Mumbai: The default risk for Indian banks is set to rise from a four-year low after the government proposed the smallest capital infusion to state lenders since at least 2009.

Prime Minister Narendra Modi’s administration will inject 7,940 crore into the banks in the year starting 1 April, finance minister Arun Jaitley said on 28 February. That’s 29% less than initially targeted for the current period. The average cost of insuring the debt of State Bank of India and three other lenders against non-payment dropped to 160, the lowest since April 2011, CMA data show.

The infusion is being scaled back as the government seeks to fund public spending after Jaitley’s budget projected a wider deficit than the previous goal. The extra capital is less than half the 200 billion rupees Fitch Ratings Ltd estimates banks need, after stressed assets climbed to the highest since 2001.

“Capital is going to come at a cost for banks and it will have a bearing on core business and plans," M.S. Raghavan, chairman and managing director at state-run IDBI Bank Ltd in Mumbai, said in a 2 March phone interview. “There will be a struggle. The course ahead is going to be extremely unusual because capital will have to be earned."

‘ Suboptimal’ performance

Of the 11,200 crore target set last year for the period ending March 2015, the government has infused only 6,990 crore into nine state lenders. Banks will be allocated capital based on performance, which has been “suboptimal" thus far, the finance ministry said in a 28 February statement.

Profitability at state-run lenders, as measured by return on assets, was at the lowest in at least seven years as of March 2014, data compiled by the Reserve Bank of India (RBI) show.

“The communication that has been sent by the government to the banks is that they have to improve profitability and efficiency," RBI deputy governor R. Gandhi told reporters in Mumbai on Tuesday. “To send the message a little stronger, the government has taken the decision to reward those banks with better numbers by giving them more capital."

Governor Raghuram Rajan unexpectedly on Wednesday cut the central bank’s benchmark rate for a second time this year. The repurchase rate was lowered to 7.5% from 7.75%.

The average capital-adequacy ratio for Indian lenders fell 20 basis points, or 0.20 percentage point, to 12.8% in the six months ended 30 September, central bank figures show.

‘Capital starved’

“This year the government cut the capital infusion to below what was originally promised," Ankit Ladhani, a banking analyst at Karvy Stock Broking Ltd in Mumbai, said by phone. “If that happens again, there will be a crisis at some of the lenders who are starved for capital."

The finance ministry estimates state banks will need an additional 2.4 trillion by 2018 to comply with the Basel III requirements aimed at boosting the capital of lenders after the 2008 global financial crisis. Under the norms, the RBI is targeting a minimum Tier 1 capital ratio of 7% by March 2019 from the current 6.5%.

State lenders’ stressed assets, including soured debt and restructured loans, increased to 12.9% of total lending as of 30 September, the highest since 2001, RBI data show. The ratio was 4.4% for privately owned banks. Loans in the system grew 10.4% in the 12 months through 6 February, near the 9.7% pace in September that was the least since October 2009. Loan growth at state lenders in the year ended 30 September trailed the overall figure by 2%age points.

More than 1 trillion of projects have been stalled due to land issues or regulatory delays, including 60,000 crore of roads, 20 coal mines and steel mills. The average time overrun increased to about 50 months in 2013-14 from about 20 months in 2008-09, according to CRISIL Ltd, the Indian unit of Standard & Poor’s.

Credit negative

“The low capital-infusion target is a negative on the credit profiles, franchise and growth prospects of midsize state-run lenders," Ananda Bhoumik, a Mumbai-based senior director at India Ratings and Research Pvt., Fitch’s local unit, said by phone Tuesday. “Capital requirements are going to shoot up after March 2016. If there’s no proper plan in place, panic will ensue."

Credit-default swaps insuring the notes of State Bank of India, nation’s largest lender, against non-payment for five years have declined 23 basis points this year to 148, according to data provider CMA. Similar contracts for the Bank of China Ltd have dropped eight basis points.

The yield on India’s 8.4% sovereign notes due July 2024 fell eight basis point to 7.68% as of 12:06pm, according to prices from the RBI’s trading system. The rupee was little chnaged at 61.8925 a dollar.

“There isn’t going to be any more hand holding by the government," Radhika Rao, an economist at DBS Bank Ltd in Singapore, said by phone on 2 March. “The government isn’t going to do much and will let banks face the reality." Bloomberg

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