🏁 Flag-Off Point
Every good story begins with “Once upon a time…”, quite like the saga of the Indian economy. Pre-2008, India's growth story had been extremely optimistic. Except, the 2008 financial crisis broke all dreams of easy riches. While this should have been the sign for entities to recalibrate their positions, it didn't deter private cos from relying on the same bullish projections to continue borrowing from banks. By 2010, the repercussions of this could be felt in the Indian economy. Some blowback is, in fact, only going to be felt if the economy slowdown continues as per the current trend.
🚀 Slowdown Gaining Speed
India’s economic slowdown did not materialize overnight. It is the consequence of lingering expectations for high growth despite indicators pointing otherwise. Continued borrowing prior to the recession had led to the creation of inessential capacities. Despite wasted labor and productivity, private cos continued borrowing to avoid an ill-timed death. This was further exacerbated when the Indian government jolted the markets with a series of reforms like Demonetization and GST.
Just as we were emerging out of the reform reverberations, the IL&FS and DHFL crisis hit us. These served to magnify the situation of cash shortage and uncertainty at hand. Weakening global growth and trade as a result of the US-China trade war and a looming Brexit further added to this complex cocktail.
Prior to Modi’s election, the UPA-II government managed to worsen the NPA ratio. Stress in NBFC builds faster than banks because of its interconnectedness to corporates, mutual funds and banks. Post IL&FS and DHFL crisis, the NPA ratio started to reduce, however, the NBFC stress increased.
Apart from policy reforms, the NDA government had endeavored to tighten fiscal deficit in order to ensure controlled inflation. Thus, since 2016-17, interest rates had remained hard, leaving little wiggle room for increased government spending to pump-prime the economy. Inflation is critical when it comes to consumption. For the Indian economy, consumption is the most important, forming three-fifths of the total. However, the non-food inflation had continued to grow faster than the food inflation, translating into a lower and negligible wage growth in the rural sector. Demonstrably, this pointed to a consumption slump in the rural sector.
In hindsight, the slowdown has been something akin to a domino effect. It has been a series of decisions taken by the various parties involved - from firms to government agencies and also the larger global circle.
🏃The race to the bottom?
💥 Car Crash - The auto sector has been on a collision course for some time now. In essence, we are seeing a growth decline, not a halt. However, alarms bells should have been long ringing due to the sector’s enormous impact. Automobiles contribute towards 7% of the GDP and 49% of the manufacturing sector. They also have several interdependent businesses like steel, rubber, leather, auto ancillaries and insurance.
Initially, the slowdown of sales was pinned on the weak festive demand. There were also murmurs of an NBFC crisis leading to declining auto sales. As most automobiles sales are financed by NBFCs, this fueled a lot of buzzes until RBI crushed the narrative with mathematical deductions pointing to fuel prices and policy decisions as the core reason. The volatility of crude oil prices shook the market valuation of automobile firms. In addition, the exogenous policy changes such as vehicle insurance, mandating emission standards, and the maturing of ride-hailing services have generated fluctuations in automobile sales.
The coming together of these factors, and Nirmala Sitharaman’s hypothesis that millennials are not buying cars, are what has caused this automobile sector deceleration.
🔮 Realty Check - India’s top 30 cities had 1.28 million unsold housing units as of March 2019. Market reports also pointed to plateauing residential property prices. Ironically, despite tepid demand, developers haven’t slashed their prices.
The unwillingness of developers to reduce prices can be explained by their inability to meet their interest payments unless they maintained substantial margins. While housing prices kept increasing, the rental yield kept decreasing showcasing caveats in the housing industry. This demand and supply gap is encapsulated in the numbers that follow: Housing sales increased by 1.6X, whereas unsold inventory grew 4.7X over the last 10 years. This too at a time when there is a consumption slowdown and the wage growth hasn’t been satisfactory.
If you thought that was the worst you could hear, wait for this. During the same period, the total lending to the realty sector increased by 3.33X and the share of NBFCs lending to realty increased from 25% to 55%.
A closer look tells us that NBFCs were mainly lending to early-stage projects which involved higher risk - creating a greater potential for NPAs. Reports suggest that mid-2020 or early 2021 could uncover the true state of the real estate industry as a huge chunk of interest and principal payment due by then.
🍫 The Great Indian Consumption Story - Being one of the fastest-growing economies, it is a no brainer that there would be an improvement in the people’s spending capacity, directly impacting consumables. Ideally, the growth then should have been stupendous. However, as pointed out earlier, wage growth in the rural area has been dismal. To strengthen our notion, most FMCG companies have reported slacking volume growth of basic consumption items like biscuits, prepared dishes, milk, and chocolates.
This means that the common man is pondering a lot over purchasing daily essentials - something as trivial as a product priced at a mere ₹10-20.
💸 Banking Brake - At a time when consumption is down, lending needs to spruce up to increase consumption. Apart from the ₹70,000 Crore package to improve lending; there have been several missteps concerning the banking industry. The government’s decision to merge banks has been seen as a disastrous step. These mergers have effectively put lending to bed at a time when they should be reviving it. Optimistically, it takes close to 18 months to close the merger. Banks are obligated to set aside those days working on the merger, effectively diverting their attention from lending.
🚧 Policy Pit Stop
Now that we have an overview of the core problems facing the economy, it is only prudent to have policies and measures to tackle them. Needless to say, it is critical to implement solutions targeting the core of the issue than solving secondary issues or symptoms. For short term solutions to reinvigorate consumption story, it is important to propel banks into judicious and prudent lending. Nevertheless, it is important for the banks to strike a balance between short term and long term goals for a thriving economy. The government and the RBI must handhold the banks through this phase as the ultimate goal for all is a stable economy. With current stimulus, such as pegging of loans to RBI repo rates, we see moves being made in the right direction. This enables transparency and increases competitiveness across PSBs, also benefiting the consumers.
Policy upheavals rocked the auto and manufacturing sector in particular. Relief in the wake of drastic changes is an unsaid expectation from the corporates. Recent amendments like the reduction of the corporate tax rate provides immediate relief with respect to investments, however, consumer demand will take time to spruce up. It’s paramount to note that slashed corporate tax rates does not directly lead to an improvement in demand unless the complete benefit is passed on to consumers. There could be a scenario where corporates don’t do so, in which case there may be no quick solution for the slowdown. Scenarios such as these are the reason why the government must be cautious in targeting the core issues and not just peripheral ones.
A possible solution for the stressed loans and assets supported by NBFCs could be refinancing. India could be projected as an attractive destination for the refinancing of loans by the government and RBI. This could boost the sentiment and improve NBFC conditions. At the same time, both institutions cannot take a back seat while relentless lending like the early 2010s prevails. It is important for both of them to set guidelines and frameworks to be followed by financial institutions and keep a check on what kind of parties are benefiting from their lending.
One of the most crucial aspects of tackling a slowdown is maintaining a stable inflation growth. A mismatched growth between inflation of non-food items versus food items is what leads to complications like slower wage growth. In conclusion, tackling the crux of sector-wide problems and maintaining a stable wage growth with lowered unemployment will be key to rewriting the script of the Indian economy.