Significant proportion of NPAs came from MSMEs; real loan growth to MSMEs turned negative: Economic Survey

New Delhi, Feb 2 (KNN) The Economic Survey 2016-17 highlights that a significant proportion of increases in NPAs came from mid-size and MSMEs as smaller companies that had been suffering from poor sales and profitability for a number of years struggled to remain current on their debts.

The crucial survey also highlights that the real loan growth to MSMEs slowed significantly in 2014-15, and actually turned negative during the past two fiscal years.

For much of the period since the Global Financial Crisis, the problems were concentrated in the large companies which had taken on excessive leverage during the mid-2000s boom, while the more cautious smaller and midsize companies had by and large continued to service their debts.

“Starting in the second half of 2016, however, a significant proportion of the increases in NPAs – four-fifths of the slippages during the second quarter – came from mid-size and MSMEs, as smaller companies that had been suffering from poor sales and profitability for a number of years struggled to remain current on their debts,” said the Survey.

The Survey warned that this trend is likely to continue into 2017.

It also pointed that the gradual tightening of the credit constraint has been felt rather unevenly across the economy.

The Survey highlighted that the corporates and MSMEs have been hit severely. Real loan growth to MSMEs slowed significantly in 2014-15, and actually turned negative during the past two fiscal years

Meanwhile, loans to corporates in the stressed sectors remained buoyant for some time, in line with the strategy of keeping them afloat, but even for this group loan growth turned sharply negative in real terms during 2016-17.

The Economic Survey said Public sector banks have also responded to their stress in another standard way.

“They have tried to compensate for the lack of earnings from the non-performing part of their portfolio by widening their interest margins. For example, by December 2016 the gap between the average term deposit rate and the average base rate had grown to 2.7 percentage points, from 1.6 percentage points in January 2015. It was only following the extraordinary influx of deposits consequent on demonetisation that public sector banks finally cut their lending rates by significant amounts,” said the Survey.

The widening of spreads, in turn, has encouraged disintermediation from the banking system. The increase in margins means that performing borrowers and depositors are effectively being taxed in order to subsidise the non-performing borrowers.

Inevitably, the good borrowers are seeking funding elsewhere: from the commercial paper market for their short term needs and the bond market for longer term financing.

“This could, in a way, be considered desirable, as it is helping develop the country’s capital markets. But if this trend of disintermediation continues, it will leave much of the “tax” burden on the MSMEs, who cannot decamp for the bond markets, since they require the knowledge intensive type of lending that is provided only by banks,” argued the Economic Survey.

This trend may also pose risks for the banks themselves, who risk being left with just the riskier ones, with the better ones migrating.

The Survey suggests that the RBI has over the past few years introduced a number of mechanisms to deal with the stressed asset problem. Initially, the schemes focused on rescheduling amortisations to give firms more time to repay. But as it became apparent that the financial position of the stressed firms was deteriorating, the RBI deployed mechanisms to deal with solvency issues, as well.

Three of these mechanisms are particularly notable. For some time, the RBI has been encouraging the establishment of private Asset Reconstruction Companies (ARCs), in the hope that they would buy up the bad loans of the commercial banks. In that way, there could be an efficient division of labour, as banks could resume focusing on their traditional deposit-and-loan operations.

The Economic Survey 2015-16 emphasized that addressing the stressed assets problem would require 4 R’s: Reform, Recognition, Recapitalization, and Resolution. (KNN Bureau)