India Loan Woes Go From Bad to Worse; India’s Slowing Economy Exacerbates Banks’ Nonperforming Loans; India’s capital crisis: Reform, not controls, is the only way to revitalise the economy

Updated August 15, 2013, 6:05 a.m. ET

India Loan Woes Go From Bad to Worse

India’s Slowing Economy Exacerbates Banks’ Nonperforming Loans

ABHEEK BHATTACHARYA

Indian banks’ loan books are already a problem. But they’re going to weaken further. At State Bank of India, 500112.BY +0.27% the country’s largest lender by assets, nonperforming loans jumped to 5.7% of the total at June 30 from 5% a year ago. AtPunjab National Bank, 532461.BY -0.26% bad loans jumped to 4.8% from 3.4% a year earlier. Standard & Poor’s says the ratio of NPLs sector-wide will increase from 3.4% in March this year to 3.9% by March 2014 and 4.4% a year later. India’s slowing economy is the main problem. Overall growth slumped to a 10-year low of 5% in the fiscal year ended March 2013. The situation is likely to worsen. The Reserve Bank of India forecasts only a slight recovery in the economy in the near term, with growth rising to 5.5% in the current fiscal year. Borrowers will remain under pressure when it comes to servicing debt.Credit Suisse CSGN.VX -1.17% says most NPLs so far are at small- and midsize businesses but larger companies will feel the strain too as relatively low economic growth persists. Worse, a pending rule change could force banks to record more bad loans.Currently, the RBI says lenders must record a provision of at least 15% of any loan classified as nonperforming. Alternatively, banks can restructure loans, easing the terms for borrowers, and record a mandated provision of just 2.75% of the loan.

Naturally, some banks prefer to go the restructuring route which likely means they are keeping some zombie firms alive rather than take a bigger hit from downgrading their loans to NPL status. As of March, 5.7% of all loans by India’s banks were classified as restructured, compared with 3.4% classified as NPLs.

From April 2015, though, the RBI will restrict the restructuring option to a few sectors such as infrastructure. The move could result in a much higher proportion of NPLs across the banking system and a lower proportion of loans being restructured.

State-owned banks will probably be hardest hit by deteriorating asset quality. They’re typically more exposed to risky areas of the economy compared with privately owned banks. At SBI, 28% of loans go to agriculture and small businesses, more than double the proportion at ICICI Bank, 532174.BY +1.50% India’s largest private lender.

For the banks, India’s slowing growth threatens a double whammy. Slowing growth will likely curtail loan growth. At the same time, profitability is sure to take a hit as the existing loan book sours.

August 15, 2013 6:06 pm

India’s capital crisis

Reform, not controls, is the only way to revitalise the economy

After a brief flurry of overdue reforms last autumn, aimed at revitalising India’s slowing economy, the Congress-led government is heading back into the bunker.Capital controls imposed on outward investment this week will do little to restore a rapidly weakening rupee and they are no answer to the country’s balance of payments crisis.

The capital controls restrict the amount that Indian-domiciled companies and residents can invest abroad. No doubt there is a fear of capital flight as pessimism sets in over gloomy economic prospects. But the measure smacks more of desperation than of sound policy.

Capital controls can play a useful role in calming volatile, international capital flows. Brazil imposed taxes on inflows to halt a flood of hot money that threatened financial stability after the global crisis. ButIndia is not Brazil, and the merits of forcing money to stay where it does not want to be are questionable at best.

The root of India’s problem is not that individuals and companies have to be stopped from investing abroad. It is that there is little incentive to do so at home. After nine years of Congress-led government, India’s economy remains hidebound by bureaucracy, regulation and corruption. Some of this could be overlooked in a booming economy. But as growth slows, the uncomfortable realities of doing business are taking their toll. Many companies have found it easier and more profitable to seek new business abroad.

Over the past two years the rupee has lost more than a quarter of its value against the dollar, and the current account deficit is growing. True, some of the weakness is beyond the government’s control. The US Federal Reserve suggestion that it might taper its liquidity programme has hit emerging market currencies. But India’s failure to implement reforms that could galvanise long-term growth makes it more vulnerable than most.

With a national election fast approaching, there is little chance that Congress will introduce politically painful measures such as labour market liberalisation or land reform. But the capital constraints risk making matters even worse. Foreign investors, who at the moment are not affected, will worry that these measures might presage even wider controls.

The rupee may win a temporary reprieve from New Delhi’s actions. But if India’s leaders want to entice investors in the long term, they will have to treat the cause and not just the symptoms of the country’s economic malaise.