Capital infusion will boost market sentiment
Nirupama Soundararajan

Demonetisation and GST have been touted as disruptive reforms and like any disruptive reform, it has affected economic growth. In most cases the slowdown in growth is temporary, one that recovers within one or two quarters. To that extent the drop in GDP growth rate is not surprising and was to be expected. Yet, the slowdown has been taken a lot more seriously resulting in the government announcing its big stimulus package.

The slowdown in growth, had it been only the effect of demonetisation and GST, would have bounced back. However, combined with the effects of the twin balance sheet crisis, the problem seems to have escalated. With elections around the corner, the government has to address their shortcomings in job creation. Employment generation is a clear priority, but employment cannot be created with economic growth, and economic growth requires private investment.

India's growth has predominantly been financed by banks. The role of capital markets in capital formation has been negligible. Banks have in the past been under tremendous pressure to fund large-scale infrastructure projects, many of which have not taken off for various reasons. The bullish period preceeding the economic crisis also meant indiscriminate lending by banks not backed by suitable credit checks and risk management measures. The result is the full blown NPA crisis at hand.

Up until such a time that India's capital markets play an important role in financing growth, industry will have to turn to banks. There have many discussions around a one-time large capital infusement for recapitalisation, but this decision has been staved off for many months and rightly so. As things stand today, circumstances have changed making it an opportune time for a large capital infusion.

 Resolution process

The first change that took place is the creation of a bankruptcy regulatory framework. The Bankruptcy Code has ushered in efficiencies in the resolution process making it easier for banks to go after their wilful defaulters. Second, the government has been focussed on maintaining its fiscal targets thereby allowing them a chance to compramise now in the interest of economic growth. The third, and most critical, is the passing of the Financial Resolution and Deposit Insurance (FRDI) Bill by the Cabinet. The Bill is expected to be passed by the parliament in the winter session.

The passing of this Bill will fill a huge regulatory vacuum in the financial sector. One of the main objectives of the Bill is to ensure that public money will be not be used indiscriminately to bail out failing financial institutions. This has been an important prerequisite for any capital infusion. It is safe to assume that the NPA crisis has bottomed out. This fact, along with the possibility of the passing of the Bill, makes it a ripe time to stimulate private investment and economic growth.

Notwithstanding the details of financial engineering, the capital infusion will immediately improve market sentiments. It sends the right kind of signals to India Inc. Access to credit is expected to improve, especially for the MSME sector, which is expected to drive economic growth. India's fiscal targets may not be met this financial year or the next due to the additional burden of Rs 9,000 crore as interest payment, however this will be within reason for missing targets. Moreover it is hoped that tax receipts from renewed growth will help fund this cost. This stimulus may also usher in a new era of financial sector consolidation resulting in better health and resilience for the sector.

The Writer is Senior Fellow Pahle India Foundation