MINISTRY OF FINANCE

GOVERNMENT OF INDIA

Economic Crises and The Twin Balance Sheet

Problem in India

Module 6
Contemporary Themes in India’s
Economic Development and the Economic Survey

Arvind Subramanian
Chief Economic Adviser
Overview
• Financionomic (Financial-Economic) Crises and Indian
Experience

• Effects of the Twin Balance Sheet Crisis.

• Successful and Unsuccessful Central Banking Experiences.

2
Crises, Crises, Crises: A Rough Time-Line

Early 1980's 1991 1994-95 1997-98 1999 2007 2008 2009-10 2013-14 2016

Tequila Asian Greece, Taper Tantrum

Latin BOP Global
Crisis Financial East Ireland, Brazil, India, Tremors
American Crisis Brazil Financial
Argentina Crisis + Europe Spain, Indonesia, South in China
Debt Crisis India Crisis
Mexico Russia Iceland Africa, Turkey
Financionomic (Financial-Economic)
Crises and Indian Experience
Debt Crises Not Uncommon (Reinhart & Rogoff, 2009)

5
What is a Financionomic Crisis?
• Broadly defined as phenomena associated with substantial loss in
value of assets with a sharp negative impact on growth. These
assets can be:
1. Currency (exchange rate)
[Example: Thailand during Asian Financial Crisis late 1990s]
2. Equity
[Example: Argentina ‘Tequila Crisis’, 1994-95, AFC].
3. Real Estate
[Example: Japan late 1980s, USA post-Global Financial Crisis 2008-09].

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 Economic Crises Manifestations
Thailand during Asian Financial Crisis Argentina during ‘Tequila’ Crisis

Japan during the Balance Sheet Crisis

1. Bakker, Bas B. & Leslie Lipchitz, 2014, “Conventional and Insidious Macroeconomic Balance-Sheet Crises”, IMF working paper WP/14/160.
2. Dabós, M. and Laura Gómez Mera, 1998, “The Tequila Banking Crisis in Argentina”.
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Costs of Economic Crises
1. Loss of income

2. High inflation

3. Unemployment

4. Banking Problems

5. Contagion

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Source: Reuters and the Wall Street Journal
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 Table 1: Anatomy and Taxonomy of Financionomic Crises
Originating Origin of Exchange
Crisis type Manifestation Trigger Remarks
countries problem rate regime
Speculative Greece was part
EMEs (Latin America Govt. Current account attack & of euro, so trigger
Debt Fixed rate
1982; India 1991); borrowing deficit exchange rate was sharp rise in
Small AE (Greece) collapse interest rates

EMEs (East Asia ‘Sudden stop’

Fragile Five had
1997-9; Eastern Asset price of capital
Corporate flexible exchange
Sudden Stop Europe, 2008; bubbles; High flows & Fixed rate
borrowing rates. Spain was
Fragile Five 2013); corporate leverage exchange rate
part of euro.
Small AE collapse
(Spain 2010)
Floating
Systemically Corporate Asset price
Balance Asset price exchange Yen
important borrowing bubbles; High
Sheet collapse rate appreciated after
corporate leverage
crisis
Systemically Bank and
Banking Correction in Flexible
important consumer Asset price bubble
Crisis asset prices exchange US$ appreciated
(GFC US 2008) borrowing in housing
rate

Crisis country's
‘Sudden stop’
The Systemically Corporate Rising debt, asset Managed currency could
with potential
NEXT important borrowing price bubbles float depreciate
for sharp
substantially.
exchange rate
decline
6/13/2017 MOOC Module 10: Twin Balance Sheet Problem 11
Historically Periods of High International Capital Mobility Have
Led to Banking Crises (R&R 2009)

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13
 India
Currency/ Debt/
Sudden Stop Banking Crisis
No Sovereign default ever

Affected 1991 2011 onwards

(fiscal profligacy (Balance sheet crisis
by Centre) but no recession and no
decisive solution yet).
1998
Less (avoided fate of 2002
‘Asian Tigers’) (high NPAs and fiscal
Affected
2013 profligacy by states
(almost a but no crisis)
‘Sudden Stop’)
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The Twin Balance Sheet Problem in India: Banks and
Corporates Stressed

*:Per cent of debt owed by companies with Interest Coverage Ratio <1 based on sample of 3700 listed companies
(Credit Suisse).

