Mixed signals for the financial sector; more resilient but NPAs may rise
While many banks have begun reporting better financial performance (ICICI Bank declared a 158 per cent jump in its net profit for the third quarter of 2019-20, for instance), the overall prospects for India’s financial sector appear to be quite mixed. A quick assessment of the pluses and minuses of the Indian financial sector reveals that while a lot in terms of recovery has been achieved, maintaining vigil against any further slippage in the financial system will be necessary in the months to come.
The half-yearly Financial Stability Report (FSR), released by the Reserve Bank of India (RBI) in the last week of December) notes how the Indian financial system has become more resilient since March 2019, largely due to the recapitalisation of public-sector banks and other prudential measures taken by the central bank. More importantly, the RBI report even expresses confidence that the collapse of any large housing finance company should not pose as big a risk to the financial system as would have been feared earlier in 2019. Even though the gross non-performing assets (GNPA) ratio remained unchanged at 9.3 per cent of all advances between March and September 2019, the provision coverage ratio (provisions made against bad loans) of the banking system rose from 60.5 per cent in March 2019 to 61.5 per cent in September 2019. It is a marginal increase, but this suggests increased resilience of the banking sector. The size of the inter-bank market also continued to shrink with inter-bank assets amounting to less than 4 per cent of the total banking sector assets at the end of September 2019. Increased capitalization of public-sector banks and the reduction in inter-bank assets have effectively reduced the contagion risk under various scenarios, compared with the situation that obtained in March 2019.
However, the RBI’s FSR has underlined quite a few areas of concern as well. It notes that the gross NPA ratio of banks may rise from 9.3 per cent in September 2019 to 9.9 per cent in September 2020. The worsening of the situation is being attributed to “changes in the macroeconomic scenario, a marginal increase in slippages, and the denomination effect of declining credit growth.” There are other risks as well. They include geopolitical uncertainties and weaknesses in exports, even though the current account would remain under control. However, the FSR underlines the need for “reviving the twin engines of consumption and investment, while being vigilant about spillovers from global financial markets”.
On the risks front, a more nuanced assessment comes out in the RBI’s latest systemic risk survey. It notes that the risk perception is medium from the perspective of all the major risk groups like global risks, risk perceptions on macroeconomic conditions, financial market risks and institutional positions. But the perception of domestic growth risk, fiscal risk, corporate sector risk and banks’ asset quality risk has increased, compared to the situation in April 2019. Early resolution of sticky loans is an important goal that needs to be consistently pursued. Public-sector banks should improve their performance and should build buffers against disproportionate operational risk losses, particularly because the capital adequacy ratio for some of them could go below 9 per cent, without any further capitalization. And private-sector banks need to work on improving corporate governance.
Massive infrastructure plan, but questions on funding remain
In fulfilment of the promise made by Prime Minister Narendra Modi from the ramparts of Red Fort on August 15, 2019, the government has quickly unveiled a plan for a Rs 100-lakh crore investment push for the infrastructure sector. That plan was made public on the last day of 2019. The National Infrastructure Pipeline (NIP) plan shows that the government has identified projects worth Rs 102 lakh crore across 23 sectors, to be located in 18 states and union territories and funded over the next five years. Of these projects, 39 per cent will be implemented by the Union government, another 39 per cent will be the responsibility of governments in different states and union territories, and the remaining 22 per cent will be implemented by the private sector. The government expects that the private sector will eventually over the next five years show greater initiative and raise its share in the total projects pipeline to 30 per cent. The bulk of the infrastructure projects, almost 57 per cent, will be in three sectors – about Rs 24 lakh crore in energy, Rs 20 lakh crore in roads and another Rs 14 lakh crore in railways. This is understandable and a clear pointer to the sectors where infrastructure gaps are the most acute.
The feasibility of attaining this massive goal will always remain a big question. The break-down of these projects reveals the nature of the challenge that lies ahead. Almost 42 per cent of the projects in the NIP plan, or worth about Rs 42.7 lakh crore, are already under implementation and another 32 per cent of the projects, or worth about Rs 32.7 lakh crore, are at the conceptualization stage. About 19 per cent of the projects (about Rs 19.1 lakh crore worth of projects) are under development. That leaves only 8 per cent of the total project value in the NIP plan. The government has to quickly plan for these projects, estimated at about Rs 7.5 lakh crore, so that there is no delay in executing them within the target date of March 2025. Another challenge will be to arrange for the financing of these projects. While the clean-up of the financial sector will remain an important imperative to help finance these projects, there will also be the need for deepening the debt market and other measures to secure alternative investment funds.
