Moody's Investors Service says that the Indian government's (Baa3, Positive) announcement of a Rs 2.1 trillion recapitalization plan for public sector banks is a credit positive for the sector.

"The quantum of the plan is large enough to comprehensively address these banks' weak capitalisation levels and is a significant credit positive as weak capitalisation is the main credit weakness for most rated public sector banks," says Srikanth Vadlamani, a Moody's vice president and senior credit officer.

Moody's conclusions are contained in its just-released report titled "Government's capital infusion plan is a significant credit positive for Indian public sector banks" and is authored by Vadlamani.

Of the total, Rs 1.35 trillion would be in the form of recapitalisation bonds, while the rest would involve a combination of already announced budgetary support and capital raisings by the banks themselves from the capital markets, said a press release issued in Singapore.

"For the 11 rated public sector banks, Moody's estimates that their external capital requirements over the next two years would be around Rs 700-950 billion, factoring in the two main drivers of their capital needs - the need to comply with Basel 3 requirements, and for conservative recognition and provisioning of their asset quality problems," says Vadlamani.

"Thus, even if only the recapitalisation bonds and the already announced budgetary support are factored in, the announced capital infusion by the government should be able to comfortably address the capital requirements of the public sector banks," says Vadlamani.

In addition, the inability of most these banks to access the equity capital markets has also been a key constraint on their capital levels. With much greater visibility now on these banks receiving adequate capital from the government, they may also accordingly regain market access.

Details on the program, including the structure of the recapitalization bonds and allocations to individual banks, have not yet been disclosed. However, the government has announced that this program will be implemented over the next two years, during which the infusion of the recapitalization bonds will be frontloaded.

In the past, the government had used the recapitalisation bond route to recapitalize public sector banks. Those instruments typically had relatively long maturities and didnt have much market liqudity. A similar structure this time would have some negative implications for the banks' liquidity and profitability profiles.

However, given that the overarching credit weakness of the public sector banks currently is their weak capitalisation levels, we would see infusion of the recapitalization bonds as a significant credit positive, notwithstanding some of these potential weaknesses in their structure, the press note said.

A key point of interest would also be the amount of capital that individual banks will receive. While there may be some differentiation, with banks deemed to be performing well receiving more growth capital, we expect all rated public sector banks to get enough capital to satisfy their Basel 3 capital requirements as well as adequately address their asset quality challenges. Thus, while the extent of improvement may vary, we expect the capitalization profiles of all rated public sector banks to improve, it added.