March 31, 2017 / 6:32 AM / 8 months ago

India bank bailout needs to clear two big hurdles

HONG KONG (Reuters Breakingviews) - India needs to convince the country’s poor that bailing out banks is in their interests. That is the top challenge facing Prime Minister Narendra Modi’s government as it seeks to clean up state-owned lenders. Meanwhile, banks are scared of being accused of selling bad assets too cheaply. Any comprehensive plan will have to overcome both hurdles.

A bank employee fills a form after counting stacks of old 1000 Indian rupee banknotes inside a bank in Jammu, November 25, 2016. REUTERS/Mukesh Gupta

Using taxpayers’ money to prop up banks which made dodgy loans is always difficult to justify. In a developing country with widespread poverty it is even harder. Tycoon Vijay Mallya has already caused a public outrage by leaving the country with big debts unresolved. 

Bank chiefs, meanwhile, prefer to sit on problem assets. Clearing bad loans off the balance sheet would not only crystallise hefty losses. It would also open executives to accusations by investigative agencies of selling the loans to private investors too cheaply.

Nevertheless, a cleanup is overdue. India’s most recent annual economic survey estimates the real level of stressed loans at state banks might amount to as much as a fifth of the total.

Indian Chief Economic Adviser Arvind Subramanian reckons the government can afford a bailout. Assuming a 60 percent haircut to the value of the bad loans, a bailout might cost up to 4 percent of GDP, he said at the Credit Suisse Asian Investment Conference in Hong Kong on March 29. That would be painful, but manageable. 

The political hurdles help explain why India is taking so long to act and why arguments for setting up a state-backed bad bank are gathering pace. One idea floated by Subramanian would be for the government to take charge of some of the biggest problem assets. Just 50 companies account for about 70 percent of the debt owed by firms whose pre-tax profit is lower than their annual interest bill.

Another idea from the Reserve Bank of India suggests setting up a state-backed bad bank to target specific sectors like power, where factors such as lower than expected demand have helped to cause the problem. 

Whatever the final fix, India needs a solution that provides political cover for writing down debt and recapitalising banks with public funds. Otherwise the cleanup of state banks will remain stuck.

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