India's economy is plagued by several problems-cyclical and structural-but, key among them is a crisis of credit. Growth can't pick up meaningfully and in a sustained fashion without a raft of reforms, and, in fact, could decelerate further before that happens. But, if consumers and companies could borrow at affordable rates, it would be a start. Right now, credit flows are weak. Bank funding to the commercial sector has de-grown 1.3% in the six months to September, compared with an increase of 1.9% in H1FY19. The year-on-year offtake in total bank credit today remains at sub-9% levels, down substantially from the 12.5% levels seen a year back. Non-bank funding to the commercial sector has grown at just 0.9% in H1FY20, compared with 7.4% in H1FY19 and 3.4% in H1FY18.
Ratings agency Moody's-which lowered the India outlook to negative from stable on Friday-is right in saying the economic slowdown could be a prolonged one. That is because the credit crisis is likely to drag on, with banks not even lending to their traditional client bases, leave alone moving into spaces that NBFCs had vacated. Some sectors-MSMEs, for instance-are getting less credit support today than they were a year back.
The quantum of NBFC funding seen in FY18 isn't coming back soon-especially to sectors such as housing, commercial real estate, and consumer durables-because, apart from a handful of top-class players, the rest aren't able to access loans; a few are bankrupt or close to it. Credit to shadow banks (from both banks and mutual funds) is up just 9.4% in FY20 so far, compared with the recent peak of 28% in FY18, and 20% in FY19.
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But, there is no shortage of money with the banking system-surplus liquidity has averaged Rs 2 lakh crore in the past few months and deposits are growing at about 9-9.5%. The problem is, it is not going anywhere. Also, loans are not becoming meaningfully cheaper, which they should have because banks today are paying savers much less for deposits; interest rates have been lowered by about 50-100 basis points. In fact, transmission has been painfully slow, with the cumulative 135 bps of repo rate cuts in this cycle yielding a fall in the MCLR of just about 50 bps. That is not enough to stimulate demand.
The problem is that only mid-tier firms or those that are not well-rated need the money; top tier companies are able to access the bond and ECB markets. Understandably, banks don't want to lend to sub-par businesses in a difficult economic environment because they fear they might not get their money back. Their apprehensions are justified; the finances of much of corporate India remain stressed and, in a weak demand environment, cash-flows are unlikely to improve soon.
Even otherwise, having burnt their fingers, private sector lenders such as Axis Capital and ICICI Bank are likely to stay away from long-term project financing, and focus on retail loans and working capital. No lender today can afford to fritter away capital; save State Bank of India, no state-owned lender has too much of it anyway. And, there are potential additions to the NPA basket, from more loans going bad in sectors such as NBFC, renewables, infrastructure,metals, textiles, telecom, and MSME. In other words, with the recovery delayed, corporate financials will stay weaker for longer, and could hurt asset quality with lenders.
If lenders were somewhat reckless between 2009 and 2014, today they are running scared. The government needs to reassure lenders they won't be penalised if genuine business decisions go wrong and push them to take calculated risks. So, while they need not lend for project finance, they must step up loans for working capital and retail purchases.
Also, while it may not seem like there is a systemic risk to the financial system from over-leveraged NBFCs and HFCs, there is no harm in being sure. The government shouldn't be bailing out weak private-sector NBFCs and HFCs; it should immediately do an asset quality review for them so that it can initiate shutdowns where necessary, and M&As where possible. If other stronger lenders want to buy out the weaker ones, the process should be facilitated with existing promoters being asked to go. Unless lenders are bigger and stronger, costs can't come down, and neither can interest rates; this can be made possible only with faster consolidation, retrenchment, and automation.
In the meantime, government must roll out structural reforms-in the areas of land, labour, regulation, enforcement of contracts-as has been pointed out ad nauseam. While an immediate fiscal stimulus-in the form of cuts in personal income tax rates-will spur demand, it needs to be accompanied by sector-specific solutions. The government has set up a Rs 25,000-crore corpus to provide last-mile funding to incomplete real estate projects. But, that is not enough to take care of all projects. Banks should be given forbearance if they are new lenders to stalled real estate projects, but only if the existing promoters are asked to go and the projects are handed over to new builders. That way, more projects can be revived. The point is that the surplus with banks must be put to work even if that requires some rules to be rewritten.