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Reuters/David Gray
Goldman has a long way to go.
THE BITTER TRUTH

Nine ways in which the PNB scam will affect India’s economy

By Sriram Iyer

To global investors, India’s economy may seem a bit like a raw mango these days—enticing from a distance but bitter to taste; good for pickles, and not much more.

That Goldman Sachs cut India’s economic growth estimate from 8% to 7.6% for financial year 2019 may not be a surprise after the swell of bank scams that have washed over headlines in the last few weeks. The global investment bank has cited the $2 billion fraud at the state-run Punjab National Bank (PNB) among the reasons for slashing the projections for the world’s fastest-growing major economy.

Goldman fears the fraud is just the beginning of a prolonged period of pain for the Indian economy. “Markets and investors are questioning whether the problem is more systemic,” the analysts wrote in the note to clients.

Indeed, in the days following the revelation that billionaire jewellers Nirav Modi and Mehul Choksi duped India’s second-largest government bank, the PNB stock has lost more than a quarter of its market value. Other public sector bank scrips have tumbled, too.

The ways in which India’s unravelling banking crisis will dent the economy could be many.

The nine pins

One, it has been established that the scam at PNB was not the first—and won’t be the last. If more skeletons tumble out, the banks’ soured loans, nearly Rs10 lakh crore ($150 billion) at last count, may turn out to be higher. India is already among the worst in the world in terms of bad loans.

Two, now that a portion of bad loans has been revealed to be frauds, the money recoverable from borrowers is likely to be far lesser than previously projected. According to Goldman Sachs, banks may to write off up to 65% of the bad loans. This estimate is more than double of the $46 billion that the prime minister’s economic advisor, Bibek Debroy, had estimated last month during an interview with Quartz.

Three, not all PSU banks drowning in bad loans may have the strength to withstand the crisis. Most of the 21 lenders were struggling for capital even before the frauds were unearthed. That would mean more of taxpayer money being poured into them before all the dirt is flushed out.

Four, the $32 billion recapitalisation of PSU banks, planned before the frauds came out, may be inadequate to kickstart lending and the growth cycle. So, despite more government investment, these banks may be happy to just stay afloat. The amount of fresh capital they could use to lend to good businesses may be far less.

Five, with the grave governance gaps being exposed now, the leash on these banks has been tightened as expected. The Reserve Bank of India’s (RBI) new norms mandate that banks must declare non-performing assets (NPAs) sooner than before, and submit weekly reports to the regulator. This could increase the pace of rising bad loans and stop banks from hiding them to make the books look better.

Six, the cracking of the whip by the RBI may make bank executives extremely cautious about fresh loans, as a former RBI governor told Quartz on March 20. Wary lenders may further squeeze private investment, already rather tepid. It will also lead to a higher cost of borrowing.

Seven, an aversion to select sectors has been among the major fallouts of the PNB fraud, particularly the gems and jewellery sector which contributed 13% to the country’s exports in fiscal 2017. Lending instruments like the letter of undertaking (LoU) have been struck down by the regulator. The LoU ban is likely to hurt importers as well as some exporters.

Eight, if foreign trade weakens, the current account deficit will widen and increase the cost of government borrowings. That, in turn, will strain public spending and the fiscal health. The rupee may weaken, fuelling inflation.

Nine, all of this will portray a clumsy picture to ratings agencies, taking the sheen off India’s image as a global investment destination. For the Narendra Modi government, desperate for an upgrade in credit ratings, the wait may get longer.

Raw, not ripe

Aside from the frauds and their cascading effects, even authorities’ reactions have been far from reassuring. Those responsible for India’s state-run banks have been found bickering following the deep crisis.

The damning impact of a such blame-game was highlighted by the former RBI governor. “Both RBI and the government should be very conscious that this is an international issue. The image of India is at stake,” the former governor told Quartz. “There may be differences in view. You should not be talking through the media to the people of India. This has definitely spoilt India’s reputation as a rising power internationally.”