comes you will see a sizable turnaround -- we have definitely bottomed out," Garg said.

Budget Deficit

India may not meet its target from the sale of telecommunication spectrum this year but it might do better in asset sales in state-owned companies, Garg said. He said the government was committed to its fiscal road-map but a clearer picture would emerge by December.

"There is nothing dogmatic or final that a certain kind of target represents the best for economy -- ground realities have to be taken into account," he added.

India wants to shrink its budget deficit to 3.2 percent of the gross domestic product in the year through March. Any deviation from the road-map could risk a cut in its sovereign ratings. Modi’s economic advisers have also warned against any relaxation in the goal.

(Updates with comment on interest rates in seventh paragraph.)
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