India Inc’s credit crunch

Economic growth, whether it is for a country or for a corporation, requires debt. Take a close look at any project which builds assets and you will likely find it has been funded 80% by debt and a mere 20% by equity. In other words, debt is crucial for India’s growth story. But unfortunately, it is fast drying up. And there is no real solution in sight.

The credit crunch is especially acute in the case of big corporate entities and other infrastructure companies. Gross non-performing assets (GNPAs) have been growing steadily since FY14 with the Reserve Bank of India’s (RBI) strict norms for recognition of bad loans, and touched Rs 10.2 lakh crore at the end of the fourth quarter of FY18, according to central bank data.

While recognition of past bad loans may peak by the end of FY19, the problem is that of finding a resolution. Cases under the Insolvency and Bankruptcy Code have been slow to reach a conclusion with only one case, Bhushan Steel, being settled and a new buyer taking charge.

And even while 39 companies go through the bankruptcy process at a snail’s pace, the worries are shifting towards loans disbursed to the power and telecom sectors. Of the Rs 5.2 lakh crore exposure of Indian banks to the power sector, Rs 1.8 lakh crore is classified as stressed, RBI data says. Bad loans are a part and parcel of any financial system. While it does hamper the lending ability of banks, what has really tightened the screws on lending is the increasing number of banking frauds in the country.

According to Reuters news agency, there have been 8,670 cases of “loan frauds” in five financial years up to FY17, totalling nearly Rs 61,260 crore. Though the amount of bad loans due to banking frauds is only a fraction of the overall GNPA, high-profile bank fraud cases—such as diamantaire Nirav Modi allegedly defrauding India’s second largest public sector bank (PSB) Punjab National Bank for over Rs 12,000 crore— have severely crippled lending activity. Bankers are being scrutinised more than ever before, and there is a fear associated with giving loans to the corporate sector. Hence, lenders have become far more risk averse.

That is something that has been on the mind of British business tycoon Sanjeev Gupta, the executive chairman of industrial conglomerate GFG Alliance and metals conglomerate Liberty House, who plans to start financial services in India, hoping to capture the space vacated by the Indian financial sector. “There is going to be a shrinkage of capital in India in the near- to medium term because of the banking issues. There is a combination of two things that are at work here. One is all about the clean-up of NPAs, which I think will take time to filter through and the confidence to rebuild,” Gupta says.

The other issue that will affect decision-making is the hunt for fraudsters that is taking place at the moment. “A combination of these two things will mean the lending will be constrained so the opportunity will be immense to bring in Western capital,” Gupta says.

His views find ready resonance with another player who is eyeing the space that banks have become wary of treading on. Edelweiss Asset Reconstruction Company is keen to enhance its presence in India. “People will be careful to borrow and banks will be careful to lend… the times are looking really good for the ARC (asset reconstruction companies) business,” says Siby Antony, chairman and managing director, Edelweiss, Distressed Assets Resolution Business.

The space for non-banking financial companies, private equity, ARCs and other alternate financing companies will simply grow. According to brokerage firm ICICI Direct’s research analysts Kajal Gandhi, Vasant Lohia, and Vishal Namolia, the share of lending by PSBs will come down as they face capital constraints, and with 11 of the 21 public lenders under preventive corrective action, there are also lending restrictions.

Credit growth in the Indian banking system is clocking a modest pace of roughly 10% on a year-on-year (y-o-y) basis, according to the ICICI Direct analysts. But, a deeper study reveals that even this growth is skewed. Banks with a retail focus are growing at more than 20%, while those which lend to corporates, especially the PSBs, are lagging behind with many of them reporting de-growth. Worryingly, the trend is not expected to be resolved anytime soon.

“Going ahead, credit to the retail segment is expected to remain healthy, while capex-driven loan growth is seen to remain muted. Increasing commodity and crude prices would keep demand for working capital loans intact,” write Gandhi, Lohia, and Namolia in their research note. In fact, the RBI’s recent report on credit deployment data strengthens the existing observations. While retail growth remained strong and broadly stable at 19% on a y-o-y basis, lending to medium- and large corporates grew at 4% and 1%, respectively, and only 0.2% for small and medium enterprises.

However, lending to the infrastructure sector contracted 1% y-o-y with the biggest casualties being the power and road sectors, which contracted by 1% and 5%, respectively. Other industry segments that witnessed deceleration include food processing, metals, and construction.

In fact, the real worrying factor for the Narendra Modi government is not a depreciating rupee, high crude and commodity prices or even a growing balance of trade and a widening current account deficit. The biggest problem is finding the necessary funding when conditions turn conducive for India’s growth story.

(The article was originally published in July 2018 issue of the magazine.)