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The government’s debt is likely to go up and to service the debt it will need to at least bear a cost of Rs8,000-9,000 crore, according to chief economic advisor Arvind Subramanian’s tweet. Photo: Mint
The government’s debt is likely to go up and to service the debt it will need to at least bear a cost of Rs8,000-9,000 crore, according to chief economic advisor Arvind Subramanian’s tweet. Photo: Mint

Who drew the short straw in mega bank recapitalisation plan?

Look closely at the government's mega recapitalisation plan for public sector banks and a loser indeed emergesthe bond market

Mumbai: The government’s mega recapitalisation plan for public sector banks is being touted as a win-win for all and has set these bank stocks on fire.

The largest shareholder will recapitalise the banks it owns by infusing a mammoth Rs2.11 trillion, of which Rs1.35 trillion will be through so-called recapitalisation bonds.

Most public sector banks’ shares have surged more than 20% (State Bank of India rose the highest since 1994) as suddenly valuations of these lenders are looking appealing. Investors are having a red letter day but it is obvious that further upside would depend on how smartly the banks utilize the money.

Indeed, the plan is expected to be a cash neutral exercise for the government, hardly making a blip on its fiscal deficit. This was crucial because the centre’s finances are already stretched. Additionally, it gives much needed funds to public sector lenders for them to step up to the demand for loans from good-rated companies. Also, it would help them weather out the provisioning requirements of their toxic loan pile. This would mean better profitability, which is why their shares have risen.

This in turn will make the wheels of investment run faster, leading to a faster and more sustainable economic recovery. As a collateral benefit, the excess liquidity that is giving a headache to the Reserve Bank of India (RBI) will also be managed.

Analysts are already hailing the move for the above stated obvious benefits. To be fair, there are obvious pitfalls as well and that have also been duly noted. In the spirit of fiscal prudence, off-balance sheet measures such as these recapitalisation bonds leave a bad taste. The government’s debt is likely to go up and to service the debt it will need to at least bear a cost of Rs8,000-9,000 crore, according to chief economic advisor Arvind Subramanian’s tweet.

But look closely and a loser indeed emerges. This would be the bond market. If the government follows what it did in the early 1990s, it will issue recapitalisation bonds to the banks and it will put back the cash received into lenders as equity capital. This circuitous route will end up adding over a trillion rupees into banks’ investment books, making subscriptions to government bonds sluggish.

For the bond market, the supply load looks formidable with the additional Rs1.35 trillion worth of recapitalisation bonds. Of course, this would be over two years but nevertheless, it would discourage the biggest subscribers to bonds, the public sector banks, to invest more and more in the future. After all, they would have enough by way of recapitalisation bonds.

Since the devil is always in the detail, how the bonds would be structured, issued and subscribed will be of major importance. It is no wonder that bond yields have surged in the aftermath of this news.

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