Let us leave Utopia behind and take only India forward. The danger of failing aggregate demand in a consumption led economy is that it can exacerbate the fiscal deficit when the tax revenues taking a beating. For example, the recent budget present by Nirmala had an assumption of around 25% increase in the tax revenue of the Govt. However with lack of demand in the economy, the GST revenue which was expected to average around 1.14 lakh crores each month is just going to hover over 1 lakh crore per month only ( almost same as last year) if things continue the way they are the rest of the financial year. This is also the reason why GST rates should not be reduced. It is a remedy that will only worsen the disease, though the car industry is clamouring for it. This will put paid to Govt’s resolve to maintain the fiscal deficit at 3.3% as envisaged in the budget. Govt is hoping , against hope - I think, that the remainder of the year will see a pick up in demand with good monsoon and with the bounty expected from Reserve Bank’s capital reserves ( See Bimal Jalan Committee Recommendations) they would be able to make it. In a bid not to crowd out borrowing for domestic investors, Nirmala also proposed to borrow abroad in foreign currency. This is unprecedented. Indian sovereign never raised debt from money markets abroad though it always borrows from the likes of World Bank, Asian Development Bank etc - it has not borrowed to meet budgetary reasons. They seem to be in double minds about it now, just 3 months since the budget was presented. The PMO is not in favour of foreign borrowings to plug budgetary gaps and we do not know whether or not they will go ahead with the plan in the ensuing months of this Financial Year.
In short, with the economy in contraction, with exports not picking up ( exports have come down 6% year or year Apr-Sept 2019 period owing to general recession world over), Govt has no fiscal space, private investment is not picking up and worst still inspite of the economy having a very low inflation, interest rates are not coming down. In fact, we are having the highest real interest rate amongst all large economies. Real interest rate is the rate available for treasury bonds vis-a-vis the long term inflation rate. Indian Govt’s 10 year treasury bond yield hovers around 6.7% while the wholesale inflation rate is as low as 2%. This means the real interest rate is more than 4.5%, too high for making borrowing cheap for both consumers and investors.
The Modi Govt inherited a badly mauled Banking System with around 15 lakh crore of Non Performing Assets ( NPA) from the corrupt UPA I & UPA II govts. Banks had lent recklessly to projects of long gestation , ostensibly on account of political pressure. Banks Balance Sheet have a liability side which represents the deposits taken from public and the asset side which represents its lending. When Bank lend hugely to long gestation projects without land acquisition or even environmental clearance as they had done in the UPA era, there arises a Asset-Liability mismatch. The liabilities mature short term and the assets see fruition in the long term. This is so stupid and so reckless that it makes us wonder what the ALCOs ( Asset-Liabilities Committees ) of the banks were doing. 70% of our banking is still in Public sector and now that they are put under strict supervison have almost stopped lending last 4 years.
This void for sometime ( 2014-2018-first six months) was filled nay NBFCs to some extent . Well run NBFCs like Bajaj Finance , Shiriram Finance, ABG groups Financial arm, L & T Finance thrived. They got money from banks, mutual funds and public deposits. Unlike Banks they cannot run to RBI when faced with liquidity constraints. RBI acts as “A Lender of Last Resort” only to scheduled banks. The biggest failure in the NBFC space have been Dewan Housing Finance and DHFL. Dewan Housing run by Wadhwas is a good company , but they ran into liquidity constraint first which has morphed into a solvency issue now. Dewan Housing had lent money to real estate companies and real estate situation is much worse than all other sectors. RERA law also put fetters on the realtors ( though in the right way), but the lack of demand for high end housing , where most real estate companies had recklessly invested in , wrecked their finances. The uncertainty due to GST also added to their owes. We have some 8 lakhs houses in unsold inventory today and many more stuck in partly completed stage. DHFL is another issue. They were a bunch of crooks , it now appears to me. They went on a binge lending and also taking over infrastructure projects of dubious viability. The mismanagement of UPA years are to blame here as well.
When DHFL and Dewan could not meet their repayment commitments , the entire flow of credit to NBFCs got affected. NBFCs which were hitherto funding whatever the consumption that was happening in the economy went into hibernation.
The Financial System of a country has savers and borrowers. Saving can be long term or short term and borrowing can be for household consumption, working capital for business or for long term investment by both Govt and private sector. The Financial System largely represented by banks does the job of “Disintermediation” ( reducing the distance between the borrowers and savers). Excessive Govt borrowing ( Central, State and public sector entities like Electricity Boards) has virtually made this disintermediation work lopsided. There is also the Govt’s political intervention to keep Post Office Saving Deposits and PPF interests high to satisfy its political constituents. There are no sources of long term finance now in the economy as banks, after the fiasco of the UPA years, are no longer doing so. ( Most are unfit to do project finance, actually) . In advanced countries corporates borrow by selling their bonds in the bond market when they want cash and buy them back when they have excess cash. We do not have a well developed bond market as we do not have a swift insolvency procedures. Whatever we have as IBC code is just 3 years old and law is still in the nascent stage of development. There are not enough insolvency courts with good infrastructure and not enough insolvency professionals. The courts also throw the spanner the works with their own interpretation of the law. No business can run without availability of liquidity and no private investment is possible if the interest rate is so high.
So one of the real reasons of the current difficulties in the economy is the dysfunctional Financial System dominated by directed lending mandated by Govt ( Mudra loans under Modi is no less stupid). Govt has to completely exit Financial Sector which will be a catharsis of sorts for the economy. This is not going to happen even with Modi govt having two-thirds in parliament as he does not seem to believe in it. What we are seeing is tinkering and throwing more and more money ( 3.5 lakh crores) at a useless banking system. Merger or no merger, PSUs have to go for the long term health of our Financial System.
When I saw ‘current difficulties’, I am talking about the project GDP growth of 7% which is puny compared what the Indian economy can do, at least compared to what the world expects of us. We need to grow above 9% if we need to pull the huge number of people we have below $5 / per day incomes. More on this in the next post…
— to be continued
Comments
Post a Comment