Has Modi Government Overcome Indian Economy's Twin Balance Sheet Problem?

Finance Minister Nirmala Sitharaman’s statement on twin balance sheet problem has brought the spotlight back on the topic. The minister argued that the twin balance sheet problem has now become “twin balance sheet advantage”.

The twin balance sheet problem refers to the deteriorating balance sheets of corporates and banks at the same time. The issue occurs when poor corporates’ balance sheets force them to default on their loans, resulting in high non-performing assets (NPAs) for banks. In India, the NPAs of bank had reached an alarming level around 2018. Prime Minister Narendra Modi had blamed the crisis on previous UPA government, saying that the huge NPAs were a result of Congress’ ‘phone-a-loan scam’ where loans were handed out to certain businesspersons on the basis of calls from people close to the ruling government. Several high profile defaulters like Nirav Modi, Vijay Mallya and Mehul Choksi had grabbed headlines during this period.

However, finance minister's recent statement suggests that the worst of the crisis might be behind us as banks and corporates performance improve. So what does data say? Let’s take a look

Declining NPAs

Data from RBI’s financial stability reports suggests that banks' gross non-performing asset (GNPA) ratio has improved substantially after hitting a high 11.6 per cent in March 2018. Aniket Dani, Director of Research at CRISIL Market Intelligence and Analytics, says that the situation of banks’ balance sheets has improved. “Due to RBI’s asset quality reviews, transparency of banks’ balance sheets has improved. Banks were also forced to undertake stringent recovery processes. The Insolvency and Bankruptcy Code has also helped in the recovery process,” Dani says. As several banks had to suffer the brunt high NPAs, government had also stepped in to infuse capital in public sector banks. Between 2016-17 and 2020-21, the government infused Rs 3.10 lakh crore in public sector banks.

Increasing Profit Margins

CMIE data suggests that the net profit margins of corporates have improved substantially after declining to a record low in March 2018. The profit margins are at an all-time high level, helping these listed firms service their debts. Due to high inflation and low growth in the early 2010s, corporates started suffering difficulties in paying back loans they had taken during high growth period, resulting in many becoming overleveraged. The declining profitability also did not help their case. Dani says that the firms have focused on deleveraging recently to cut down on their borrowings and the improved profits have helped them meet their debt obligations. In the last few years, government has also taken initiatives to help the private sector as it had introduced large corporate tax cuts and production-linked incentives scheme to aid investment in the country. 
 

High Credit Growth

The data on credit growth suggests that banks’ confidence has improved amid declining share of NPAs. The credit growth in the last financial year touched an all-time high at 15.4 per cent. Experts say that the credit demand is being led by services sector as the requirement of working capital increases. Some have also termed the record-high credit demand as an evidence of economic recovery after the pandemic shock. With improved balance sheets, banks have been able to meet the working capital requirements across sectors. 

The finance minister’s confidence on the balance sheet problem reflects in the declining trend of NPAs and increasing profitability of corporates. According to Sitharaman, government’s 4R strategy (recognition, recapitalisation, resolution and reform) has helped the economy emerge out of the twin balance sheet crisis.