India risks coming out of the Covid crisis with big impediments to future growth unless its ailing banking sector is turned around rapidly and government takes a longer term view on reviving the financial industry, leading market experts have told GlobalMarkets.
The south Asian country’s banks did not enter the year from a position of strength, with weak corporate asset quality and rising non-performing loans (NPLs) wreaking havoc on their balance sheets and profits well before the Covid crisis began.
With limited fiscus stimulus from the government hobbling growth, the Reserve Bank of India has taken unprecedented steps to get the economy back on track through interest rate cuts and extended debt moratoriums.
But its efforts may be in vain unless banking sector reform is put at the top of the agenda, senior leaders warned.
“The time to reform India’s banking sector is now,” said Viral Acharya, former deputy governor told GlobalMarkets. “In the short run, this can be through recapitalisation of public sector banks.
“But if the government can’t provide capital given the fiscal constraints, it should shed its stakes in some state-owned banks below majority to say 25%, improve their governance by empowering the boards, and even consider providing a blueprint for reprivatising some of them.”
Legacy loan issues
Acharya added that India needed to avoid a situation where banks were undercapitalised and “being an impediment to growth after the country comes out of the Covid crisis”.
“You’re setting yourself up for much lower growth after Covid if you don’t reform the banking sector now,” said Acharya, now a professor at the New York University Stern School of Business. “Under-capitalised banks will end up dealing with legacy loan issues, and do ‘zombie lending’, or ever-greening defaulted loans, or ‘lazy lending’ by just buying government bonds. This will crowd out credit to healthier borrowers and push India into a ‘growth trap’.”
Growth has already stagnated. For the quarter ending in June, GDP plunged by a higher than expected 23.9% year-on-year. In its World Economic Outlook report published on Tuesday the IMF projected India’s GDP would slide 10.3% in 2020 from growth of 4.2% in 2019, before rebounding by 8.8% the next year.
Against this backdrop, stabilising one of the most important parts of the Indian economy is all the more critical. And for this, the RBI and the government need to work closely.
“Before Covid, the fiscal effort that would have been required to clean up the banks didn’t seem huge, but seemed achievable,” said Shaun Roache, Asia Pacific chief economist at S&P Global Ratings. “It’s bigger now. The RBI can help by improving the way monetary policy works and trying to get some rate cuts through to the real economy and setting up new lending facilities. But ultimately, if it’s a balance sheet issue, it’s a fiscal problem.”