India’s economy

Reflections of reality

Does India have a bad-debt problem?

Aug 6th 2011 | MUMBAI | from the print edition

The Economist

A RITUAL familiar to students of the subprime and euro crises has started taking place on Indian banks’ conference calls with analysts and investors. The number-crunchers probe the lenders about their exposures to potential bad debts. Bank bosses insist that, although there are niggles, all is under control.

Some scepticism is due. With India’s economy slowing—growth could dip below 8% this year, from a peak of 9-10%—and interest rates rising (see chart), borrowers will be under more strain. India’s banks have been growing fast for years, often a sign that discipline has slipped. Total loans have almost tripled since 2005.

The Reserve Bank of India (RBI), which regulates banks and sets interest rates, has a record of running a tight ship. Gross non-performing loans have fallen from about a fifth of the total in 1995 to under 3% today. But the RBI is neither infallible nor squeaky-clean. Between 2005 and 2008 some foreign banks and several local ones got caught by a mini-boom in unsecured loans to consumers that quickly soured. And since the start of the global financial crisis the RBI has quietly given Indian lenders some get-out-of-jail cards; these may pale into insignificance compared with perks doled out by Western regulators but they suggest that the central bank prefers to fudge the recognition of losses in the system if it thinks stability is at risk.

In 2008, for instance, banks were allowed to restructure weak loans without recognising them as bad debts; these now account for 3-4% of all loans. Lenders have also reportedly been allowed to avoid booking losses on loans to Air India, a state-owned zombie. The stock of all provisions held against all non-performing loans is lower than in other countries, particularly at the state-owned banks that dominate the industry. That means there is less of a buffer before losses start to burn up banks’ capital.

It is a big leap, though, from a slowing economy and a crafty regulator to a systemic bad-debt problem. India is not very indebted: at 55% of GDP, bank credit is far lower than in China, let alone rich countries. Banks dominate lending, so the risk of problems hidden in the shadows of the financial system is small. Companies dominate borrowing and their gearing is low. Aashish Agarwal of CLSA, a broker, says he is not too worried about borrowers suddenly being unable to afford interest payments. A recent RBI stress test simulated the sort of slowdown bearish economists now fear. It suggested banks overall would be largely unscathed.

Rising rates will pinch, though. Stuart Davis, chief executive of HSBC’s Indian arm, says there has been a surge in big firms borrowing abroad in dollars, which can be cheaper than doing so at home even once currency-hedging costs are included. High-profile allegations of graft could also affect banks: a handful of corporate customers, from telecoms firms to miners, are implicated in scandals, and if they end up being clobbered by the authorities, their creditworthiness could be hit.

Many infrastructure projects, from roads to power plants, are stalled or reliant on public-sector customers which are bust in all but name and which enjoy uncertain backing from the state. Infrastructure loans have risen quickly to account for about 15% of overall loans—not enough to bring the system to its knees, but enough to harm a handful of banks if any losses are unevenly distributed. India may not have the bad-debt problems of the rich world, or even China. But as elsewhere, its banks are a reflection of its economy, warts and all.