India’s banking system has restructured more than 6 trillion rupees ($92.34 billion) in bad debts over the past three years. The recent $2 billion Punjab (PNB)-Nirav Modi fraud has made it worse.
Though statistical methods vary, even the lowest estimate of the bad debt ratio exceeds 10 percent. But it is unlikely that India faces a debt crisis since Prime Minister Narendra Modi’s reform of the banking system will have a positive effect despite some negative impact in the short term.
The rise in bad debt has several causes. India’s economy was affected by the financial crisis, and low economic growth then hit companies’ profits, undermining their debt repayment abilities. Easy monetary policy aiming to stimulate the economy led to more debt. Many infrastructure projects, as well as the real estate and stock markets, attracted capital, and that in turn drove up lending.
The bad debt in the banking system stabilized in 2017. A crisis happens when debt affects both public and private banks. But this is not the case for India, since its bad debt problem is concentrated in the public bank sector.
Modi’s bank consolidation move may affect the economy in short term, but it will generate positive effects in the long run. Competition among large number of banks generated bad debt in the past. The reform of the banking system, especially the public banks, has reduced the number of banks. Also, foreign banks have gained more access to the market. To alleviate pressure, India injected $32 billion into the banking system.
Policies have been introduced by the Indian government and banks to curb bad debt. Banks have issued more loans to help companies with good prospects get through tough times. A bankruptcy law was passed that forces more indebted companies out. Bad debts are then moved to asset management companies.
The industrial structure of India means that the debt pressure will not last long. India has fewer companies than China, and most Indian companies are in the services sector – tourism, transportation and the information industry. Unlike heavy industrial companies, which find it hard to raise money during a market downturn, the services sector has an easier time during economic dips.
If India’s economy can keep up high-speed growth, the debt issue will stay stable. The gross amount of bad debt may continue to increase, but the ratio is likely to decrease slowly. But risks during this process cannot be ignored.
To ensure there’s no debt crisis, the Indian economy cannot slide. The banking system needs support from the real economy. If the economy slows down, the profit rate of companies will not improve. The banking system will face huge pressure if companies do not have enough profit to repay their debts.
If the economy heats up, India then has other problems. Rising import costs can affect the current account, thus the banking system. Further, more economic activity means the potential risk of more debt fraud.
The biggest uncertainty is whether Modi’s reforms will be successful. The massive bank consolidation in such a short period may be too much for the Indian people to digest. Last year, millions of public sector bank staff went on strike against the reform. But if the reform is held back or fails to relieve the pressure on the current account, bad debt will pile up faster.
Reform extending to the rural areas also adds uncertainty to the banking system. The rural economy is the weak link in the Indian economy, and pouring more capital into rural areas will create more debt.
Overall, Modi’s reform has played some role in the economic recovery. The temporary drop caused by the cash ban has eased. Economic growth went back to 7.2 percent in the October-December 2017 quarter from 5.7 percent in April-June quarter. Inflation fell to about 2 percent from 10 percent before Modi became prime minister.
The reform will provide more space for Indian economic growth and lessen the chances of a debt crisis.