Mumbai, May 12

India’s bad-loans problem looks much worse than lenders have been willing to acknowledge, heaping pressure on banks’ profits and further tightening screws on distressed debt that could be bigger than New Zealand’s $170 billion economy.

The magnitude of debt-mess was laid bare late last month when two of India’s largest private sector lenders provided unprecedented guidance on non-performing loans, underscoring repeated warnings by Reserve Bank of India (RBI)’s Governor Raghuram Rajan on the need to clean up banks’ balance sheets.

The dangers are clear cut. Increasing provisions to cover rising bad loans are likely to hurt banks’ profits and curb credit growth, stoking a vicious circle of lower economic growth triggering more defaults and choking off business investment and production.

Indeed, banks’ loan growth at 10.7 per cent in the last fiscal year ended March 31, was the slowest in nearly two decades, partly on lower lending to debt-heavy sectors such as iron and steel that account for the lion’s share of bad debt.

Profits at most lenders have also taken a hit in the past six months as they set aside a higher sum to cover for defaults after a clean-up exercise ordered by the RBI.

“Banks need to keep provision covers high,” said Abhishek Bhattacharya, director at Fitch’s Indian affiliate, India Ratings and Research. “That all points to fact that the earnings should continue to be under pressure.”

Bhattacharya estimates about INR 13 trillion, or a fifth, of bank loans are already stressed — bigger than the size of New Zealand’s economy.

That compares with INR 8.06 trillion of distressed loans reported as of December or 11.5 per cent of India’s entire bank debt, meaning more pressure on profits.

RBI’s Rajan, who wants banks to fully disclose and provide for bad debt by March 2017, is calling for ‘deep surgery’ to clean up the balance sheets.

Investors and analysts have long suspected that Indian lenders, especially the dominant state-run banks, are not disclosing the true extent of their troubled loans to avoid having to raise provisions.

Moody’s estimates bad loans at the 11 state-run banks it rates to be between 10.5 and 12 per cent.