The Economy of a country when is about to boom, the corporate sector in anticipation of this takes loans from banks and makes investment in building new projects.

These projects involve generation of employment but have no effect on the Government's capacity or fiscal deficit and so are very important.

The projects then are launched and these generate returns for the corporates. The corporates then earn profit and repays the loans taken and also pays tax to the government. The profit is then used for further investments and more jobs are generated and more taxes are paid. This is the normal economic cycle.

However, suppose the economic climate changes and the anticipated boom doesn't take place. Then the company cannot get the return on its investment. It can't repay the loans and jobs too are lost. Loans taken for the projects are then classified as Bad loans / Non Performing Assets [NPA's]. The Corporate's then don't borrow and no investment is made and hence no new jobs or growth in taxes. This begins Deflation. Or the Corporate's then take newer loans and begin more projects, but since the old loans weren't repaid either the banks won't lend again or the banks don't have the capital to do so. The Corporates that are not under under debt also can't borrow or invest as the banks can't find the Capital to lend.

So the Banks are under bad debt and the Corporate's are already overdebted. This is the Twin Balance Sheet problem.

The NPA of PSU Banks were 12% of the total loans and 4/5th of the NPA's were in PSU Banks. Also almost 40% of the Corporate Debt was owned by companies which didn't earn enough to repay their loans [Interest coverage ratio < 1].

India's Twin balance sheet problem is worse than the one during the East Asian Crisis of 1997 and the worse than any other emerging economy except China.

Indian TBS problem is a bit different from the other nations. During boom time the Corporate's were prevented from taking excessive loans and even foreign loans were not allowed to be taken as there were capital controls. This meant that during slack years the TBS problem didn't emerge for some time.

Also the bulk of the NPA's were with PSU banks and so they were backed by Government that already had the resources to meet the NPA problem and so the investors weren't too worried.

However now would be the right time to have a formal agency to solve this problem as the levels of NPA's shouldn't become unsustainable. This was also the path taken by the East Asian countries and this helped them recover from the TBS problem in two years.

The time around 2000 was a great period for the economy. The economy all around the world was booming and so was India. The country recorded very high growth rates and also there was a feeling that this would continue even for a decade.

The Indian firms started taking loans and launching infrastructure related projects. They hired aggressively and pushed up the ratio of investment to GDP. The foreign capital too arrived and companies borrowed from abroad.

The forecasted growth rate too boosted their expectations.

However the Global financial crisis changed everything. The growth rate halfed and investments took a long time to fructify due to delayed environmental clearances and red tape. The returns from these projects too was below expectation. The firms that had borrowed from outside sources had to face a depreciated rupee and so the repayment capability suffered.

This was the start of the Twin Balance sheet problem. However the difference was that the Indian balance sheet problems coexisted with high growth rates and moderate to high inflation.

The infrastructure boom although not financially sustainable added capacity to the economy. Now the country had more roads, power plants and steel and cement manufacturing and this boosted the industries further.

The economy then recovered as it needed these infrastructure projects as India faced severe supply side constraints like poor electricity, poor roads etc.

However the Crisis in US and Europe was due to the housing sector and this couldn't contribute to the economic growth anyway.

The Indian firms also got a postponement from their creditors and delayed payment of interest and loans to a further date. Some were allowed to borrow further to continue their projects in the hope that they economy might recover in future and so these loans can be repaid.

It was a combination of both the above factors that helped the country.

The PSU banks now facing the larger share of NPA's have made two strategies: To reduce lending to others as they face capital shortage and also too reduce the interest rates on deposits. This was done to allow lending to the borrowers of bad debt as they needed the capital to tide over the current crisis. Thus good borrowers and depositors were taxed for the protection of bad borrowers.

The Depositors now moved to other sources of earning returns like bonds and capital markets and this has helped the Capital markets in India too some degree.

Meanwhile the private banks and the government have taken up the task of providing investments in place of the private sector. However as the Private banks are smaller they couldn't match up to the task and so overall a decline was seen in the investments to GDP ratio.

PSU bank shares also fell as the investors exceptation couldn't be met and this saw a flight of capital from the Indian share markets. PSU bank shares are now selling at 2/3rd of their book price.

Large corporates have tided over the crisis in a limited manner by selling off their assets. But even this won't help in the long run.

Smaller corporate's have been facing slowing growth and declining sales and so their debts and losses are piling. But as they weren't as aggressive in borrowing as the large private sector corporates their balance sheets are moderate.

Private Asset Reconstruction companies have been setup and these would buy the stressed assets from the banks and then restructure the debt. However due to their small size they were able to buy only 5% of the NPA's. Also since the recovery of profits from the stressed assets is low, the price offered by the ARC's to the Banks is less and so banks don't sell to the ARC's.

Strategic Debt restructuring [SDR] under this the creditors would take over the stressed asset and then sell it to new owners.

Sustainable structuring of Stressed assets [SSSA] under this creditors would provide firms with debt reductions of 50% in order to restore viability.

However the schemes though have the potential to reduce bad debt but haven't made any impact because:

Banks are afraid of attracting the contempt of judiciary, investigating agencies due to the write offs.

More incentive to just keep on giving loans to the debtors and postpone the crisis i.e. put good money after bad money.

Public Sector Asset Rehab Agency [PARA]

Chapter Review

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