State Of The Economy 2016

A long way to go

Capex revival & NPA clean-up take a backseat as Jaitley bites the fiscal austerity pill

Kashti chalaane walon ne jab haar ke di patvaar humein, lehar lehar toofan mile, phir bhi dikhaaya hai humne, aur phir ye dikha denge sabko ki in halaat mein aata hai dariya karna paar humein.

Arun Jaitley’s couplet in Hindi while presenting the Budget was in context of the turbulent times facing the economy and how he expects the nation to emerge unscathed. Though Jaitley’s rendition received a resounding thumping of desks in the lower house of Parliament, the Street was far from impressed as the Budget had failed to address the twin challenges facing the economy: spurring a revival in the capex cycle and a comprehensive resolution for the bad loan problem. Not surprisingly then, the benchmark Sensex ended 152 points lower at 23,002, after a bout of volatility that saw the index plummet 600 points intra-day. The nearly 800 point bounceback that followed the next day saw minimal public sector bank participation.

With non-performing assets (NPAs) of around Rs.4 lakh crore, the Reserve Bank of India (RBI) has been quite vocal about why state-owned banks need to take a tough call by acknowledging the severity of the problem and clearing their books. “If the bank wants to pretend that everything is alright with the loan, it can only apply band-aids,” RBI governor Raghuram Rajan had remarked at the recent CII banking conference. But clearly the owner of the banks doesn’t seem to agree with the governor’s view and is instead opting to recapitalise banks with public money. Only this time, the allocation of Rs.25,000 crore appears minuscule given the magnitude of the problem. 

In fact, the outlay for FY17 mentioned in the Budget is part of the Indradhanush package announced last year by the minister, which will see the exchequer pumping in Rs.70,000 crore as equity over four years (FY16-19) even as it examines options to bring down its stake in some banks below 51%, like in the case of IDBI Bank. But given that the cumulative gross non-performing assets of the 24 listed public sector banks, including State Bank of India and its associates, stood close to Rs.4 lakh crore as of Q3FY16, the overall outlay of Rs.70,000 crore, itself, appears inadequate. That the pain in the banking system has worsened over the past one year is evident in the fact that gross NPAs, at over 5% of total loans, saw a 50% jump from Rs.261,918 crore a year ago. And if one were to take into account the overall stressed assets (declared and potential), the number goes up to 11% of the overall loan portfolio. 

It was not without reason that the Nifty bank index, which hit a 52-week low of 13,556 on February 25, ended up with marginal gains of over 1% on Budget day. The gain day after, too, was led by private sector banks. Further, international rating agency Standard & Poor’s, which has a clutch of PSU banks on CreditWatch with negative implications, too, has voiced its concern. “We believe Indian public sector banks will find it difficult to meet the 7.625% target Tier 1 equity ratio (including capital conservation buffer) by March 2016. We believe the capital requirement for banks is likely to be much higher than the amount allocated,” mentions analyst Geeta Chugh of S&P. The agency feels the RBI’s recent directive to banks to clean up their balance sheets by FY17 has only pushed ahead the capital requirement of Rs.2.3 trillion, needed by 2019.

Though the minister also spoke of introducing the Bankruptcy Bill in FY17, it’s still unclear what the contour of the Bill is likely to look like. More importantly, the domestic banking industry’s track record of bad loan recovery doesn’t inspire much confidence. In 1997, when the gross NPA touched 15.4%, it took nine years for the NPA rate to fall below 5% with laws such as Sarfesi Act and creation of Asset Reconstruction Companies (ARCs). While the Budget has introduced a proposal where sponsors of ARCs can now hold up to 100%  in companies against the current 50% and has also paved the way for non-institutional investors to invest in securitization receipts, it’s still early days. 

Though there is a sense of disappointment on the Street, Sunil Singhania, chief investment officer-equities at Reliance Mutual Fund, the country’s third-largest AMC, does not expect too much downside for the banking sector. “While the headline number [for recapitalisation] looks inadequate, the FM has clearly mentioned that, if need be, more money can be allocated. And if the black money amnesty scheme takes off, then funds should not be an issue and also the minister appears conservative in terms of revenue receipt growth [at 11.2%], which could be higher,” feels Singhania. Also, the recent trend of stressed-asset buyouts like the Rs.17,000-crore deal that will see Ultratech buy JP Associates cement plants across six states is expected to ease the NPA burden. “Once couple of such deals go through, you will see confidence slowly building up in the banking system,”
adds Singhania.

Even as the cloud of uncertainty hovers over banks, what is not helping matters is a moribund capex cycle. For the upcoming fiscal, Jaitley has earmarked  Rs.2.21 lakh crore for the infrastructure sector, a decline of 12% compared with Rs.2.51 lakh crore announced last year. Of the total, roads and highways will account for Rs.55,000 crore in addition to Rs.15,000 crore from bonds that NHAI is expected to raise. In fact, in the run-up to the Budget, Ficci in its Economic Outlook Survey had urged the government to focus on growth. “Fiscal consolidation is important, but not at the cost of productive investments”, the report had stated. 

But history shows that the bulk of government spending is towards non-productive consumption rather than investments. In FY16, revenue expenditure (read consumption) accounted for roughly 86% of government expenditure, while only 14% was in the form of capital expenditure (read investments). Interest payments, defence, pay and allowances and subsidies are the main components of the central government’s revenue expenditure. “While the share of capital expenditure in total has increased from 11% in FY15 to 14% in FY16 thanks to government efforts to boost public capex, we believe it still remains quite low compared to the historical average,” mentions Rakesh Arora of Macquarie India in a recent report. In fact, from a high of 24% in FY91-99, the share of capital expenditure has come down to 12% over FY10-15.

However, with the government sticking to its fiscal deficit target, there is hardly any room for the government to spend its way out of the rut. Mahesh Nandurkar, head of research, CLSA India, says, “Against the backdrop of the One Rank One Pension scheme for the armed forces, the 7th Pay Commission proposals and the fact that government itself is looking at 40 basis points reduction in the fiscal deficit, there is absolutely little it could have done to spur investment. The government has clearly made a choice of sacrificing growth at the altar of fiscal austerity.”

As far as corporate capex is concerned, given the extent of leverage on India Inc’s balance sheet, a quick recovery seems unlikely. The top 10 business groups in the country have seen a 7x jump in their debt over the past eight years to 12% of system loans. According to Credit Suisse, even as some groups have cut back on capex and looked to sell assets (JPA and GMR), their debt/EBITDA have deteriorated further as the relatively better assets (contributing to as much as 70% of EBITDA) were sold. Further, most of them have pulled back on their capex plans due to cost overruns and project delays.

Nandurkar does not expect corporate capex to recover at least for the next 18-24 months. “The stretched balance sheets,  global uncertainty and the fact that capacity utilisation levels are significantly lower at 70% for steel and cement and around 60% for power plants, it is unlikely that corporates are going invest afresh in new capacities unless one sees a consistent volume growth of 8-10% over the next three to four quarters.” But, if the third-quarter results are any indication, then the road to recovery will be a long and winding one. 

Back in 1991, Manmohan Singh, the-then finance minister, had said: “Yunaan-o-Misr-o-Roma, sab mitt gaye jahaan se, ab tak magar hai baqi, naam-o-nishan hamara. (Ancient Greece, Egypt & Rome have turned to dust, but India lives forever).Today, as India enters the 25th year of reforms, Jaitley could well be praying that this indeed remains the case.