Boost for PSU Banks

Finally, there seems to be the much-needed credit boost…

When the government announced the unprecedented Rs.2.11 trillion bank rescue package this week, it did stir a sense of euphoria. A day after the announcement the PSU banks was up anywhere between 20% and 45%. The question is whether this package is actually a boost for PSU banks. More importantly, will this address the core reason for poor credit off-take, which is weak industrial demand for credit!


Nuances of the PSU package…

The package was a lot more liberal and larger than what was originally anticipated. While the government will contribute Rs.18,000 crore, the banks are expected to raise Rs.58,000 crore from the market. The balance of Rs.135,000 crore will come in the form of Recapitalization Bonds. Just to dwell on this concept for a minute; it is essentially an accounting adjustment. The capital will be provided by the GOI to the banks and in turn, these very banks will subscribe to the bonds issued by the government for this purpose. That is understandable considering that the Indian banks are sitting on nearly Rs.500,000 crore of surplus liquidity in the aftermath of demonetization. Effectively, the money from the bank’s balance sheet goes to indirectly enhance its own capital. The only concern from the point of view of the government is that this issue of bonds will raise the fiscal deficit. That could create an issue on the sovereign rating front!

Managing the fiscal deficit

The immediate reaction from rating agencies like Fitch was that this move will increase the fiscal deficit of the government for the fiscal from 3.2% of GDP to 4.1%. That is likely to harden bond yields and raise questions over the much avowed fiscal responsibility. The other option is to issue these bonds through an intermediate agency, but that will still be a contingent liability for the government. Either way it is likely to increase the effective fiscal deficit of the government for the coming fiscal.

What about credit growth?

The government is actually undertaking a big wager here. The bet is that a larger capital base will take away the constraints to lending and banks will see a sharp pick-up in credit. Remember, growth in bank credit is currently at a 60-year low; hardly a situation conducive to a growing economy like India. Over the last 1 year, we have seen that demand for bank credit has dried up and that is due to a weak investment environment. However, the government has also sought to address this issue. This bank package is accompanied by an additional Rs.700,000 crore plan to invest in a massive road project. Like the Golden Quadrilateral in 2003, this is likely to spur downstream investments. To be fair, the government has done its bit. It is now for the banks and business to take the next step forward! ©

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