Assumptions behind the successful execution of the NIP plan have also come under close scrutiny. The proposed investments have projected that the Indian economy will nominally grow by 10.5 per cent in 2020-21 and even higher by 12 per cent in 2021-22. In other words, the plan is based on expectations of a quick economic recovery from the lows of 7.5 per cent nominal growth of 2019-20. There is yet another critically important assumption that the NIP plan has made in its calculations. It has projected a hefty 21.5 per cent increase in the government’s budgetary support for the infrastructure sector to Rs 1.86 lakh crore in 2020-21. Similarly, the NIP plan projects a 21 per cent increase in the government’s total outlay for the infrastructure sector to Rs 4.58 lakh crore. In 2019-20, this increase was only 6.5 per cent. The NIP plan, therefore, is critically dependent on a sharp increase in the government’s outlay for the infrastructure in the coming year or two. Given the tight government finances, made worse by its compulsions to meet the fiscal consolidation commitment under the law, providing for more resources for the infrastructure sector will become a necessary, but difficult challenge to be overcome. Will the government rise to this challenge? The Union Budget to be unveiled on February 1, 2020 will provide an answer to this question.
Air India sale on, without respite from disinvestment blues though
The government has come out with the bid documents for the sale of Air India. It wishes to sell its entire 100 per cent stake in Air India and its wholly owned subsidiary Air India Express, in addition to exiting from its joint venture with Singapore Airport Terminal Services, AISATS, in which it has 50 per cent equity. The last date for submitting expression of interest against the bid document is March 17. This has raised expectations that the government may complete the sale to book its gains for the current financial year. There are many questions over whether this time the government will succeed. Its last attempt envisaged the sale of only 76 per cent stake in Air India and the sale exercise ended in failure. With only about Rs 23,000 crore of debt on Air India’s books (the remaining debt has been parked in a new special vehicle consisting of its other subsidiaries including the Hotel Corporation of India) and the lure of a 100 per cent equity with management control, chances of success have certainly improved. How much the government nets by way of the sales proceeds will depend on how intense is the race, if any, for the beleaguered airline.
In its July 2019 Budget, the government had stated that it would garner as much as Rs 105,000 crore through sale of government equity in public sector undertakings. The target for the current year was 31 per cent more than what was achieved through this route in 2018-19. So far, the government has been able to mobilise only about Rs 18,095 crore, or just 31 per cent of the annual target. This will obviously increase the stress in the government’s finances and make its task to meet the fiscal deficit of 3.3 per cent of gross domestic product (GDP) a little more difficult.
Even though it had fewer months to achieve the disinvestment target this year (the final Budget was presented only in July and the first two months of the financial year were spent in elections), the government had actually lined up a promising list of public sector enterprises for strategic sale. These included the sale of about 53 per cent stake in oil major, Bharat Petroleum Corporation Limited (BPCL), 31 per cent stake in Container Corporation of India (Concor) and the entire 100 per cent stake in Air India. If the government had managed to pull these strategic sales off in the current year, its disinvestment receipts could have been boosted by about Rs 85,000 crore (an estimated Rs 56,300 crore from BPCL, Rs 18,000 crore from Air India and Rs 10,700 crore from Concor). While the sale of its shares in BPCL and Air India would have led to the government’s exit from the two companies, its sale of 31 per cent shares in Concor would have reduced its equity in the transportation company to 24 per cent.
However, procedural delays and the need to complete the bidding formalities have meant that the government may complete the deal for Air India only before the end of the current financial year. The failure to meet the disinvestment target for the current year, however, should mean that the benefits from the three strategic sales would accrue to the government in 2020-21. The Medium-Term Fiscal Policy-cum-Fiscal Policy Strategy Statement, released in July 2019, had revealed that the disinvestment target for next year in the normal course would have been set at Rs 80,000 crore. That target now looks quite easy, given the postponement of these strategic sales to the next year. And the Budget on February 1, 2020 is likely to propose a higher disinvestment target than the originally envisaged Rs 80,000 crore for 2020-21.
Telecom sector faces AGR shock; will government come to its rescue?
A judgement delivered by the Supreme Court on January 16 has dealt a body blow to Indian telecom service providers, mainly to Bharti Airtel. Vodafone Idea and Tata Teleservices. These three companies had moved the apex court with a petition to review its earlier order asking the telecom companies to pay up a total amount of Rs 1.47 lakh crore by way of pending dues of adjusted gross revenues (AGR), including interest and penalty. The dispute was over what should constitute AGR. The apex court had ruled that all non-telecom earnings should also be included while estimating a telecom company’s AGR. The burden on this account is estimated at Rs 53,038 crore on Vodafone Idea and Rs 35,586 crore on Bharti Airtel.
