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Bank recapitalisation to improve credit, GDP growth: Report

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The government's decision to infuse Rs 2.1 trillion of capital in public sector banks (PSBs) could improve the credit growth by up to 10 percentage point and also boost the GDP growth by up to 5 percentage point, said a report.

The government yesterday announced a capital infusion of Rs 2.11 lakh crore in state-run banks over a period of two years, which includes recapitalisation bonds, budgetary support and equity dilution.

It said that Rs 1.35 trillion will be financed by recapitalisation bonds, with the remaining Rs 0.76 trillion will be coming from the budget and raising funds from markets by reducing government equity.

According to the Goldman Sachs Research Report, every incremental Rs 100 billion of bank capital infusion by the government has the potential to increase credit and GDP growth by 1 percentage point (pp) and 0.5 percentage point (pp).

"By the same calculations, a Rs 1.05 trillion infusion into PSU banks over the next 12 months (half of the Rs 2.1 trillion announced) would lower the drag on bank credit growth by up to 10 pp and boost GDP growth by up to 5pp, assuming the banking system leverage ratio remains constant as it has over the past 8 years," the report said.

Even with some slippage in the leverage ratio, though, the bank recap will generate a powerful credit impulse, likely imparting a substantial boost to investment and activity growth over the coming year and creating upside risk to our current GDP growth forecasts for the coming years, it said.

Given the sheer magnitude of this recap package and the significant implied easing in credit conditions, as credit and investment growth rebound, the report expects a re-rating of growth expectations in the country in the coming quarters.

"This will likely be bullish for equities and the rupee in the medium term," it said.

The government also said it is committed to keeping the fiscal deficit under control but will reassess the 3.2 per cent fiscal deficit target for FY18 in December.

"While the near-term risks are clearly skewed towards a deterioration in the fiscal position, medium-term fiscal fundamentals could actually improve, should private sector growth and private corporate investment spending rebound meaningfully following the easing of credit conditions."

The current account deficit would likely increase but from a low level, it said.

The report said the measures announced by the government are likely bearish for short-term rates, as they make the RBI more likely to hike rates sooner than market expectations, should growth momentum improve substantially, reducing economy-wide slack, and core inflation inch higher.

"We currently forecast that the RBI will hike rates three times by the end of 2018, an outcome that is not fully priced in by the market," the report said.