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 India’s Twin Balance Sheet Problem
• Why ‘Twin’?
– Legacy of boom years (2005-2007).
– Private credit boom financed by public sector banks.
– Thus, impaired PSB balance sheets post-GFC
derives from and mirrors damaged corporate
balance sheets
– Twins- corporates and banks (mostly public sector).
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What Happened in India?
Boom in Gross Capital Formation (Per cent of GDP)

17
What Happened in India?: Boom Financed by Credit
Creation and Capital Flows

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 30
35
40
45
50
55
60
65
70

Mar-1992
Dec-1992
Sep-1993
Jun-1994
Mar-1995
Dec-1995
Market

Sep-1996
Determined

Jun-1997
Mar-1998
Exchange Rate

Dec-1998
Sep-1999
Jun-2000
Mar-2001
Dec-2001
Sep-2002
Jun-2003
Mar-2004
Dec-2004
Sep-2005
Rupee per US$

Jun-2006
Mar-2007
Dec-2007
Foreign Borrowing

Sep-2008
Jun-2009
Mar-2010
Dec-2010
Sep-2011
Jun-2012
Mar-2013
Dec-2013
Sep-2014
Jun-2015
Mar-2016
Dec-2016
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Sharp Currency Declines Worsened Balance Sheets of Companies with
 In February 2016 as PSB financial results came in
investors fled PSB shares..
4

3.5

2.5

1.5

0.5

0
12-Feb-15 12-Feb-16 12-Feb-15 12-Feb-16
Public Sector Banks HDFC

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NPA ratio in India higher than other EMEs
10
9.2 8.9 9.0
9
8
7
6
5
4 3.8
3.2
3
2
1
0

Brazil Russia South Africa Korea (2000) India

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But, not as bad as China’s..

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 Why hasn’t growth suffered in India?
Unique structure of financial system: Public Sector
dominated.
• Increase investment and supply capacity
• No sharp adjustments
• ‘Give time to time’ strategy (that worked in early 2000s)
• Allow companies time to turnaround ( high growth improving
cash flows) by postponing principal payments
• ‘Evergreening’

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India: Real GDP growth

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 Why hasn’t growth suffered in India?
Boom (2004-05 to 2007-08) led to investment in infrastructure that
eased long-standing supply constraints and helped growth.

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 Strategy so far:
‘Giving Time to Time’ and Evergreening
About 6.5 % of loans outstanding of With little improvements in cash flow
stressed Companies were stressed Co.s* have borrowed
restructured by 2014-15 significantly to continue operations
8,000 7,519
7,083
7,000 6,689
6,298

6,000
5,349

5,000

4,000 3,572

3,000 2,675
2,101
2,000
1,372
990
1,000
454

FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
Source: Credit Suisse database. * Top 10 stressed Groups. Includes bank debt, bonds, ECBs, and other debt.
Picture from CartoonStock, Andrew Toos.
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Effects of the Twin Balance
Sheet Crisis
Health of Public Sector Banks in the Red
(Return on Assets)

International Norm

Return on Assets is obtained by dividing net profits by average total assets. The dotted
red line indicates the international norm.
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Investment is Contracting
(Real growth in Gross Fixed Capital formation)
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
-1.0
2015-16 (1RE) 2016-17 (PE)
-2.0
-3.0

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Credit to Industry lowest in over 20 years
(Real growth in Credit to Industry)

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Real Credit Growth to MSMEs and Corporates:
Suffering

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 Dec. 2, 2011
Jan. 13, 2012
Feb. 24, 2012
Apr. 6, 2012
May 18, 2012
Jun. 29, 2012
Aug. 17, 2012
Sep. 28, 2012
Nov. 9, 2012
Dec. 21, 2012
Feb. 1, 2013
Mar. 15, 2013
Apr. 26, 2013
Jun. 7, 2013
Jul. 26, 2013
Sep. 6, 2013
Oct. 18, 2013
Nov. 29, 2013
Jan. 10, 2014
Feb. 21, 2014
Apr. 4, 2014
May 16, 2014
Jun. 27, 2014
Aug. 8, 2014
Sep. 19, 2014
Base Rate Mean
Policy Repo Rate

Oct. 31, 2014

Dec. 12, 2014
Jan. 23, 2015
Mar. 6, 2015
Term Deposit Rate Mean

Apr. 24, 2015

Jun. 5, 2015
Jul. 17, 2015
Aug. 28, 2015
Oct. 9, 2015
Nov. 20, 2015
Jan. 1, 2016
Feb. 19, 2016
Apr. 8, 2016
May 20, 2016
Jul. 1, 2016
Aug. 12, 2016
Sep. 23, 2016
Nov. 4, 2016
Dec. 16, 2016
Jan. 27, 2017
Mar. 10, 2017
Apr. 21, 2017
6.0
6.5
7.0
8.0
8.5
9.0
9.5

7.5
10.0
10.5
Monetary Policy Transmission 1A: Interest Rate and Borrowing

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Channel, Transmission of Recent Rate Cuts Impeded by Rising NPAs
How does India fit in the Balance Sheet Crisis Model?
• Similarities with other cases (Japan)
• High NPAs
• Decisive resolution time-consuming.
• Weak (private) investment.

