Chapter 04 – The Festering Twin Balance Sheet Problem – Highlights of Economic Survey 2016-17

The Festering Twin Balance Sheet Problem

Union finance minister Arun Jaitley tabled the Economic Survey 2016-17 in Parliament during the first day of the budget session. Here are the major highlights from the Chapter 4 of Economic Survey 2016-17.

Chapter 4 of the Economic survey 2016-17 deals with the banking system, its vulnerabilities, ability to adapt to shocks, structural changes and problems associated with the twin balance sheet syndrome.

What is the Twin Balance Sheet (TBS) problem?

The balance sheets of both public sector banks (PSBs) and some corporate houses are in terrible shape and it has been seen as a major obstacle to investment and reviving growth.

What are Non-Performing Assets?

The NPAs are assets that stop generating income for a bank. Bank’s assets mostly comprise of loans and when these loans are on the verge of default (that is, about to go bad), they are classified as NPA.

In India, a loan is classified as NPA, if the interest or any installment remains unpaid for a period of more than 90 days.

What are stressed assets?

Stressed assets are NPAs plus restructured assets. Restructured loans are loans that have been converted to equity under the corporate debt-restructuring scheme.

Origin of Non Performing Asset (NPA) or the TBS problem:

In mid 2000s (Yes, the Economic Survey does pin point it to the UPA regime), everything was going right: corporate profitability was amongst the highest in the world, encouraging firms to hire labour aggressively, which in turn sent wages soaring.

Within the span of four short years, the investment-GDP ratio has soared by 11 percentage points, reaching over 38 percent by 2007-08.

An astonishing credit boom, also the largest in the nation’s history, financed this investment. In the span of just three years, running from 2004-05 to 2008-09, the amount of non-food bank credit doubled.

There were also large in flows of funding from overseas, with capital in flows in 2007-08 reaching 9 percent of GDP. All of this added up to an extraordinary increase in the debt of non- financial corporations.

But just as companies were taking on more risk, things started to go wrong.

• Costs soared far above budgeted levels, as securing land and environmental clearances proved much more difficult and time consuming than expected.
• At the same time, forecast revenues collapsed after the Global Financial Crisis; projects that had been built around the assumption that growth would continue at double-digit levels were suddenly confronted with growth rates half that level.
• Financing costs also increased sharply. Firms that borrowed domestically suffered when the RBI increased interest rates to quell double- digit inflation. And firms that had borrowed abroad when the rupee was trading around Rs 40/dollar were hit hard when the rupee depreciated, forcing them to repay their debts at exchange rates closer to Rs 60-70/ dollar.

What is ‘Balance Sheet Syndrome with Indian Characteristics’?

TBS did not lead to economic stagnation, as occurred in the U.S. and Europe after the Global Financial Crisis. It co-existed with strong levels of aggregate domestic demand, as reflected in high levels of growth despite very weak exports and moderate, at times high, levels of inflation.

Why this characteristic?

1. The unusual structure of our banking system.
2. The lack of infrastructure has hindered expansion of manufacturing and even some service activities, such as trade and transport. These constraints were loosened considerably during the boom, as new power plants were installed, and new roads, airports, and ports built. As a result, there was ample room for the economy to grow after the GFC.
3. Indian strategy of “give time to time” – companies sought financial accommodation from their creditors, asking for principal payments to be postponed, on the grounds that if the projects were given sufficient time they would eventually prove viable.

Banks decided to give stressed enterprises more time by postponing loan repayments, restructuring by 2014-15 no less than 6.4 percent of their loans outstanding. They also extended fresh funding to the stressed firms to tide them over until demand recovered.

The Economic Survey notes that the Indian banking strategy was similar to that of China. Both countries provided generous amounts of bank financing to allow highly levered corporations to survive. And in both countries this strategy has proved successful so far in allowing rapid growth to continue. But there remains a question of whether the model is truly sustainable.

Effects of Twin Balance Sheet:

• Countries with TBS problems tend to have low investment, as stressed companies reduce their new investments to conserve cash flow, while stressed banks are unable to assume new lending risks
• TBS is taking a heavy toll on the health of the public sector banks. At least 13 of these banks accounting for approximately 40 per cent of total loans are severely stressed, with over 20 per cent of their outstanding loans classified as restructured or NPAs.

*Indian Public sector banks have a negative Return on Assets (ROA) for the past 2 years.

• Total credit to the corporate sector has been decelerating steadily. In real terms, such credit growth is now negative, the lowest it has been in 23 years. But at the same time, household credit and agricultural loans have increased.

STEPS TAKEN TO SOLVE THE PROBLEM:

• The RBI has been encouraging the establishment of private Asset Reconstruction Companies (ARCs), in the hope that they would buy up the bad loans of the commercial banks. (But ARCs have been limited in success, buying only 5 percent of NPAs)

• In June 2015, the Strategic Debt Restructuring (SDR) scheme was introduced, under which creditors could take over firms that were unable to pay and sell them to new owners.
• The Sustainable Structuring of Stressed Assets (S4A) was announced, under which creditors could provide firms with debt reductions up to 50 percent in order to restore their financial viability.

(Their success, however, has been limited; while two dozen firms have entered into negotiations under SDR, only two cases have actually been concluded as of end-December 2016. And only one small case has been resolved so far under S4A.)

The Economic Survey 2016-17 goes onto talk about the reasons as to why the progress has been limited and slow, but from UPSC Civil Services point of view, one need not dwell into the details of the same.

STRATEGY FOR FUTURE:

Creation of ‘Public Sector Asset Rehabilitation Agency’ (PARA)

The Economic Survey 2015-16 had on similar line emphasized that addressing the stressed assets problem would require 4 R’s: Reform, Recognition, Recapitalization, and Resolution.

Also Read : Top 10 Key Highlights of Economic Survey 2016-17 for UPSC Aspirants

Also Read: Chapter wise highlights of Economic Survey 2016-17

Chapter 01 – Economic Outlook and Policy Challenges

Chapter 02 – The Economic Vision for Precocious, Cleavaged India

Chapter 03 – Demonetization: To Deify or Demonize?

Chapter 04 – The Festering Twin Balance Sheet Problem

Chapter-05 – Fiscal Framework: The World is Changing, Should India Change Too?

Chapter 06 – Fiscal Rules: Lessons from the States

Chapter 07 – Clothes and Shoes: Can India Reclaim Low Skill Manufacturing?

Chapter 08 – Review of Economic Developments

Chapter 09 – Universal Basic Income

Chapter 10 – Income, Health, and Fertility: Convergence Puzzles

Chapter 11 – One Economic India

Chapter 12 – India on the Move and Churning

Chapter 13 – The ‘Other Indias’ – Highlights of Economic Survey 2016-17

Chapter 14 – From Competitive Federalism to Competitive Sub-Federalism