Bad loans: Recapitalisation bonds are not enough to resolve the mess in Indian public sector banks

The battle against the twin balance sheet problem of the Indian economy will not be conclusively won unless further reforms are implemented.

A few days after Diwali last year, India’s were tearing their hair out as they struggled to manage long queues of people and replace old currency notes of Rs 500 and Rs 1,000 in the wake of demonetisation.

This Diwali was different, particularly for the public-sector banks.

Less than a week after the festival, they heaved a sigh of relief, though for a different reason. On Tuesday, October 24, the government announced a grand plan: public sector banks will be recapitalised to the tune of Rs 2.11 lakh crore over the next two years.

This amount may be a little short of the estimated requirement of Rs 3 lakh crore of total recapitalisation, but it is a step that shows the government’s seriousness in tackling the financial mess in the state-owned banking sector.

Full details of the recapitalisation are not yet out. An estimated Rs 18,000 crore will come straight from the central exchequer by way of equity. Another Rs 58,000 crore is expected to come from banks raising capital from the market. The remaining Rs 1.35 lakh crore would be in the form of recapitalisation bonds, the details of which are yet to be made public.

But even as Finance Minister Arun Jaitley, Reserve Bank of India Governor Urjit Patel and Chief Economic Advisor Arvind Subramanian spoke separately on the implications of the recapitalisation plan, three messages are coming out loud and clear.

One, the Modi government is preparing for a slippage in its fiscal consolidation plan in order to provide the much-needed capital for public-sector banks.

Contrary to suggestions made by some influential voices in the government, the fact is that the issuance of the recapitalisation bonds under the new package will result in an effective widening of the fiscal deficit. And if higher revenues do not come to its rescue, this will be the first year of the Modi government when it would fail to meet its fiscal deficit target and indeed could change the trend of a declining fiscal deficit witnessed in each of the last five years.

True, as the RBI governor pointed out, the issuance of bonds would be “liquidity-neutral” for the government, but they would certainly add to the government’s borrowing. Both the additional borrowing and the annual interest outgo of Rs 8,000-9,000 crore on these bonds should widen the government’s fiscal deficit. Indeed, Patel himself does not rule out a widening of the fiscal deficit when he says that by “deploying recapitalisation bonds, it will front-load capital injections while staggering the attendant fiscal implications over a period of time.”

The chief economic advisor has noted that international standards and even the accounting norms followed by the International Monetary Fund do not require these recapitalisation bonds for the financial sector to be captured while calculating the government’s total fiscal deficit. These numbers are mentioned “below the line”. But effectively it will imply a widening of the fiscal deficit. Even Subramanian has admitted in a public lecture that “under India’s convention, these bonds would add to deficit”.
It is possible that the government may choose to present the impact of the recapitalisation bonds separately “below the line”, as was done many years ago for the oil bonds to help oil companies absorb the impact of higher crude oil prices, without passing it on in the form of increased prices for consumers.

If that path is chosen, it is likely that analysts and rating agencies may start referring to two sets of fiscal deficit numbers – the actual fiscal deficit including the impact of the recapitalisation bonds and the official fiscal deficit that does not reflect such an impact. Analysing the Indian government’s fiscal deficit numbers will get a little more complex.

The final confirmation that the Modi government may be accepting a widening of its fiscal deficit in the wake of these bonds came from none other than the finance minister, though in an indirect way. In a tweet, Jaitley said: “Government is committed to maintaining a balance between fiscal prudence and capital spending to push growth.”

A balance between fiscal prudence and capital spending suggests that a middle path is likely to be followed wherein some relaxation in the fiscal deficit reduction target is possible to make way for higher capital expenditure to attain higher growth.

Two, the stock market has given its thumbs up for the government move.

A 435-point jump in Sensex on Wednesday has taken the Bombay Stock Exchange benchmark index to a record high, reflecting a Rs 1.2 lakh crore increase in the market capitalisation of 22 listed public-sector banks. The Nifty Bank index jumped by 30% in a day – a record in itself. Clearly, the stock market believes that the combined impact of the Insolvency and Bankruptcy Code and recapitalisation of state-owned banks would help relieve the stress in the financial sector.

The positive market response is significant and augurs well for the government’s recapitalisation package. Remember that almost Rs 58,000 crore out of Rs 2.11 lakh crore will have to be mobilised through flotation of equity in the capital market. If the market sees an improvement in the listed state-owned banks’ ability to grow their business profitably after the infusion of recapitalisation bonds, it will help retail subscription of fresh shares of these banks. The RBI governor was hopeful that the package would help “involve the participation of private shareholders of public sector banks by requiring that parts of the capital needs be met by market funding.”

Three, the recapitalisation package will not in itself be capable of preventing further deterioration in the quality of assets of these public-sector banks.

Hence, expectations of what further reforms of these banks will follow have risen. The finance minister did talk about a package of reform measures that the government would announce to supplement its recapitalisation efforts. Details of such reforms will be eagerly awaited.

The RBI governor has already hinted at what those reform measures could be. Patel seemed hopeful that banks worthy of capital infusion would be prioritised. He said: “It will allow for a calibrated approach whereby banks that have better addressed their balance-sheet issues and are in a position to use fresh capital injection for immediate credit creation can be given priority while others shape up to be in a similar position. This provides for a good way of bringing some market discipline into a public recapitalisation program compared to the past recapitalisation programs.”

Indeed, the battle against the twin balance sheet problems of the Indian economy (indebted India Inc and rising bad loans of banks) will not be conclusively won unless further reforms are implemented. Will the government go in for ownership change in the state-owned banks? Will the managements be revamped in a way that such bad loans problems do not recur?

