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India: Public spending support and a bad bank could further boost a strong recovery this year


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Last month, India’s Finance Minister Sitharaman unveiled major measures as part of the budget for the new fiscal year (FY) 2021/22. One is to raise public spending on health and infrastructures; another is to set up a bad bank to manage the high level of non-performing loans (NPLs) in the banking sector. The extension of the privatisation process, including a few banks, is also planned. Those policies are likely to further boost an ongoing recovery that is expected to be the world’s strongest among large economies this year. 


After a record recession last year – expected around 8% in FY 2020/21 ending this month – due to the impact of Covid-19, the government wants to boost growth beyond the mechanical rebound. The decision to raise public expenditures significantly deviates from Modi government’s fiscal cautiousness implemented until now to avoid the risk of losing the country’s investment grade status from credit rating agencies. Fiscal consolidation and a reduction of the wide fiscal deficit (expected at 13.1% in FY 2020/21) has been postponed to FY 2021/22 and will be closely monitored with a largely domestic public debt flirting now with 90% of GDP (from less than 70% in 2018) and heavier public interest charges. Meanwhile, the government will sharply cut spending that it greatly expanded to cope with the Covid-19 fallout, notably on food subsidies and employment funds towards rural areas. This might add some instability after months of farmers’ protests against Modi’s liberalisation plans in the agriculture sector. On the revenue side, the government is betting on an increase fueled by the economic recovery and extended privatisation of public sector assets in non-strategic sectors, including some state-owned commercial banks (SOCBs). This process has been going on for some time and might accelerate. 

The banking sector will continue to be a focal point of attention for the government. After a partial recapitalisation of the sector, followed in 2019 by a broad consolidation – with 27 state banks merged into 12 – a public divestment plan is on the agenda. More urgently, after having been called a bad bank for seven years, the National Asset Reconstruction Company (ARC) is finally about to be set up to reduce the sector’s bad loan mountain and revive confidence in an ailing financial industry. Indeed, the financially poor banking sector has constrained India’s growth potential for years. Moreover, it further deteriorated during the Covid-19 crisis as the state had to bail out some banks and shadow banks while NPLs surged to more than 13% of total loans in the last quarter 2020 (according to the Reserve Bank of India) from already high levels resulting from years of mismanaged bank lending. The transfer of NPLs and restructured assets to the ARC – which will sell them to investors at a discounted price – will allow banks to focus on boosting lending during the current recovery. This positive step having been made to tackle financial risks, it remains to be seen how the ARC will be managed and whether the banking sector’s governance and risk management practices will enjoy a structural improvement.

Those government measures come at a time when India’s economic recovery is on track – it cautiously started in the last quarter of 2020 – which might propel growth to world’s heights (+11.5%) in 2021. As elsewhere in the world though, forecasts could be revised down due to a persisting Covid-19 pandemic and, in spite of the advantage of local vaccine production, a long vaccination rollout (potentially a few years) of the world’s second largest population. In addition, the massive informal sector has been severely hit by the Covid-19 shock and will not recover swiftly. Those factors could mitigate somewhat the strong economic recovery expected this year. 

Analyst: Raphaël Cecchi – r.cecchi@credendo.com


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