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India has proposed a new fix for its bad debt problem. It may not be enough

Kristie Neo, Associate Producer
Key Points
  • Earlier this month, Piyush Goyal, India's interim finance minister, revealed plans to set up an Asset Reconstruction Company or a "bad bank" aimed at absorbing the 9.5 trillion rupee bad debt in state-owned banks.
  • But experts said the plan may not be enough to fix India's bad debt problems.
  • A "bad bank" also wouldn't be able to fix another problem in the system: India’s weak judiciary.
Adeel Halim | Bloomberg | Getty Images

Experts say the Indian government’s latest plan may not be enough to fix its bad debt problems.

Earlier this month, Piyush Goyal, India's interim finance minister, revealed plans to set up an Asset Reconstruction Company or a "bad bank" aimed at absorbing the 9.5 trillion rupee bad debt in state-owned banks. Doing so would allow those banks to stay afloat by resetting their balance sheets.

"The ARC is a viable option," said Ismael Pili, co-head of Asian bank research at research firm CreditSights. "But India still runs the risk of turning out like the Philippines, where bank debts end up festering for over 20 years due to deficit issues."

ARCs have a poor track record in India, despite having been around for more than a decade. That's leaving analysts doubtful about whether adding another one to the mix will improve things further. According to CreditSights, India’s current 24 ARCs only have the ability to acquire 3 percent of bad assets in the system, rendering them ineffective in alleviating India’s debt woes.

A "bad bank" also wouldn't be able to fix another problem in the system: India’s weak judiciary is keeping companies from swiftly declaring insolvency, and so letting bad debt fester for longer.

“You don't have a very effective judicial system,” says Pili. “If you look at the recovery rate, it's quite low — just 26 percent from ARCs. And if you look at the time they took to resolve it, it was 4.3 years on average. That's one of the highest out there.” A recovery rate is the extent to which defaulted loans can be recovered.

What India really needs is more capital. Earlier this year, the government of Prime Minister Narendra Modi proposed a $14 billion capital injection to rescue public banks, but experts said that isn’t enough. At least $20 to $50 billion is needed, they said, for those banks to even meet minimum regulatory requirements.

"Unless the government is willing to put in their own money,” said Prateek Khawar, director at asset manager Avendus Capital, “I personally don't believe that creating ARCs and expecting private participation of capital (from ARCs) will further solve any issues."

Meanwhile, the systemic nature of India’s debt makes it a challenging problem to tackle: The bad debt includes important parts of the economy beyond just the financial system. In fact, some of the biggest defaulters for India’s state-owned banks are large steel and energy companies like Bhushan Steel, Electro Steels and Monnet Ispat.

“A lot of these problems are systemic as well as structural,“ said Manish Tewari, a practicing lawyer in the Supreme Court of India. “It is extremely imperative that we need to take a nuanced view of what is happening when it comes to building a solution in India.”