IMF flags concern over India's high stock of bad bank loans

Finance Minister Arun Jaitley, who is in the US to attend the IMF-World Bank meeting, addressed investors in New York on Tuesday on issues concerning reforms and economic outlook | Photo: USISPF/Twitter
The International Monetary Fund (IMF) is concerned about Indian banks’ high stock of bad debts and sees as ‘extremely important’ the continuation of institutional mechanisms to recover soured loans. 

The Fund was also concerned about India’s high government debt-to-gross domestic product (GDP) ratio, at nearly 70 per cent, and which could rise further, following populist measures taken during and after the general elections. 

The country also continues to grow at a high rate of over 7 per cent, at a time when about 70 per cent of the world economy is witnessing a downturn. The growth, however, should be more inclusive, even as revenue augmentation should be the focus, said IMF officials. 

“There continues to be a high stock of non-performing assets (NPAs) in India. There has been some progression, but we would welcome further progress on NPAs in India,” said Tobias Adrian, director of the Monetary and Capital Markets Department of the IMF at a press conference to release the Global Financial Stability Report (GFSR). 

He was responding to a Business Standard query on Indian banks’ high bad debt stock, and the recent setback received by the Reserve Bank of India (RBI) on the exercise of Section 35AA of the Banking Regulation Act. The Supreme Court earlier this month said the central bank had no right to drag a slew of companies towards resolution and possible insolvency proceedings, without taking permission on a case-by-case basis from the government. 

The total bad debt of the Indian banking system at the end of December 2018 quarter was roughly Rs 10 trillion — Rs 7.78 trillion for public sector banks, Rs 1.88 trillion for the private sector. The RBI’s stress test shows that the asset quality of Indian banks will improve in March this year, but the gross NPA of all banks still remain over double digits at 10.3 per cent in March 2019, according to the central bank’s Financial Stability Report for December. 

The IMF officials were clearly concerned about such high NPA ratios in Indian banks. 

“…the institutional mechanisms for recognition and resolution of NPAs are an extremely important part of the process of cleaning up the banking system of non-performing loans and I think the authorities should continue working along these lines,” said Anna Ilyina, division chief for Emerging Economies in the IMF. She advised more capital support for Indian banks. 

“The level of non-performing loans in India remains high. The level of capitalisation of some banks, particularly government-owned banks, should be bolstered. This was also one of the recommendations of the financial sector assessment programme for India,” Ilyina said. 

She acknowledged that steps taken by the authorities to boost capital buffers in banks and improve governance in state-owned banks have had some positive impact. “In particular, we have seen average price-to-book ratios for Indian banks improving somewhat,” she said. 

In an election year, when political parties are making promises that would likely widen the fiscal deficit, India’s priority should continue to be gradual fiscal consolidation, said Paulo Mauro, division chief in the IMF’s Fiscal Affairs Department during the release of the IMF’s fiscal monitor report. 

“In the case of India, priority continues to be gradual fiscal consolidation because the gross general government-to-GDP ratio is at about 70 per cent, including states and sub-nationals,” Mauro said, adding, “From a macro-fiscal perspective, you also have very rapid growth rate. The economy is growing in excess of 7 per cent. The objective there is to make sure growth is inclusive, and it filters down to poverty reduction.” 

On poll promises that could widen the fiscal deficit further, Mauro said the important thing was not to look at benefits alone, but to look at the costs and at the details. “Certainly when one looks at the case of India, there is a lot of scope for reducing untargeted food and fertiliser subsidies and enhancing revenue administration, including for the goods and services tax, which was a transformational positive reform. But again, even there, improved tax compliance would be a priority.” 

In emerging markets, overseas investments run by managers tracking popular indexes have increased dramatically over the past decade. Widening the range of investors can be positive factors for emerging markets. Yet that trend leaves these economies vulnerable to sudden reversals to capital flows in response to global trends. 

The GFSR had a warning for the global economy where interest rates are going at an extremely low level, and the yield curve (plotting interest rates) is even negative at the 10-year point for a number of economies. 

According to Adrian, interest rates are likely to remain low, which can “fuel higher valuation levels because future cash flows are discounted at a much lower rate. And that is giving rise to financial stability concerns.” 

According to the GFSR, emerging markets facing volatile capital flows should limit their reliance on short-term overseas debt and they should ensure they have adequate foreign currency reserves and bank buffers. 

“Monetary policy should be data dependent and well communicated,” said Adrian.  According to him, addressing non-performing loans is the “first-order importance for financial stability. Many countries have tackled that by developing a secondary market for non-performing loans. There has been a change in international accounting standards, in terms of how non-performing loans are provisioned for. We expect that is going to improve the situation over time. But that is being slowly phased in around the world.”

In the case of India, the RBI delayed implementation of such norms, which was modelled after IFRS-9, concerning NPA recognition.

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