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Will government’s plan to recapitalise banks hurt its fiscal performance?

06 August, 2015

While the government is all set to infuse Rs 70,000 crore over the next three years and Rs 25,000 crore in the current fiscal in NPA-laden state-run banks to revive investment and growth in the world’s fastest growing economy, there are doubts whether the investment will be enough. There are also concerns if the government can fund the Rs 25,000 crore which will come over and above its expenditure without slipping on the fiscal deficit target. The government is targeting a fiscal deficit of 3.9 per cent for the current fiscal and increasing the amount of capital infusion may add to that number.  

The Reserve Bank of India (RBI) in its meeting on Tuesday welcomed the government’s efforts and said while the health of the economy is improving, future rate cuts will be predicated upon the transmission mechanism of banks. RBI, which has delivered three rate cuts of 25 bps each this year, has not been able to encourage banks to pass on the benefits to the consumers. With the industry struggling to find growth and corporate earnings remaining weak, banks have been reluctant to lend further to corporates.

Is it enough?

The move to infuse Rs 25,000 crore in the current fiscal has been welcomed by the market players as a good start to deal with the NPA problem. The government was criticised during the budget session for allocating just Rs 7,940 crore for adding to capital reserves of state-run banks.

While the current plan creates a buffer for the banks which are already meeting Basel III norms, the amount is still low going by the standards of the government which believes that public sector banks need Rs 1.8 lakh crore in extra capital for four years up to FY19.

“The Indian banks may need up to Rs 1 lakh crore over and above their Basel-III capital requirements to manage the concentration risks arising out of their exposure to highly levered, large stressed corporates,” said India Ratings and Research (Ind-Ra) in a report published on Thursday.

The government has extended an olive branch for now and may have to pump more money to keep a buffer for the PSBs, but it also faces a constraint in terms of fiscal deficit which it is trying to constrain.

Containing fiscal target

Though Minister of State for Finance Jayant Sinha pointed out that the government will be able to fund the additional corpus from revenues accrued from lower crude prices and higher tax collections, the government may find it difficult to implement the plan. 

Figures released recently by the Controller General of Accounts showed that the government is on track with fiscal deficit at 51.6 per cent for April-June quarter compared with 56 per cent in the year-ago period. 

Though a RBI survey of professional forecasters pointed that the government will be able to deliver on its target of 3.9 per cent fiscal deficit, the current round of infusion adds 0.1 per cent to the fiscal deficit if no funding is raised. 

Also the government is relying heavily on higher revenues from tax collections and divestment in various PSUs which seems to be a long bet at the moment.

Tax collections till now have been good for the government with indirect tax collection growing by 37.5 per cent for April-June quarter, but weak corporate earnings and depressed industrial growth may bring down the revenue receipts in the coming months.  

Betting on divestment and crude 

The government’s attempts to contain fiscal deficit at 3.9 per cent hugely hinge on its divestment plan and the fall in crude prices. While the process has been slower than the market players have anticipated, the government has been able to raise approximately Rs 3,300 crore of the Rs 69,500 crore divestment target this year through stake sales in Rural Electrification Corporation Ltd and Power Finance Corporation Ltd. 

While the government track record has not been good in terms of meeting its divestment target—it managed to achieve only 50 per cent of the target set last year—attractive valuations with stock market being at all-time highs may draw more money for the government. 

Also, with the government working relatively faster on strategic sales, it may be able to move closer to its divestment target compared with how it fared over the last few years.    

The fall in crude process may also enhance the government’s ability to improve its financial performance. Crude prices have come down more than 50 per cent since last year, with price of brent crude at $45 on Thursday. 


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Will government’s plan to recapitalise banks hurt its fiscal performance?

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