The government has announced a much-needed wider two-year recapitalisation plan for State banks (SOCBs). The necessary capital for the USD 32bn (INR 2,100bn) programme will mostly (nearly 2/3) come from the State’s recapitalisation bonds. Delhi foresees a direct budget contribution not exceeding USD 2.8bn by March 2019 while the banks will raise less than 25% of the total amount from the financial markets.     

Impact on country risk

A sharp increase in the recapitalisation of SOCBs, which account for about 70% of bank assets, had long been requested and had become inevitable for the government. Indeed, the ongoing multi-year recapitalisation plan appeared far too modest (INR 700bn) to cover the high (estimated at over 13% of total loans at the end of June) and increasing non-performing loans (NPLs) and allow a recovery of credit supply growth, which has fallen to 5%, i.e. a 50-year low. Therefore, this is positive news as it is likely to restore investor confidence in a financially poor banking sector which is hindering economic activity and has contributed to the latest disappointing growth performances. Healthier SOCBs might not translate immediately into stronger credit inflows as weak credit demand will have to be fostered from a cautious and much-indebted corporate sector. The government plan will increase an already high general government debt (almost 70% of GDP in FY 2016) by less than 1% of GDP but the budget deficit should not be impacted as recapitalisation bonds are recorded off budget as an asset transaction. In the future, this plan would have to go together with banking reforms, especially management and governance. Political influence in lending decisions is often seen as largely responsible for the bad health of SOCBs. This is corroborated by private banks, which look stronger and have low levels of NPLs. Otherwise, there is a risk that the banking sector and the government will again be faced with rapidly increasing bad loans in the medium term. An effective implementation of the plan will be of high importance when it comes to supporting the one-year economic outlook.

Analyst: Raphaël Cecchi, r.cecchi@credendo.com