Bailing public sector banks out of their bad loan quagmire has presented the NDA with a devil-or-deep-sea-choice. With capital requirements for the balance sheet repairs pegged at a mammoth ₹2.4 lakh crore, finding the money has been difficult amid fiscal constraints. But delays on this front have stalled credit growth in a sluggish economy. This is why the ₹ 2.11 lakh crore recapitalisation package announced on Tuesday comes as a pragmatic and long-overdue move to shore up depositor and investor confidence in PSBs. The package envisages an infusion of ₹1.35 lakh crore through recapitalisation bonds and market funding of ₹58,000 crore, aside from ₹18,000 crore from the Budget. While the modalities are yet to be announced, expectations are that the exercise will be modelled on the lines of a similar bailout in the nineties, when the Centre issued recapitalisation bonds to PSBs, and re-routed the sums so raised as equity capital.
A valid criticism of the recap bonds is that they are just an accounting sleight of hand. But in contrast to the other ideas for PSB bailouts — notably bad bank or mergers — recap bonds can have three positive economic fallouts. As PSBs supply the funds needed, the Centre avoids roiling the bond market with new borrowings or hiking taxes for the overburdened taxpayer. The steroid shot of over ₹2 lakh crore should also hopefully jolt PSBs out of their excessive risk-aversion, and restart credit flow to segments such as MSMEs. The ‘stimulus’ from this move, however, will depend on whether credit demand revives from the large corporates. The issuing agency for the recap bonds, the borrowing cost to the fisc and the identity of the banks who receive infusion will all be keenly watched. Also unclear is whether global rating agencies will be willing to ignore the higher debt-to-GDP ratio while assigning their India ratings.
While the recap bond idea offers an expedient solution to PSB capital woes, there can be significant negative repercussions in the long run which the Centre would do well to recognise. The main one arises from the moral hazard of allowing PSBs to dip into the exchequer time and again to paper over their bad or corrupt lending practices. The large capital infusion that the Centre is now willing to fork out militates against the spirit of the original Indradhanush scheme which had tied PSB infusions to performance metrics. The other big worry is that governance reforms at PSBs, particularly those related to the distancing of bank boards from government interference, have made snail-paced progress in the last three years. Far from cutting the apron strings, this big-ticket bailout will actually raise the Centre’s equity holdings in the PSBs, making them even more vulnerable to undue interference. The best way to alleviate these concerns would be for the Centre to provide a roadmap for disinvestment from PSBs, even as it thrashes out the modalities of this bailout plan.