Quality of Bank Credit in India

Quality of Bank Credit in India

A lot of talk about India being one of the best emerging economies in in the world and a stand out economy compared to the rest of the world and projected as replacing China in terms of growth and world trade.

With the government perusing new policies and with a boost to many sectors and policy frame work like “Make in India “, Indian economy is projected to grow at a rapid pace. In order to growth the most important aspect is to have easy access to credit and a reasonable rate. Bank credit in India is still not very easy to get and with the conservative approach of the bankers in India the overall leverage provided by the banks is very modest compared to international standards.

One of the reasons the banking system stood strong in the 2008 crises is the limited leverage given to the companies and superior asset quality mainly due to stringent credit appraisal and quality selection of the borrower. However there is a big question today on the actual quality of the books in the banking system and the statics hide more than they reveal due to smart accounting methods like ever greening of loans, reconstruction of loans and loan top ups.

A big question is been asked about the true picture of the economy and more important the asset quality of most banks with reverence to statistical secret over stressed bank loans

Look around Asia for questionable economic figures and it is hard to get beyond China. Officially, the continent’s largest economy grew at 7 per cent in the first half of this year, bang in line with government targets. But many observers are suspicious, suspecting that creative accounting is hiding a sharp slowdown in growth.

Viewed from Mumbai or New Delhi, these China doubts are met with worries over their effects on India’s corporate sector, but also happy anticipation that the title of fastest-growing big global economy may be about to change hands. Yet anyone in India feeling an early sense of superiority would do well to remember that India has its own dirty statistical secret: a rate of troubled bank loans that is almost certainly in worse shape than government data suggest.

Officially it is bad enough. The Reserve Bank of India says that 11 per cent of loans, worth about $111bn, were stressed at the end of the last financial year. Of this, slightly less than half were non-performing. The remainders have been restructured, for instance by giving errant borrowers extra time to pay. Both measures have risen steeply over recent years, although the problem is most severe at state-backed banks, where 14 per cent of loans are stressed.

The true figure is probably even worse. Almost every big Indian industrial company has suffered delays to investment projects in recent years, including those of prominent businessmen. But a handful of sectors have been hit by even bigger problems. Steelmakers are suffering from a collapse in global commodity prices. Power producers are struggling to find buyers at bankrupt Indian state electricity boards.

 Despite this, most loans at heavily indebted metals and power companies are yet to be labeled as stressed. This year proper recognition of bad steel debts alone would push India’s non-performing assets levels up by nearly a third.

About $60bn of debts in the hands of businesses that have not earned enough to pay their loan interest for three years or more — a clear indication that repayment is unlikely. Despite this, 92 per cent of those same loans are still classified as healthy.

Tallying up figures like this is not easy and definitive figure for India’s true level of non-performing loans. But the research suggests it would be in the high teens rather than the official 11 per cent.

The significance of this is obvious. India’s economy appears to be recovering nicely, expanding at 7 per cent over the last quarter, the same rate as China. But underlying credit growth has stayed mysteriously low as banks shy away from lending, aware of the true problems in their loan books. In time, this will to choke off growth and most medium size companies find it extremely difficult to raise money from banks and financial institutions. 

It also means greater recapitalization. As part of plans to meet new Basel-III capital requirements, government last month announced it would inject Rs700bn ($11bn) during the next four years into state-owned lenders, which control about three quarters of loans. But a recent analysis from India Ratings, a division of Fitch, suggests that Rs1tn ($15bn) will be needed over and above that level to cover unrecognized bad loans across the banking system.

This cash is required because India’s bankers have been optimistic. They hope all those troubled steel and power projects will come good, and have given borrowers more time to recover — a sanguine policy that critics might describe as extend and pretend. But even if these projects do get finished eventually, many will remain unviable without loan haircuts, a step India’s banks have so far been unwilling to contemplate.

The RBI Governor has tightened some rules, forcing banks to put more money aside to cover loans that may go bad.  Whatever measures are taken, admitting the scale of India’s bad loans is a necessary start. As China might be about to discover, it is hard to fix a problem without it admitting it first.

