• The London Financial

India and Non-performing Assets

By Yogen Mudgal, BSc Accounting and Finance Student at Warwick Business School

Storming 'capitols' seems to be a growing trend in global democracies. After the incident in Washington DC, similar scenes rocked the capital of the world’s largest democracy. Albeit not a capitol, India’s Red Fort holds a privileged position in the nation’s politics. The country was stunned when protestors striking against a set of new farming laws tried to barge into the fortress. For the government in Raisina however, the fallout from its new laws to liberalise the agricultural markets is merely a sideshow. Delhi knows it’s dealing with a very real possibility of a financial crisis and credit crunch hitting the country in the 2020s — one that would kill India’s growth ambitions.

I have written previously about the pain that the $1.8 trillion Indian financial sector is feeling from the pandemic-induced recession and the raging liquidity crisis that has been in the works since 2018. In the two years since, five key financial institutions have failed. It started with the default from infrastructure lender IL&FS, followed by the collapse of housing finance company DHFL. The contagion then spread to commercial banks in 2019 and 2020 with PMC, Yes Bank and LVB being taken over by the Reserve Bank of India. Each time the resolution has been different, and the authorities have only been able to get it right once: with LVB’s sale to Singapore’s DBS.

Three years on, the insolvency proceedings for IL&FS are still far from clear with resolution on less than a third of the debt. As for DHFL, its bidding process attracted distressed debt specialist Oaktree alongside local groups. The auction took over a year to settle and the case might still end up in court after Oaktree alleges foul play on the part of the authorities which accepted bids after the deadline and picked a domestic company instead, side-lining the American credit giant. Yes Bank, a commercial lender with over $20 billion in deposits, got one of the most disastrous bailouts that wiped out debt held by pensioners and barely scratched the surface of the cash the bank needs. PMC’s auction process is still ongoing.

In the past three years, regulators and authorities have effectively crushed non-banking financial companies, undermined depositor’s trust by imposing withdrawal limits, alienated potential distressed credit investors that could take over the country’s massive pile of bad debts and increased the financial sector's woes rather than sorting them out. Added to this are one of the world’s most draconian Coronavirus lockdowns and a massive economic contraction; you have the perfect recipe for disaster.

Forecasts predict that India’s non-performing assets ratio — already the highest in the world — will rise to nearly 15% in FY 2021-22. In her budget, the Finance Minister floated the decision to set up a bad bank to deal with troubled assets, albeit without delving into any details on how it would work. While this would be obviously a welcome decision to the markets fearing further bank failures, it fails to address the inherent underlying causes of this debt pile-up.

At the heart of India’s failing financial infrastructure are its state-owned banks. Their ratio of non-performing loans is set to increase from 7.5% in 2020 to well over 13.5%-14.8%. Even though private and foreign banks’ books will worsen due to the recession, state lenders account for most of the rise of India’s NPAs. Prone to corruption, bureaucracy and inefficiency, these lenders have lacked the discipline to deliver performance that the newly emerged private banks have. The post-2000s slowdown and the government’s mismanagement of the economy haven’t exactly helped.

However, operating in the same macroeconomic environment, India’s HDFC has created the most shareholder value of all banks in the world even when its peers are lining up for a bailout. This startling divergence hasn’t gone unnoticed in Delhi and the government announced the privatisation of 2 small state lenders alongside the country’s largest insurer, LIC.

Privatising small sections of the financial sector, though, doesn’t have the kind of lasting effect that the Indian financial sector needs in its current crisis. In a perfect world, this would be the opportunity to sell-off swath of government assets across the economy, and even open up the financial services market to global players that bring expertise, discipline and above all, cash to support the struggling industry. It may have played out well in the case of LVB’s sale to DBS, but would send shocks through the political system if a large state-owned lender was sold to foreign entity. Much like the controversial farming laws from earlier, the government lacks the political capital to oversee meaningful reforms to the financial sector.

The inherent socialist reluctance in the country’s political establishment lingering on from the 70s means that 1991-style market reforms are very unlikely. But even without the parliament, the executive can make significant changes to steer the ship through. First, it could stop botching up bailouts in what are completely unforced errors. Second, it could fix the disastrous 2016 bankruptcy law, or at least create a new regulatory base for financial companies. Third, albeit slowly, the need to keep pushing for privatisation is essential for the financial sector. And finally, it needs to show the world that India is open for business by not rigging open auctions or prioritising domestic companies.

Three decades on from its balance-of-payments crisis, India faces another pivotal moment to redefine its growth story. So far though, it seems to be failing in the face of this challenge. This could be a moment of reset in driving the next phase of growth for the nation, or it could be left grappling with slowdowns and underperformance for another generation.

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