In that sense, this package is incomplete even though it has elements of both the Sudarshan Chakra that Reserve Bank of India Deputy Governor Viral Acharya had asked for and of the Brahmastra, a term that Chief Economic Advisor Arvind Subramanian has used to describe the package.

Disclaimer: Views expressed are personal. They do not reflect the view/s of Business Standard

This article first appeared on Business Standard.

We welcome your comments at letters@scroll.in.
Sponsored Content BY 

Relying on the power of habits to solve India’s mammoth sanitation problem

Adopting three simple habits can help maximise the benefits of existing sanitation infrastructure.

India’s sanitation problem is well documented – the country was recently declared as having the highest number of people living without basic sanitation facilities. Sanitation encompasses all conditions relating to public health - especially sewage disposal and access to clean drinking water. Due to associated losses in productivity caused by sickness, increased healthcare costs and increased mortality, India recorded a loss of 5.2% of its GDP to poor sanitation in 2015. As tremendous as the economic losses are, the on-ground, human consequences of poor sanitation are grim - about one in 10 deaths, according to the World Bank.

Poor sanitation contributes to about 10% of the world’s disease burden and is linked to even those diseases that may not present any correlation at first. For example, while lack of nutrition is a direct cause of anaemia, poor sanitation can contribute to the problem by causing intestinal diseases which prevent people from absorbing nutrition from their food. In fact, a study found a correlation between improved sanitation and reduced prevalence of anaemia in 14 Indian states. Diarrhoeal diseases, the most well-known consequence of poor sanitation, are the third largest cause of child mortality in India. They are also linked to undernutrition and stunting in children - 38% of Indian children exhibit stunted growth. Improved sanitation can also help reduce prevalence of neglected tropical diseases (NTDs). Though not a cause of high mortality rate, NTDs impair physical and cognitive development, contribute to mother and child illness and death and affect overall productivity. NTDs caused by parasitic worms - such as hookworms, whipworms etc. - infect millions every year and spread through open defecation. Improving toilet access and access to clean drinking water can significantly boost disease control programmes for diarrhoea, NTDs and other correlated conditions.

Unfortunately, with about 732 million people who have no access to toilets, India currently accounts for more than half of the world population that defecates in the open. India also accounts for the largest rural population living without access to clean water. Only 16% of India’s rural population is currently served by piped water.

However, there is cause for optimism. In the three years of Swachh Bharat Abhiyan, the country’s sanitation coverage has risen from 39% to 65% and eight states and Union Territories have been declared open defecation free. But lasting change cannot be ensured by the proliferation of sanitation infrastructure alone. Ensuring the usage of toilets is as important as building them, more so due to the cultural preference for open defecation in rural India.

According to the World Bank, hygiene promotion is essential to realise the potential of infrastructure investments in sanitation. Behavioural intervention is most successful when it targets few behaviours with the most potential for impact. An area of public health where behavioural training has made an impact is WASH - water, sanitation and hygiene - a key issue of UN Sustainable Development Goal 6. Compliance to WASH practices has the potential to reduce illness and death, poverty and improve overall socio-economic development. The UN has even marked observance days for each - World Water Day for water (22 March), World Toilet Day for sanitation (19 November) and Global Handwashing Day for hygiene (15 October).

At its simplest, the benefits of WASH can be availed through three simple habits that safeguard against disease - washing hands before eating, drinking clean water and using a clean toilet. Handwashing and use of toilets are some of the most important behavioural interventions that keep diarrhoeal diseases from spreading, while clean drinking water is essential to prevent water-borne diseases and adverse health effects of toxic contaminants. In India, Hindustan Unilever Limited launched the Swachh Aadat Swachh Bharat initiative, a WASH behaviour change programme, to complement the Swachh Bharat Abhiyan. Through its on-ground behaviour change model, SASB seeks to promote the three basic WASH habits to create long-lasting personal hygiene compliance among the populations it serves.

This touching film made as a part of SASB’s awareness campaign shows how lack of knowledge of basic hygiene practices means children miss out on developmental milestones due to preventable diseases.


SASB created the Swachhata curriculum, a textbook to encourage adoption of personal hygiene among school going children. It makes use of conceptual learning to teach primary school students about cleanliness, germs and clean habits in an engaging manner. Swachh Basti is an extensive urban outreach programme for sensitising urban slum residents about WASH habits through demos, skits and etc. in partnership with key local stakeholders such as doctors, anganwadi workers and support groups. In Ghatkopar, Mumbai, HUL built the first-of-its-kind Suvidha Centre - an urban water, hygiene and sanitation community centre. It provides toilets, handwashing and shower facilities, safe drinking water and state-of-the-art laundry operations at an affordable cost to about 1,500 residents of the area.

HUL’s factory workers also act as Swachhata Doots, or messengers of change who teach the three habits of WASH in their own villages. This mobile-led rural behaviour change communication model also provides a volunteering opportunity to those who are busy but wish to make a difference. A toolkit especially designed for this purpose helps volunteers approach, explain and teach people in their immediate vicinity - their drivers, cooks, domestic helps etc. - about the three simple habits for better hygiene. This helps cast the net of awareness wider as regular interaction is conducive to habit formation. To learn more about their volunteering programme, click here. To learn more about the Swachh Aadat Swachh Bharat initiative, click here.

This article was produced by the Scroll marketing team on behalf of Hindustan Unilever and not by the Scroll editorial team.