-       Farzan Ghadially

India Wrestles with Inflation

Inflation or Deflation – One Nation two Stories

A random walk down Dalal street and every person you meet says that inflation is easing and high time the RBI cuts rates just walk a little ahead crossing a few by lanes and when you reach the main street, people say it is almost impossible to survive and everything has become so expensive, restaurants have stopped serving extra onions and have cut the dish quantity and cost of other essential things have really increased and the Government and RBI should do something ….

OOOPS

Who should RBI listen to the pundits  and analyst in suit boot or the common man who knows nothing about sophisticated terms like CPI ( Consumer Price Index) or WPI ( Wholesale price index) all he knows is the ground reality enough to make him survive and if possible keep some savings for a rainy day.

Price rise or price fall…. India wrestles with inflation-deflation puzzle.

Baffling figures prompt heated debates between hawks and doves on interest rate strategy.

Anyone studying India’s economy by looking only at its wholesale prices index for the past year could be forgiven for assuming that the country is in the grip of severe deflation, if not economic depression.

In August, the year-on-year change in the country’s WPI fell to minus 4.95 per cent, the lowest for nearly 40 years. The index has been in negative territory for nearly 12 months.

In the same month, however, the consumer prices index showed inflation of 3.66 per cent, and is expected to rise again in the coming months to about 5 per cent. Indians still fret about the price of everything from onions to medical care, and the gap between the WPI and CPI measures stands at more than 8 percentage points.

Disagreements over the significance of India’s puzzling inflation numbers, like those over its reported economic growth rate of 7 per cent a year, are fuelling a sometimes heated debate between monetary doves and hawks over interest rate policy.

Indian business leaders, supported by the government, complain about high real interest rates and the cost of capital. They are pleading with the Reserve Bank of India to slash its policy interest rate from 7.25 per cent, so that the economy grows and people start spending more there by giving boost to India Inc.

RBI (Reserve Bank of India) , on the other hand, is determined to force down India’s traditionally high inflation for the long term and is seeking to meet a CPI-measured inflation target of 6 per cent by January next year, although he is still likely to reduce rates by a further 50 basis points in the months ahead.

On the other hand the government’s feels, that challenge for India appears not to be price inflation but possibly price deflation and a blended measure using components of both the CPI and WPI, suggested annual inflation of 1.7 per cent if calculated for gross domestic product as a whole and just 0.1 per cent for gross value added, excluding the distortionary elements of indirect taxes and subsidies. In a situation like this, to exclusively focus on the CPI makes no sense, contrary to what the respected RBI governor feels.

It is almost impossible to have a perfect inflation index for all concerned in the society but India’s WPI is not a good indicator of future CPI because the two indices measure different things: WPI measures prices of tradable goods, including those of fuel and basic manufactured products such as steel, which have fallen sharply on international markets, while CPI includes services such as health and education.

CPI would nevertheless have fallen further, if India was not burdened by chronic supply-side bottlenecks that government needs to tackle. The government expects CPI inflation to rise, especially after demand is stoked by civil service pay increases to be awarded by the forthcoming Seventh Pay Commission.

The continuing large gap between WPI and CPI is a puzzle: This diverging wedge is not completely understood clearly in a complex economy like India.

While hawks and doves pursue their agendas with the help of their preferred inflation indicators, investors and analysts seem to be leaning towards the notion that India is afflicted neither by the drastic deflation indicated by WPI nor the high inflation usually reflected in the CPI.

There is a lot of anticipation a large rate cut to the tune of 50 basis points by the RBI in its next meeting as India Inc and the government is holding RBI responsible for the lack of growth and they feel that a rate cut would really boost the spending power and people would open their purses. Even if there is a good rate cut by the RBI, what is to be seen is how much of that cut is actually transmitted to the end users by the respective banks.

