Narendra Modi’s structural reforms have generally been well received, but recent scandals, bad loans and ATM cash shortages imply a banking system in crisis – to the tune of $210 billion.
There was plenty of optimism among investors when Narendra
Modi's government was elected in May 2014. He promised to introduce
a raft of structural reforms and to unravel India's notorious red
tape in order to create a more businessfriendly environment.
In some respects, prime minister Modi has met expectations. This
year, India leaped 30 places to break into the top 100 of the World
Bank's Doing Business index for the first time.1
Investors have responded positively, pushing the benchmark Sensex
index 28% higher in 2017 to close at a record high.
However, the immediate effects of the government's headline
measures have been ambiguous, causing short-term disruption and a
drag on economic growth. But they may have set the foundations for
longer-term benefits.
Most controversially, in November 2016 India announced that all
500 and 1,000 rupee notes ceased to be legal tender, with immediate
effect.
That amounted to about 80% of all cash in circulation. In an
economy that is greased by physical money, the result was chaos. A
lot of private wealth held in undisclosed currency was destroyed in
an effort to purge illegal tax-free earnings, reduce cashfinanced
terrorism, take fake bills out of circulation and push Indians back
into the formal banking economy.
A few months later the Modi government introduced a national
goods and services tax (GST) to replace a myriad of excise, sales
and cross-state border taxes. The objective was to give the country
a tax base that wasn't reliant on a small number of wage earners in
the formal economy.
The measure was given credibility by the introduction of the
Aadhaar biometric identification system. When a person registers,
they can use their number for withdrawing and depositing money at
banks. Already, 1.2 billion people are registered and the
government has opened default bank accounts for all of
them.2
These fundamental reforms have the potential to improve
productivity and the tax take. Private banks are using Aadhaar to
licence small rural shops to take deposits or withdrawals - which
is a significant convenience for the country's largely rural and
agricultural population. More businesses are being forced to comply
with the GST, for instance through the introduction of a system
that tracks every lorry and piece of cargo in transit in the
country, so owners will have to start using the formal banking
system to pay their taxes.3
Bad banks
However, India's official Economic Survey, published in January,
noted that an investment slowdown during the past six years was
associated with 'stressed balance sheets' due to the bad debts in
banks and many other businesses. The reform agenda, it suggests,
includes cleansing these unhealthy balance sheets and further
progress towards easing the costs of doing business by 'creating a
clear, transparent and stable tax and regulatory
environment'.4
It's unfortunate, then, that recent scandals, huge bad loans and
ATM cash shortages have implied a banking system that is in
crisis.
India's $1.7 trillion formal banking sector is coping with $210
billion of problem loans, and some regional banks have been
ensnared in fraud scandals. Many companies have been unable to pay
down their debt as the economy has slowed during the past two
years, especially in the power, steel and telecommunications
sectors.
In a high-profile fraud case, a billionaire jeweller was accused
of masterminding a $2 billion scam at Punjab National Bank, the
country's second largest public sector bank, by using fake
guarantees. Further tarnishing the banking system's image, ATMs in
some parts of the country have been reported to be running
dry.5
India announced a $33 billion recapitalisation plan for the
stateowned banks in October last year, but the concern is that the
injection of capital will be used to provide for more losses rather
than for new lending to help boost the economy.
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Sources
1 World Bank, January 2018.
2 Financial Review, 23 March 2018.
3 IMF Report, April 2018.
4 Economic Survey, January 2018.
5 Bloomberg, 23 April 2018.