How did oil reserves fund Norway's $1T pension plan?
History
In 1969, Norway struck oil. One of the world’s largest offshore oil fields was discovered in Norway. Prior to this, the only natural resource Norway had was its fisheries. Being an oil-rich country could do wonders for its economy.
But Norway had a long-term vision, they realized that being an oil economy has its own perils. They based their understanding on something called the ‘Dutch Fever’.
Netherland's natural gas discovery
Similar to Norway, Netherlands too had acquired a huge resource of natural gas within its country. Realizing they’ve discovered gold, the Dutch government doubled down on natural gas as the country’s primary resource. Several natural gas plants were set up within the country and natural gas was exported to several other countries.
The cash was funnelled in again on government expenditure to set up more plants and produce more natural gas.
The Dutch Fever
However, the result was - as soon as the money started flowing into the country, its currency became more and more expensive. As a result, Netherlands’ trade with other countries declined.
Consequently, the Netherlands had to shut down the plants and rely on other natural resources, resulting in an impending financial crisis.
Generational wealth creation plan
The Norwegians took a lesson from this and realized that oil may not last forever. It decided to save all of this oil money and store it in a sovereign wealth fund called - The Norway Government Pension Funds.
While the definition is debatable, a simplistic understating is that it's a financial reserve created by the government as a long-term savings plan, so that both current and future generations could benefit from its oil wealth.
According to the website of the central bank of Norway-Norges Bank :
The funds in the reserve are diversified into several institutions. Although revenue from oil and gas production is transferred to the fund, these deposits account for only less than half the value of the fund. Most of it has been earned by investing in equities, fixed income, and real estate.
The fund is one of the world’s largest, owning almost 1.5% of all shares in the world’s listed companies. This means Norges has holdings in around 9,000 companies worldwide, earning a small share of their profits each year.
In addition, the fund also owns hundreds of buildings in some of the world’s leading cities, which generate rental income. The fund also receives a steady flow of income from lending to countries and companies. And by spreading their investments widely, they reduce the risk of the fund losing money.
Now, while the government cannot directly dip into the funds, it can use the interest rate on it (which as of now is 3%) to invest in a wide array of developmental projects.
The value of the fund is up for public viewing on Norges Bank, the Central Bank of Norway’s website. As of now, its value is USD 1.1 trillion, accounting for USD 248,000 per citizen.
This makes these funds one of the largest central reserves any government has. Not only does the interest from the reserves help fund all kinds of state initiatives in education, healthcare and infrastructure, but it also protects Norwegian citizens from any impending crisis in the long term.
Something like, perhaps, a global pandemic.
NARCL: The dark knight for Indian banks?
Business
On Sep 16, 2021, Finance Minister Nirmala Sitharaman announced the details of the National Asset Reconstruction Company Limited (NARCL), a concept first floated at the 2021 Union Budget.
NARCL is the government’s grand plan to address the bad loan epidemic that is plaguing the country’s banking industry.
In this article, we explain the need and significance of this move.
Why is the Indian banking industry struggling?
For a long time now, India is facing an economic slowdown, which was further aggravated by the pandemic. As a result, a host of companies, unable to repay debts to the banks, defaulted on their payments. These unpaid debts piled up as bad loans in the bank’s accounts - affecting the bottom line of the bank.
With the resulting cash crunch, banks are struggling to extend new loans further affecting their business. Investors are also shying away from banks in this situation.
Why should the banks be saved?
Banks are the lifeline of an economy! They are the primary sources of credit to individuals and corporations. If banks stop lending money at reasonable interest rates, economic activities will be stemmed. Corporates will find it hard to access capital for business growth and individuals will curtail their spending - a slow death for the country’s growth!
What can the banks do?
In cases of unpaid debt, the banks can sell the collateral backing the loan. But this is easier said than done!
The collateral backing the bad loan will be deeply diminished in value. It needs to be restructured, financially and operationally, to ensure the sale reaps in a decent amount. The restructuring process requires a separate set of expertise and trained professionals that banks do not possess.
Bad banks
Given this context, bad banks are the ultimate saviours for the banks!
Bad banks are technically Asset Reconstruction Companies (ARC) that buy the bad loans from banks at a discounted price to revamp the collateral and then sell it off to potential investors for a modest amount.
This is a win-win situation for all. The banks clean up their books and get rid of bad loans while the ARCs make a neat profit by selling the restructured collateral at a higher amount.
What is NARCL?
NARCL is a bad bank with the Union Government claiming a 51% majority stake.
It plans to purchase bad loans worth approximately INR 2.2 lakh crore in a phased manner from a multitude of banks to clean up their books so that the banks can go back to what they know best - capital growth and business expansion.
For phase 1, NARCL has identified 26 accounts with non-performing assets of value greater than INR 500 crore each. The total cumulative bad loans targeted for phase 1 sum up to INR 9000 crores.
How will NARCL work?
NARCL will pay the banks 15% of the asset amount in cash upfront while the remaining 85% will be paid as security deposits i.e. after the asset value is realized. The union cabinet has approved INR 36,000 crores as a guarantee for these security receipts in case the asset fails to realize its value.
The collateral assets will be managed by India Debt Resolution Company Ltd (IDRCL), which will bring professional turnaround expertise for the resolution of the company.
Will the problem end?
As of March 2021, a whopping INR 8.35 lakh crores is the total amount of bad loans in the country! This huge sum has the potential to wreck the economy and cause rippling distress across industries. In this context, the government’s move is much needed and welcomed.
However, the real success will be realized only when the collaterals from the identified 26 accounts are reconstructed and sold at a handsome amount!
Else it will be the taxpayers’ money to the rescue once again!
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