Bonds are the best solution
Source: By Madan Savnavis: The Financial Express
The idea of issuing recapitalisation bonds is alluring as it handles the problem of bank capital quite well with no risk attached. Typically, in such a situation, the government would issue bonds to the extent of Rs 1.35 lakh crore, which will be subscribed to by banks with their surplus funds. At present, they are investing in excess SLR securities to earn money on the excess deposits that have been kept with them post-demonetisation. Hence, it looks like a win-win situation. It is a good solution that was used earlier as well to recapitalise banks (in the 1990s) when there was a pressing need to make them commercially viable in terms of enhancing their lending power when capital was scarce. At present, with high NPAs and provisioning, it is hard for them to raise funds on their own as the market would not give a good price given their situation. Also, as the government is on its toes when it comes to direct budget allocation—beyond what has been provided for—this route is a better option.
How does this work? The government raises these bonds, which are then used to capitalise banks—the funds actually come from their own kitty. The bonds issued will add to the debt of the government which has to be serviced. And, if the rates are determined by market forces in a transparent manner, then, automatically, the cost will be about equal to that on G-Secs of similar duration. Hence, banks would receive the same amount as before on SLR securities. Will it add to the fiscal deficit? Yes, it has to add to the deficit because, at the end of the day, when bonds are issued, it has to be shown as borrowing on someone’s books. Therefore, the overall debt of the government would go up to the extent of these issues. To draw an analogy with the UDAY scheme, where state governments took on the debt of discoms, states were allowed to break the-3% rule for two years—this can be done here, too. This is globally acceptable as it is not really fresh debt being issued that would add to the demand spiral—normally, the concern of very high fiscal deficits.
Also, as this capital is coming from the government through these bonds, there is zero risk as the government of India is always solvent. Hence, there is no catch in terms of accounting. But an interest cost has to be paid on these bonds which mean that at, say, a 7% rate, an additional interest cost of around Rs 9,500 crore will be added to the revenue expenditure. This, thus, becomes a running cost until such time that these bonds are extinguished or converted into equity, which is also an option for the government. This approach appears to be fairly pragmatic for the government given that banks require money to be in a position to lend in the future, and the PSBs—which account for around 70-75% of credit—are particularly constrained due to pressure on capital.
At present, as demand for funds is low, there is no apparent problem as banks clean up their balance-sheets by accelerated recognition of NPAs and making provisions for these. However, once demand picks up when the economy actually moves into the high, 8%-GDP growth orbit—which is expected in the coming years—there would be a capital cliff for PSBs that has to be addressed now. The conventional modes of finance are not feasible today. Why? If the government has to infuse directly, then it will mean flouting the 3.2%-fiscal deficit mark which is being held sacrosanct today (which it will also do through these backdoor recap bonds which are being floated). This will not be acceptable, but the route of recapitalisation bonds is palatable as it comes in a different form.
Alternatively, selling stake is an option, but while it has been included as a part of plan for the balance Rs 0.76 lakh crore to be raised by these banks, valuation is always a challenge. With high levels of losses, the market cap of these banks is, at present, low and will continue to remain so until they turn around, thus making it circular in nature. Hence, selling at this stage may not yield the best results and can ignite controversy at a later date. Therefore, what is required today is thinking obliquely, and, therefore, the recapitalisation bonds could be the answer. What are the next steps? The government will have to decide the exact mode of issue and how this will be spread over the years. This cannot be a one-time exercise and has to be spread over one-two years, depending on how the PSBs shape up. Also, it has to cherry-pick the banks that should be capitalised through this route—and, ideally, it has to be those that are the weakest and are not in a position to command a good market value that get recapitalised through the bonds issue. Also, such funding should be conditional for banks, just like the UDAY scheme, with safeguards built in to ensure that the banks keep their side of the deal—else, the scheme can go awry. It looks certain, given the clinical way in which the government has approached the issue of bank capitalisation, that these tenets will not just be drawn up but also followed rigorously to get value from the process.
[printfriendly]
