If you lend money to someone, you expect the payment to be settled – and hopefully on time. But in India, that is not always the case.
In what could be the biggest bank fraud in Indian history, government-owned Punjab National Bank (PNB) last month uncovered up to $2 billion in unauthorised loans made to diamond jeweller Nirav Modi over the past seven years.
PNB was accused of granting new loans to Nirav Modi every time a loan was due. In practice, the jeweller never needed to repay the amount since the new loan granted was sufficient to cover the principal owed plus the interest incurred.
If that could conceivably be attributed to human error, the following case definitely cannot.
Last year Prime Minister Narendra Modi ordered the state of Uttar Pradesh to write off as much as Rp360 billion ($5.6 billion) of small loans made to over 21 million farmers, a promise he alledgedly made in exchange for votes for his Bharatiya Janata Party during elections held in March in the country’s largest state.
It is not the first time India has granted loan waivers to farmers, which account for 69% of India’s population. In 2008, New Delhi picked up a bill of $10.8 billion – equivalent to 1.3% of the nation’s gross domestic product at that time – for the indebted farming community.
These waivers were short-term solutions to bloated rural debt and arguably had some economic merit. However, the cumulative long-term effects could yet be damaging to India.
These loan waivers, together with an ineffective and bureaucratic system to collect outstanding loans, have encouraged Indians to think defaulting loans – sometimes even intentionally – may be the norm.
Local media has reported that some wealthy farmers chose to default their debt on purpose, even when they were capable of repaying, after learning that the government would pick up the bill for them.
CORPORATE DEFAULT
The habitual practice of defaulting on loans also exists in the corporate world.
According to India Ratings & Research, the three-year average default rate for non-investment grade credit was 12.8% over the last five years. This suggests that out of 100 speculative-grade Indian companies, more than eight of them have defaulted on their debt within three years after issuance.
In August last year, the Reserve Bank of India made a bold move to publicise a list of large companies on the brink of defaulting on their loans. The central bank sent a list of 40 companies to local banks, urging them to start the process of debt resolution early or initiate bankruptcy proceedings before the end of 2017.
The list includes prominent names like Jaypee Group, the property-to-energy conglomerate sitting on as much as $10.3 billion of debt. Vijay Mallya, the Indian billionaire who fled to the UK after his Kingfisher Airlines collapsed in 2012 and never repaid his $1.3 billion loan to Indian banks, is also on the list.
Similarly, the government has a habit of waiving corporate loans made by public sector banks.
In response to soaring bad debt, the Indian government last year announced a $32 billion recapitalisation plan for public sector banks. However, since nearly half of the funds came from the government's capital injection, the plan could be seen as a large-scale loan waiver to bank loan borrowers.
India’s public sector banks last year wrote off loans worth $8.5 billion in the six months to November-end, a 54% increase on the same period a year earlier.
CONSEQUENCES
New Delhi’s frequent debt write-offs have arguably contributed to a deep-rooted Indian mindset to delay loan repayments and default on loans, which is the root for the country’s mounting bad debts.
As of the end of September last year, the overall non-performing asset ratio of Indian banks stood at a staggering 10.2% – the world’s second-highest behind Italy, according to the RBI. China, which India has always sees as a key competitor globally, has an NPL ratio of just 1.7% (if it's data is to be believed).
According to RBI, losses arising from financial sector fraud rose 72% over the past five years to $2.6 billion as of the end of June last year.
For Indian companies, bank loans remain the main source of funding since the local bond market accounts for only 31% of corporate credit. The corporate bond market also faces other issues such as a limited issuer base, low liquidity and it lacks a benchmark yield curve across maturities because of inactive government bond trading besides the traditional 10-year bonds.
That suggests that when a company runs into financial difficulty, it is less able to resort to other means of debt financing and is likely to turn back to bank borrowings, thereby suffering even higher interest rates and increasing the chance of running into a default.
To start off with, the Indian government has to cut the practice of granting waivers to personal and corporate loans. Then it should overhaul the banking system and introduce private capital and speed up the development of the corporate bond market to reduce the reliance on bank loans, which could eventually force banks to lower their lending rates and make borrowing easier for local businesses.
These are easier said than done. For one, the growing debt worries among Indian banks mean the government may have to continue bailing them out.
But if the government continues to bail out everything from farm loans to corporate borrowings, India’s credit system is unlikely to make a step forward.
