India’s banks need more than a bailout

India has long been faced with a slow-motion bank crisis. In particular, the state-controlled institutions that dominate the sector have a bad-loan ratio that’s almost twice as bad as their private counterparts. At last count, non-performing assets made up more than 10% of banks’ advances, and were growing ever faster.

Naturally, banks faced with this burden are not exactly eager to lend, so credit growth to the private sector has hit historic, multi-decade lows. Set against this, the central government’s plan to recapitalise the banks it owns has long been considered laughably small — just US$1.5 billion (49.6 billion baht) was set aside in the last federal budget.

On Tuesday, the government took its first step towards fixing that problem. Finance Minister Arun Jaitley announced a plan to give $32 billion to banks over the next few years. This is still only a fraction of what independent analysts estimate is necessary to restore state-owned banks to health. But it’s a start towards ensuring that the investment pipeline in India works again.

Even so, it’s far too early to celebrate. The finer print of the announcement was, frankly, disquieting. The implications for both India’s banks and its macroeconomic stability are not quite as positive as they might appear.

The first question is this: Will the recapitalisation leave Indian banks stronger and more sustainable? After all, this is not the first time they have needed help from taxpayers. In addition to various smaller bailouts now and then, the government put 200 billion rupees into the banks in the early 1990s. In the years following the financial crisis, it injected another 586 billion rupees. A system that needs constant bailing out is one that needs to be abandoned.

The activity, including lending, of Indian public-sector banks is constantly subject to political pressure. At times their “extend and pretend” behaviour is driven by the demands of what we are now supposed to euphemistically call Politically Exposed Persons.

At other times, the banks are compelled to ignore their primary purpose — providing savers with returns, and supporting worthwhile projects — because of government policy.

In the past few years, for example, they have been forced by their principal owner, the federal government, onto the front lines of other policy battles. They spent months dealing with the withdrawal and replacement of high-value currency. When they were not doing that, they were having to meet various inclusion targets and running camps for the prime minister’s pet projects.

In other words, unless the banks are allowed to either run independently of government diktat, are privatised, or are encouraged to slowly shrink into nothingness as private competitors expand, this recapitalisation is meaningless. The banks still would not work as they are supposed to, and taxpayers will inevitably have to shell out money again before too long.

The second question is this: How will this recapitalisation affect the government’s balance sheet? It’s not a small amount, and how India pays for it is important.

There is not a lot of clarity about that yet. The amount of direct budgetary support is clear: It’s about a third of the total. This is, in the words of India’s chief economic adviser, “not new”, and the “residual resource mobilisation” of a bailout package designed a few years ago. The remainder will be financed by “recapitalisation bonds” issued by the government. Here is where it gets dicey. The government wants to have its cake and eat it too; it will argue that this big increase in debt does not in fact change its creditworthiness.

India’s leadership is desperate for a sovereign ratings upgrade, and it has done a good job of sticking to fiscal consolidation and a transparent budget process. Yet this bailout may well destroy that process. On one hand, it will be hard to claim that you are focused on fiscal restraint when you are massively increasing public debt, as well as keeping yourself on the hook for similar calls on your purse in the future.

On the other hand, if you, through sleight of hand, hide these bonds from your fiscal deficit, you are ending your commitment to transparency — and reducing your credibility as economic managers.

These are the two things to watch: Will India act to reduce government control over banks, and will it be clear and transparent about how it is spending its money? Short this knowledge, I don’t think we should be particularly sanguine about how India’s new bailout will turn out.