Opinion
Watch out for a silent build-up of bad assets
Summary
Banks’ gross NPA ratio decline of 2021 was not just because of better recoveries but partly thanks to relaxed regulatory norms that offered them leeway not to classify loans as such.The Reserve Bank of India (RBI) has the unenviable job of choosing to fight inflation or promote economic growth. In the era of multi-objective multi-instrument monetary policymaking, there was an inbuilt trade-off in the objectives. The trade-off might not have been fully transparent, but by and large, there was enough manoeuvring room. Since 2016, we have had the Monetary Policy Committee (MPC) regime, with a single mandate of targeting inflation to keep it between 2% and 6%. This is as per a contract between the central bank and the government. Failure to meet this flexible target for three successive quarters calls for the offending party (i.e., the MPC or RBI itself) to explain the failure. The MPC has been ultra-accommodative for nearly four years, since much before the pandemic’s onset. During the worst phase of the pandemic, monetary policy was used to the hilt. The Prime Minister’s Atmanirbhar Bharat Abhiyan relief package, placed at 10% of India’s GDP, was nearly all in terms of either liquidity injection or loan guarantees, or some loan restructuring. The fiscal restraint on display then did not prevent the fiscal deficit from hitting 9.5% of GDP during fiscal 2020-21. With loss of incomes and livelihoods, it was no surprise that there was initially lukewarm demand from small entrepreneurs for state-guaranteed loans. It took a while for credit offtake under the Emergency Credit Line Guarantee Scheme (ECLGS) to cross ₹2 trillion. With hindsight, that is not surprising. When business comes to a halt, a fresh loan, even if guaranteed partially by the government, is hardly the top priority.
RBI additionally also imposed a moratorium on loan repayments, giving extra relief through regulatory forbearance. Major loan restructuring was offered via the Kamath committee, for sectors particularly harshly affected by the pandemic. The moratorium had a perverse impact on the reported extent of bad loans, or the ratio of non-performing assets (NPAs). The banking sector’s gross NPA ratio declined from 7.3% in March to 6.9% in September 2021. This was not merely because of better recoveries. It was partly the impact of relaxed regulatory norms that allowed leeway in not classifying loans as NPAs. We should remember that back in December 2020, RBI’s Financial Stability Report (FSR) had forecast a scenario of 13.5% as gross NPAs by September of the following year, even rising to 14.8% under severe stress conditions. Naturally, there was great anxiety about asset quality, loan recovery possibilities, survival of businesses badly hit by the pandemic and labour market prospects. By July 2021, the revised forecast as per the FSR was more optimistic than before, but still saw the NPA ratio going up from 7.5% to 10% by March 2022, and 11.2% under severe stress. So, the FSR was being a conscience keeper cautioning us about the true health of corporates, small businesses and retail buyers, despite others predicting a V-shaped recovery.
Not surprisingly, the MPC kept its monetary stance accommodative all through. Concerns about a weak recovery were seen to override worrying signals on the inflation front. Oh, don’t forget that the MPC overshot its inflation target in most of the 12 months prior to April 2021, for which it was not hauled up as per the contract of the targeting regime. In fact, there was also an RBI research report which recommended that the MPC “failure" rule be extended to four successive quarters of missing the target, rather than three. The low-rate stance of the MPC was merrily cheered by stock and bond markets, and RBI’s statement about doing “whatever it takes" for liquidity support was music to their ears.
For quite a while, our wholesale price index (WPI) based inflation has been much higher than consumer price index (CPI) inflation, the latter being the MPC’s target mandate. Surely, the 14% plus inflation rate of commodities as captured by the WPI would eventually slip into retail prices, would it not?
And finally, amid the war in Ukraine, continued supply chain disruptions (partly caused by lockdowns in major Chinese cities) and a global oil price that threatens to remain in three digits, the MPC has abruptly raised rates and the cash reserve ratio, removing nearly 12% of market liquidity.
Its action came just hours before a 50 basis points rate hike by the US Federal reserve. Much has been written about the shadow of stagflation in the Western world and dismay over the unending war in Europe. The world is also struggling with mounting sovereign debts, with countries like Sri Lanka and Ghana at the brink of default and bankruptcy. Since 2008, we have seen massive money expansion and a rising mountain of debt, and it has not been clear how all this will unwind, short of outright defaults and repudiation, even by sovereigns.
What also needs urgent attention in the Indian context is a build-up of NPAs. The large amount of write-offs, healthy tax collections and handsome corporate profits of the last quarter should not make us complacent over hidden and growing NPAs.
The time for regulatory forbearance is over and lessons from the ILFS collapse should not be forgotten. The MPC’s actions will of course increase interest burdens and add to stress on loan repayments. Hence it is imperative that we urgently and dispassionately examine the books of banks to spot the rot before it grows into another crisis.
Ajit Ranade is a Pune-based economist
