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

In the fourth chapter, the survey has discussed the Twin Balance Sheet {TBS} problem and made a case for establishment of a Public Sector Asset Rehabilitation Agency (PARA).

Understanding Twin Balance Sheet Problem

The centre-piece of TBS problem are Non-performing assets (NPAs) which have resulted into two inter-twined economic issues viz. over-leveraged & distressed corporate and NPA encumbered banks.

The menace of NPAs or stressed assets in looming large in the Indian Economy for past few years. In the mid-2000s, economies all over the world were booming, and India was no exception to that. The growth rate of the country was around 9-10 % and there were optimism that India would dash into Double digit growth that would persist for several decade. In this phase of optimism, funds worth lakhs of crores were readily infused particularly in infrastructure related areas such as power generation, steel and telecoms, setting off the biggest investment boom in the country’s history. The implications of all this was that the Capital inflows in 2007-08 reached 9 percent of GDP; Investment-GDP ratio soared by 11 percentage points, reaching over 38 percent by 2007-08; and firms abandoned their conservative debt/equity ratios and leveraged themselves up to take advantage of the perceived opportunities.

However, in 2008 the Global financial crisis set in. It derailed the growth bonanza and had serious consequence on the world economy like loss of market, inflationary tendency etc. Moreover there were significant bureaucratic friction and rules rigidity in granting land and environmental clearances, which led to increased project cost.

Effect on corporate

Due to fall in revenue due to financial crisis, increased cost due to lack of clearance, and high financing cost due to RBI tightening of monetary policy,- cooperates cash flow got squeezed. By 2015, the share of company 40% of debts were owed to IC1 companies (Company who’s interest coverage ratio is less than 1 which means they don’t earn enough to even honour their interest obligation)

Effect on banks

Their ROA (return on assets) became uncertain, and in many cases the principal amount got stuck in the loop, leading to eroding of bank’s capital base

What is unique about TBS in Indian context?

World over whenever the problem of balance sheet has occurred at this scale it has been followed by the economic crisis Ex in Japan after 1990s, and USA and Europe after the Global financial crisis of 2008. However in India’s case, the non-occurrence of economic stagnation can be attributed to following reasons:

• The banking structure in the country is such that there are both public and private entities. And since bulk of the problem was with public banks which not only have their capital base but also backing of the government, NPA problem has so far being tackled. Thus guarding the investors’ confidence.
• In addition, as an emerging economy India economy requires huge investment and development of supply side infrastructure. So unlike US economy where once the Housing sector got saturated there wasn’t need for funds for other critical development infrastructure, in India the need for such infrastructure still holds relevance and thus gives plenty of scope for India to stay on growth trajectory.
• Moreover, in other economy creditors would have by now triggered bankruptcies. But in case of India, Stressed assets issues arose in early 2000’s too, where the bank followed “giving time to time strategy” and these issues eventually got subsided. Similar optimism still holds the economy especially when there is still wide untapped market potential, to resolve the current issue. However owing to this strategy to a large extent there have been instances of ever greening of loan and huge NPAs.

Is the financing strategy sustainable?

For financing strategy to work, where the funds would continue to be provided to the corporates, either of the scenario must occur-

• Phoenix scenario: Under this the fund flow to the companies would be uninhibited till the point comes, where the growth in the economy would be able to resolve the existing problems with banks and companies via increased earning.
• Containment scenario: This involves containing the NPAs, so that over the period of time as the economy is growing at the nominal level of 10%, they became insignificant.

Both these approaches assume growth to take place, however as has been observed the condition of the economy is not in a good shape:

• When looking into the stressed companies, their aggregate cash flow which even wasn’t enough to service their debts has roughly by 40%.
• Debts of the top 10 stressed corporate groups in particular, have tripled in the last six years.

Looking into industry we finds following:

• Power sector industries suffers from low plant load factor (actual electricity production as a share of capacity) which stands around 59.6% for April and December.
• Even the Telecom sector is also reeling under pressure from new entry competition.
• Also the MSMEs who have fared well due to their cautious approach in mid-2000, since recent years have been contributing significant proportion of the increases in NPAs. As per estimates four-fifths of the slippages during the second quarter of 2016, incurred by MSMEs due to poor sales and profitability.
• Also the public sector banks shares prices have fallen to just two- thirds of their book value. On the other hand, due to rising stressed assets banks are exercising control over credit creation. Also the banks have increased their lending rates (though got trimmed due to post demonetization). However this is resulting in Disintermediation of banks, as the firms are resorting to capital market. But for MSMEs who requires Handholding support from banks, capital market still stands elusive.

All this above mentioned situations have drastically reduced investment in the economy, even though public investment has been unleashed by the government.

What has been done and issues with it?

Initially RBI did rescheduling of instalments to give firms more to pay. However in the backdrop of widening stressed assets, RBI took slew of the following measures:

• Establishment of private Asset Reconstruction Companies(ARCs) under SARFESI Act 2002, with the aim that bank would be able to focus on their core competency of loan -deposit operation and the body of specialist could relieve the banks from resolving stressed assets issues. However owing to difficulty with resolving the assets that ARC purchases, they are willing to purchase loans at low prices. This makes difficult for banks to accept Arc offer.
• In June 2014, RBI floated 5:25 scheme. Under this lenders were allowed to increase debt period up to 25 years with interest rates adjusted every five years. However owing to such long debt period, the companies find it difficult to endure high interest burden, forcing banks to infuse additional grants leading to ever greening of loan.

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. However those firms who are not able to pay back despite restructured loan terms were to be selected. Banks can convert debt to 51% of equity and sell them, subject to authorization of the stakeholders.