Bharti Airtel has mobilised some funds, estimated at over $3 billion, through a successful qualified institutional placement of shares and the flotation of an overseas bond. This should help Airtel to manage the huge demand of the AGR dues. Vodafone Idea is exploring various options. Its initial response to the Supreme Court’s judgment indicated that so huge was the financial hit that the telecom company might decide to shut its business. Later, however, there are indications that the company is exploring alternative options. While the fate of the legacy players was embroiled in AGR dues, new entrant, Reliance Jio, did not have to pay up a huge amount of AGR dues simply because it had entered the space much later, compared to the other two.
For the government’s finances, the Supreme Court judgement on the telecom companies’ AGR dues will be a shot in the arm. It will help the government reduce its fiscal deficit at a time when tax revenues have fallen short of the target by over Rs 3 lakh crore, according to some estimates. While the government will benefit from this one-time bonanza, questions will be raised if the schedule for payment of the AGR dues could have been staggered to soften the adverse impact on the telecom service providers. This could have allowed them to invest a little more on basic infrastructure to improve the quality of telecom services, which have worsened significantly in the last several months.
Big reforms in coal sector signal end of coal sale monopoly
A big dose of economic policy reform was announced on January 8. The Union Cabinet relaxed the qualification criteria and regulations for mining and selling of coal in the country. This essentially opened the coal sector completely. Foreign companies and even non-coal domestic companies could undertake both coal mining and selling of coal in the country either for domestic consumption or exports. Until this decision was taken, only companies engaged in the metals, mining and power industries could take part in coal block auctions and the coal sector was not open for foreign direct investment.
A bigger impact of the Cabinet decision was that it virtually broke the near-monopoly of state-controlled Coal India Limited in the sale and distribution of coal in the country. Some relaxation had been given earlier for existing coal miners, who could sell a fourth of their coal output in the open market, a move which had been questioned within sections of the government. With the Cabinet decision of January 8, all those doubts and questions have been addressed and coal sale is no longer a monopoly business in India.
India’s coal sector has been an epitome of ironies. It is the world’s second largest coal producer and yet it imports coal to the tune of almost $15 billion a year. It has huge number of unexplored and unmined coal blocks and yet it suffers from a shortage of quality coal with high calorific value. In 2014, the Supreme Court cancelled all coal block allocations made over the previous two decades in the wake of allegations of favouritism and corruption in the allotment of coal blocks. The Narendra Modi government introduced e-auctions to allot coal blocks and later allowed commercial mining and sale of coal by private companies already in the mining sector. Now, any company in any field, foreign or domestic, can mine and sell coal. The reform in the coal sector has reached a new high.
Growth pangs, exports woes and now inflation worries
The first advance estimates of India’s economic growth in 2019-20, released in the first week of January, showed that the Reserve Bank of India and a few other independent analysts were not far off the mark in forecasting the extent of slowdown in the Indian economy. India’s gross domestic product (GDP) growth in 2019-20 is expected to be 5 per cent, down from 6.8 per cent in 2018-19. This will be the lowest economic growth for India since 2008-09, the year of the global financial meltdown. More worrying was the nominal growth (without inflation), which was estimated at just 7.5 per cent, down from 11.2 per cent in 2018-19, and a 44-year old low.
Driving the slowdown in real terms was the manufacturing sector that grew by only 2 per cent, the lowest level since 2005-06, making it the worst industrial slowdown in two decades. Investments are expected to grow by less than a per cent, the lowest in at least 15 years. The only silver lining came from the gross value added for agriculture, where the real growth rate was 2.8 per cent, but the nominal growth was 9.8 per cent. The difference of seven percentage points between the real and nominal growth rates could result in higher income effect for farmers, with a marketable surplus of their produce. In the months to come, this might help in reviving demand, particularly of consumer goods, in rural India. The difference between real and nominal gross value added growth in agriculture during 2018-19 was 1.1 percentage points – the real growth was 2.9 per cent, while the nominal growth was 4 per cent.
In foreign trade, India’s merchandise exports declined 1.8 per cent in December 2019, falling for the fifth month in a row. Even imports of merchandise goods dropped over 8 per cent. The cumulative exports for the April-December 2019 fell by 2 per cent and imports for the same period slumped by 9 per cent, reducing the trade deficit. While this gave some relief to India’s current account balance, the trade numbers were ominous for hopes of an industrial revival, dependent as it is on some buoyancy in imports.
Adding to the concerns was the sharp rise in retail inflation in December 2019, which shot up to 7.35 per cent. Higher inflation doused hopes of a further cut in interest rates, as the headline rate was higher than the mandated upper limit of 6 per cent. Little comfort could be drawn from the fact that the retail inflation, based on movements in the Consumer Price Index, was driven largely by food and vegetables prices, which have a weight of over 40 per cent in the index.
While GDP growth falling and exports contracting could be bad news economically, rising retail inflation would be bad news politically as well.