Let’s take an example if the rates do decrease and the banks transmits a 25 basis points decrease in rate (0.25%), the difference on a home costing INR 150 lacs would be INR 30,000 a year or INR 2,500 a month, on a car of INR 10 Lacs the savings would be INR 2,000 a year or INR 167 a month, in both cases assuming that the loan amount would be 80% of the total value.

Would this be enough to encourage the people to but more homes, cars and spend much more or would such decisions be based on overall macro stability business outlook and growth which looks bleak overall.  With head winds from China , Europe and with the country with weak monsoon which has hurt lacs of farmers , the common man is not going to start spending even with a 50 basis points cut.

To buy a car this festive Diwali season or next would a common man wait for the next year as the interest rates may go down; sure he will save money to an extent in the interest payment as the rates would go down but what about the cost of a car?? Has it historically ever been recused to a large extent? With all the analyst and pundits on Dalal Street talking of a commodity super cycle at its all-time low with metals, crude at all-time lows has the cost of taxi’s or tuk tuk reduced; not really ..

Hence it is important for RBI to pay attention to the Main Street rather than Dalal Street which analyst in suit boots and it could oblige the government and India Inc with a 25 basis point cut to test the waters but it needs to trot carefully.

_ Farzan Ghadially

US Fed Rate hike: Impact on Emerging Markets like India

 US Fed Rate hike: Impact on Emerging Markets like India

The Long awaited decision on when will the US Federal Reserve (Fed) increase the interest rates and how will it affect Emerging economies (EM) like India. The Indian economy is a relatively stable economy compared to the rest of the other comparable EM, however it is not isolated and a change in stance by the Fed would result some foreign institutional investors (FII) drawing out of the Indian market and also resulting in change in the demand supply in the real economy.

Emerging markets braced for ripple effect Fears grow that tightening US policy would damage economies across the globe.

For policymakers in emerging markets, the prospect of the US Federal Reserve raising interest rates for the first time since 2006 has been building like a storm cloud on the horizon for much of the past two years.

Officials at the Fed, however, seem determined to play down any suggestion that their actions might contribute to slower growth in EMs and the rest of the world. Yet if they do raise rates, the impact on already fragile emerging economies threatens to bring economic woes to the US and Europe.

The consequences of a US rate rise, would be appropriate by year-end, would be felt across the world, from China to the likes of India, Brazil and Turkey. The countries that grew used to ultra-loose monetary policy in the US and the cheap financing that it spawned. since the recession. EMs have seen growth soar, partly in response to US interest rates being cut to historic lows, then fall back as the Fed moved to tighten even as Chinese growth slackened. Now, against a backdrop in which developed economies account for less than half of world GDP by some measures, the question is whether the US and other industrialised countries will suffer from the fallout from a further EM slowdown caused by a Fed rate rise.

First we had the spill over phase; this was the inability of the west to generate growth and its use of experimental monetary policies, which have undermined growth in EMs.

Stage two is the spillback; the weakness in EMs that disrupts the economies of the west and makes its challenges even harder.

The most profound consequence of higher US rates will be to accelerate capital outflows from China, the source of recent global market turmoil, making the world’s second economic superpower potentially yet more unstable and to an extent from relatively stable EM’s like India.  

That could create another layer of risk for the Chinese economy, the most important, or the least anticipated, consequence for EM, will be the impact on China.

This is because of a big increase in lending to China by foreign banks over the past six years. The funding costs of such banks are affected by the Fed’s short-term interest rates, which are expected to rise by more than long-term rates. As they rise, this source of capital for Chinese borrowers is likely to be cut.

This, in turn, threatens to feed directly back to the US by contributing to a reduction in Chinese buying of US Treasuries. China had to sell more than $100bn of its holdings of US Treasury debt to support the renminbi during the turbulence that followed Beijing’s decision last month to devalue its currency.

If China, which is the largest foreign investor in US Treasuries with $1.27tn, starts to liquidate its holdings regularly, it could create funding shortfalls for the US government and add upward pressure on US interest rates.

