Mumbai: The Economic Survey has identified what it calls the “twin balance sheet” problem as one of the most critical short-term challenges confronting the Indian economy.
The problem is of the impaired balance sheets of public sector banks (PSBs) and some large corporate houses, which the Survey says is a major impediment to private investment.
The problem is now well known. Even the “4 Rs” solution suggested by the Survey — Recognition, Recapitalisation, Resolution and Reform — is actively debated.
What is new is the suggestion that the burden of recapitalising banks should not fall only on the government but also on the Reserve Bank of India (RBI).
While acknowledging the need to recapitalise banks, the Survey asks where the resources for recapitalisation will come from at a time when public finances are constrained.
One, and the more obvious answer, is that the government sell stakes in non-financial companies and use the proceeds to recapitalise banks. The second part of the solution, the Economic Survey suggests, may lie within the RBI’s own balance sheet.
“Given the tight fiscal position, where might the resources to recapitalise PSBs come from? One possible source is the public sector’s own balance sheet. For example, the government could sell off assets that it no longer wants to hold, such as certain non-financial companies, and use the proceeds to make additional investments in PSBs. This option is reasonably well understood. What is less appreciated is that RBI could do the same. That is to say it could redeploy its capital as well,” reads a box item in the Economic Survey.
What does that mean? Well, essentially, the government seems to be asking the RBI to release some of its reserves for the purpose of recapitalisation.
The Survey looks at the ratio of shareholder equity to assets of various central banks and comes to the conclusion that the RBI has much higher equity as a percentage of total assets of 32%, when compared to other central banks. The median across central banks is 16%, says the survey.
Shareholder equity is defined to include capital plus reserves (built through undistributed retained earnings) plus revaluation and contingency reserves.
“If the RBI were to move even to the median of the sample (16%), this would free up a substantial amount of capital to be deployed for recapitalising the PSBs,” said the Economic Survey.
At present, the RBI transfers its surplus to the government annually. In 2014, a committee headed by Y.H. Malegam had suggested that the central bank can transfer its entire surplus to the government, without allocating anything to its various reserve funds, for three years because it had adequate reserve funds.
Since then, the annual transfers to the government have risen. In 2015, the annual divided paid was Rs.66,000 crore, which was the highest on record.
The Economic Survey seems to want the central bank to go beyond that.
“Of course, there are wider considerations that need to be taken into account. Most important, any such move would need to be initiated jointly and cooperatively between the government and the RBI. It will also be critical to ensure that any redeployment of capital would preserve the RBI’s independence, integrity, and financial soundness—and be seen to do so,” said the Economic Survey.
The markets have been seeking upfront recapitalisation of public sector banks, which have seen their non-performing loans surge following an attempt by the RBI to clean up bank books. The increase in bad loans wiped out profits for a number of banks in the December quarter. While the government has committed to providing Rs.70,000 crore to banks over a four-year period starting fiscal 2016, analysts have noted that the amount of capital needed may be higher and that the capital infusion may also need to be front-loaded.
“Stressed assets (non-performing loans plus restructured assets) have been rising ever since 2010, impinging on capital positions, even as the strictures of Basel III loom ever closer on the horizon. Banks have responded by limiting the flow of credit to the real economy so as to conserve capital, while investors have responded by pushing down bank valuations, especially over the past year,” said the Economic Survey while commenting on the twin balance sheet problem facing the Indian economy.
The vulnerability seen across banks mirrors frailties in the corporate sector where big business groups have become over-indebted. This together with the fact that corporate profits are low is forcing firms to cut investment to preserve cash flow, noted the Survey.