• But unique due to

• Relatively robust growth.
• Moderately high inflation.

• Key: In Japan and India fixing of balance sheets has taken time unlike
in US (after GFC) and Thailand (after AFC). So for the latter recovery
have been quicker.

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Timeline of RBI/Government Actions

June 16:
Scheme for
June 2014: June 2015:
Sustainable
5:25 Flexible SDR
Structuring of
Refinancing Scheme
Stressed Assets

Mar- Dec-14 Mar-16

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August October May-17
2014: 2015:
Banking
Change in AQR
Scheme Regulation
ARC Fee (Amendment)
Structure
Ordinance
2017
 Core Problems
• It’s not just about banks, it’s a lot about companies. Public discussion has focused on bank

capital which is the easiest part. More problematic is to resolve the bad debts in the first place.

• It is an economic problem, not a morality play. Several of the problems have been caused by

unexpected changes in the economic environment: timetables, exchange rates, and growth rate

assumptions.

• The stressed debt is heavily concentrated in large companies. Concentration is an

opportunity, because TBS could be overcome by solving a relatively small number of cases. But

large cases are also more difficult to resolve.

• Many of these companies are unviable at current levels of debt requiring debt write-downs

in many cases. Cash flows in the large stressed companies have been deteriorating over the past

few years. The only alternative would be to convert debt to equity, take over the companies, and

then sell them at a loss.

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 Core Problems
• Banks are finding it difficult to resolve these cases, despite a proliferation of schemes to
help them. They face severe coordination problems, since large debtors have many creditors. If
PSU banks grant large debt reductions, this could attract the attention of the investigative agencies.
But taking over large companies will be politically difficult, as well.

• Delay is costly. Since banks can’t resolve the big cases, they have simply refinanced the debtors.
But this is costly for the government, because it means the bad debts keep rising, increasing the
ultimate recapitalization bill for the government. Delay is also costly for the economy.

• Progress may require a Public Sector Asset Rehabilitation Agency (PARA). Private ARCs
haven’t proved more successful than banks. But international experience shows that a
professionally run central agency with government backing – while not without its own problems --
can overcome these difficulties.
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Stressed Companies in Difficult Situation
Example: Power
Given large cost over-runs, break even tariff is well above current merchant rates*
160 9
Original Cost per MW (Rs mn) Cost overrun per MW (Rs mn)
Required Tariff (Rs/KwH) (RHS) Current Merchant tariff (Rs/KwH) (RHS) 8
140

7
120

6
100
5
80
4
60
3

40
2

20 1

0 0

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*: Tariffs are in Rs./KwH and on shown in RHS. Costs are in Rs. Million.
 The 4 Rs for Progress
• Recognition

• Resolution

• Recapitalization

• Reform
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 Successful and Unsuccessful Central Banking
Experiences
Run-up (to high inflation and/or Clean-up (after inflation and/or
Location crisis) crisis)
Success
Success Less Success
Less Success Success
Less Success Less Success
Failure
Alan
Greenspan:
Identified rapid Paul Volcker:
growth in late Alan Brutal tightening
1990s as a Greenspan: to fight inflation
positive Failed to see in early 1980s
productivity the housing that led to severe Japan: Failure to
shock and not bubble leading but short clean up banking
as overheating. up to the recession, system led to
Did not raise Global followed by long nearly two decades
International interest rates Financial Crisis boom. of lost growth.
Mario Draghi:
"Whatever it
takes" in 2012
leading to
quantitative
easing thus
alleviating
economic
Jean-Claude downturn in
Trichet: Europe and
Tightening in averting crisis in
2009 that Southern
aggravated European
economic countries. Also
downturn in QE under Ben
Eurozone Bernanke

D. Subbarao/
Y.V. Reddy: D. Subbarao: Raghuram
Anticipating Inadequate Rajan: Using Post-2011 India:
asset price rise action to head FCNR to arrest Twin Balance
and taking pre- off inflation in decline in Sheet challenge
India emptive action the mid-2000s confidence still unresolved

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Recommended Readings*
1. Claessens, Stijn and M. Ayhan Kose, 2013, “Financial Crises Explanations,
Types, and Implications”, IMF working paper WP/13/28.

2. Economic Survey 2016-17, Chapter 4.

3. Reinhart, C. M. & K. S. Rogoff, 2008, “This Time is Different: A Panoramic

View of Eight Centuries of Financial Crises”, National Bureau of Economic
Research working paper 13882.

4. Subramanian, A., Josh Felman, Rangeet Ghosh & Zubair Noqvi, 2017,
“Rehab for the Balance Sheet”, The Indian Express.

*: The video clips used in this presentation from the movie ”The Big Short” have been
taken from YouTube.

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