Spark Capital: Banks - Government’s Austerity vs Asset Quality
Spark Capital Advisors(India) Private Limited
22 Mar 2013
Available for Immediate Download
Banks - Government’s Austerity vs Asset Quality Government’s spending cut adds another untimely dimension to asset quality woes “The boom, not the slump, is the right time for austerity” – Paul Krugman Govt. expenditure has historically tended to spike during the month of March each year accounting for as much as 21% of the full year’s spend. This percolates to the system as a whole in the form of improved cash flows with multiplier effect as each recipient pays its creditors through the supply chain. As a result, the correlation between Govt. expenditure and asset quality of banks has been strong. March quarters have historically seen lower slippages as well as higher recoveries for banks, accounting for more than a third of the year’s total recoveries. Importantly, we observe that slippages as well as recoveries improve sharply during periods of fiscal profligacy, where Govt. expenditure is much higher than budgeted, such as in FY09 and FY12. This seasonality in the NPA/ recovery cycle is, in our view, determined significantly by the cyclicality of Govt. expenditure. However, during FY13, given the Govt.’s spending cuts to the tune of Rs. 600bn, Govt. expenditure for the month of March’13 is likely to be only 14% of even the revised budgeted expenditure for the year, the lowest in more than a decade. Ministries and departments have been asked to restrict their January-March spending to under 30% of the Budget estimate for the full year, reducing bunching of expenditure in the fourth quarter. The twin impact of a) delayed payments and b) spending cuts is likely to distort the seasonal recovery cycle. Although recoveries could still be high, we do not see the yearly 33% 4Q pattern repeating, while restructuring is likely to spike as banks resort to tiding over ‘spending cut imposed cash flow problems’. We do not brush this away as a short term phenomenon as the Govt. appears committed to bring down the fiscal deficit to 4.8% of GDP for FY14. Deferring annual expenditure to the next year, in a bid to appear fiscally prudent looks all set to become a yearly occurrence thereby bringing about a longer term change to the cycles. High fiscal deficit is a twin edged sword. On one side, 1) it fuels inflation and 2) high market borrowing by Govt. crowds out private borrowing and increases interest rates. On the other side, it is a counter-cyclical growth driver, role of which cannot be undermined in a weak environment. This makes us believe that the cuts in Govt. expenditure add another untimely dimension to the already stretched repayment capabilities of borrowers, beset by problems of mothballed infrastructure projects, falling exports, weak capex cycle, inflation induced lower profit margins and elevated interest rates. Given that the March quarter led asset quality seasonality is more pronounced for PSU banks, we continue with our polarized views with a heavy bias towards Pvt Banks and against PSU Banks.