India's Twin Balance Sheet problem as referred by Economic survey are: overleveraged and distressed companies and the rising NPAs in Public Sector Bank balance sheets. The issue is important because it is holding up private investment in the country and therefore, growth in all sorts of sectors. It has identified most of the issues that prevented many measures introduced by the government - from Sarfaesi Act, to Asset Reconstruction Companies, to Strategic Debt Restructuring and the Sustainable Structuring of Stressed Assets.
But it is the prescription, a Public Sector Asset Reconstruction Agency (PARA), that is disappointing because it offers nothing new. The twin balance problem required a coordinated approach to debt management, which was lacking. NPAs are largely the result of the stressed cash flows of a few large companies, mainly in core industry and infrastructure, caused by economic downturn rather than bad governance.
Therefore, the solution lies in trimming debt to sustainable levels, including through write-offs or conversion to equity. While the RBI introduced several schemes on exactly the same lines, they did not work because banks were apprehensive about writing off loans or taking strategic stakes.
First, the vast bulk of the NPA problem was caused by unexpected changes in the economic environment, which is at odds with its statement that growth will not solve the problems of the stressed firms. The sectoral distribution of NPAs of PSU banks reveals a widespread issue, not confined to a few sectors, which makes it hard to accept that economic distress was the main cause.
Second, if most of the distressed loans are concentrated only in a few large companies and in a few sectors such as infrastructure, the debt restructuring that banks undertook should have borne some results, but that was not the case.
Which leads us to the real problems with financing this sector. It needs long-term financing (10 years and above) with long start-up periods (three-five years) — a remit that is clearly unviable for banks that have an average liability profile of less than two years, and limited project financing capabilities.
It is not the debt levels that are unviable, but the terms of the debt — the cost, the repayment. It is no coincidence that banks’ exposure and NPA levels in the infrastructure sector shot up after the demise of specialised term lending institutions such as the IDBI and ICICI.
Finally, the operational model of PARA is unclear. Although several assumptions are offered, most are variants of old themes — funding through transfer of government securities and not cash, or government support, capital market issues etc. The report says that private asset reconstruction companies (ARCs) failed because they probably did not see value in the debts, reflected in the low prices offered. But, this can hardly be the rationale for setting up a public ARC, unless it implies that PARA will pay higher prices irrespective of loan quality. Another stated objective of PARA appears to be to do what banks hesitated to do — write off unviable debts and take over companies.
When the reluctance of PSU banks came from their very public character — fear of retribution from investigating agencies and political fallout — one wonders how a new public sector agency will confront these issues.
Credit delivery and appraisal are two clear areas crying for reforms. Either fit-for-purpose specialised agencies need to be revived or serious attempts have to be made to develop debt markets to meet the needs of large corporates, failing which the root causes of the NPA problem will remain unaddressed.