Immediate recapitalisation of banks is needed to keep the flow of credit going

The ongoing second wave of Covid-19 has introduced a big element of uncertainty in India’s economic prospects for 2021-22. Given this backdrop, FM Sitharaman did well to reassure industry during a recent engagement with its representatives. She promised that government will support recovery and urged them to wait and watch to assess the situation. The surge has come at an inopportune time. In the current financial year, RBI forecast the economy will bounce back with an annual growth of 10.5%. It’s early days but there is now a higher downside risk to that forecast.

One way to mitigate the fallout of the current situation is for government to selectively advance some of its proposed spending. An area where there is compelling need is recapitalisation of public sector banks. The Budget proposed a recapitalisation of Rs 20,000 crore, which now needs to be done at the earliest. Last year’s stimulus was based mainly on monetary policy measures. Not only was RBI’s policy rate lowered, it was complemented by measures to enhance the potential supply of money. However, it hasn’t had the desired effect on banks on account of risk aversion arising from an uncertain environment.

Right now, the uncertainty has been exacerbated by a combination of localised lockdowns and disruptions due to a surge in infections. The outcome will be to make banks even more risk averse as the resilience of smaller firms is being severely tested. RBI’s January financial stability report estimated that 14.8% of bank advances can turn bad by September under a severe stress scenario. This scenario will choke the flow of credit even to firms that are strong enough to survive. One way to head off a situation of dwindling credit flow is to reassure banks by recapitalising them early. That’s what the government should do soon.


This piece appeared as an editorial opinion in the print edition of The Times of India.


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