China and other EMs have already had a big negative impact on the US economy by contributing to the sharp fall in oil prices, in turn reducing the flow of petrodollars

THE US currency from the dollar-dominated oil trade that is recycled back to US markets.

By cutting the knees from under a critical contributor to the recovery, China and other EMs have flipped the switch from risk on to risk off.

To many investors, the impact on developed markets of slowing growth in China and other EMs is already clear; falling import prices, lower capital goods orders and much weaker profitability of US and European companies, many of which do a lot of business in EMs.

The biggest direct impact from the Fed outside the US is likely to be in those economies that depend on short-term capital flows to finance current account deficits. Worst off are the commodity exporters such as Brazil, Russia and South Africa as they get caught between the strong dollar and a weak China.

Many emerging economies are less vulnerable to a rise in US rates than they were during the EM crises of the 1980s and 1990s as governments have cut back on so-called original sin. The sin consisted of borrowing in US dollars or other foreign currencies and thus exposing themselves to the risk of a devaluation of their own currencies and a consequent explosion in debt servicing costs.

While that is broadly true of governments in the past decade, there has also been an explosion in foreign currency borrowing by corporations in EMs. Many of these have earnings in foreign currencies, saving them from original sin. But the build-up in such debt among other EM corporate borrowers has generated big currency mismatches. This is not the only problem. Sovereign borrowers have committed less original sin but more new sin.  Even though their debts are in local currency, debt levels have gone up, he adds. Most people believe EMs are structurally sound in terms of debt. That is no longer valid.

The idea that EMs have built up enough forex reserves to cover debt payments is misplaced, as the guys holding the assets and the guys holding the liabilities are not the same. This would mean a vast stock of EM debt coming under pressure as rates rise, even if forex reserves stay put.

  

Real economy woes fuel chronic malaise in emerging markets shrinking harvest how developing nations are suffering. Are emerging markets already mired in a crisis? The question of when to apply this description to the unravelling of EM fortunes is more than academic. The word crisis has a way of fixing perceptions among investors, executives and policymakers while displacing nuance from analysis.

The big difference, between the current bout of EM frailty and the Asian crisis in the late 1990s — the last economic meltdown to originate in the developing world is that this episode has evolved over many months, whereas the Asian crisis was an eruptive shock.

EM has a persistent problem that results from two irreversible shocks. One is the end of an era which saw rapid, investment-led growth in China. And, two, the collapse of global trade growth to levels unseen for a generation,

These twin frailties supply a defining characteristic. The current EM malaise has thus far been driven more by real economy debilities than financial market stresses.

Whereas in the aftermath of the 2008-09 financial crises, the dynamism of EM economies helped drag the world back to growth, the vigour is now all but spent. In the first half of this year, emerging markets became a net detractor to global trade growth for the first time since 2009.

In gross domestic product terms, EM growth is likely to fall to 3.6 per cent this year, its lowest level since 2001 — if the 2008/09 crisis, which originated in the US and was therefore an external shock to EM, is excluded. However, the impact on commodity-exporting EM economies is particularly severe, with average GDP growth falling fast towards zero.

This is not a repeat of the ripples that spread across the world’s financial markets in the late 1990s and into systemic banking failures. This is a crisis of growth.

Part of that crisis, is caused by weaker demand: a reversal of capital flows, falling commodity prices and slowing credit growth. Another part is caused by structural problems on the supply side, such as the misallocation of resources in China, persistent low investment in Brazil and Russia, and excessive regulation in India and Mexico.

There is froth in some markets. Like, Turkey looks vulnerable. There is a worry about South Africa’s current account deficit, but economies will not be wiped out in the way Argentina was in 2001 or Brazil was in 1999. We have not seen that real, sudden pain. This is much more of a slow grind.

The bottom line is that there is no EM crisis for as long as debt defaults do not become a big concern.

But the prospect that the US Federal Reserve may raise interest rates for the first time since 2006 is adding uncertainty to the gloomy EM outlook. the potential for tighter US monetary policy has exacerbated significant EM capital outflows even as EM productivity growth slows.

_ Farzan Ghadially