Who moved my demand curve?

FM Sitharaman 7

Finance Minister Nirmala Sitharaman might well be already thinking of penning a book on how demand vanished the moment she assumed charge. She faces an uphill task and has to carry the ball of lax governance earlier. We have sat on collapsing real estate demand for the last decade without doing anything more substantive than to throw money at the problem and leverage realty corporates way beyond prudent limits. 

Disrupting a level level economic equilibrium is costly

In 2016 one of the actions complementary to the December 2016 demonetisation and the introduction of the GST in 2017 was the introduction of the Indian Bankruptcy Code (IBC) 2016. This pulled the plug on a well-honed system of deliberately lax supervision, and “evergreening” of loans. Poorly run corporates had to keep borrowing and just sit through periods of downturn. 

The IBC was transformational. It forced business to carry the burden of their poor decisions. But it has proved way too slow. Public sector banks have no “time value of money” pressure to accept steep haircuts. 

Of the 1858 companies which have been admitted into the resolution process only 38 per cent have been liquidated or resolved and pendency is growing, even around 12,000 companies are waiting to be admitted to the process as Suman Layak of the Economic Times reported on July 9, 2019. Also, the RBI is giving in to “operational outs” requested by banks, like extending the period available with them to resolve the default beyond six months, which merely postpone the inevitable.

Just as the bank stressed asset imbroglio seemed to be getting under control, the financial health of the 9500 Non-Banking Finance Companies (NBFC) captured the investing public’s imagination due to the dramatic meltdown in June 2018 of the once iconic Infrastructure Leasing and Financial Services Company (ILFS) followed by payment defaults in Dewan Housing Finance Corporation. 

Imploding NBFCs expend the pain of adjustment

NBFCs have grown to an asset size of Rs 29 trillion by March 2019 compared to banks at Rs 100 trillion. Just under one-third of their borrowing is from banks. Part of the NBFC problem is that lightly regulated NBFCs became proxies, to whom banks could transfer stressed assets that they – being under scrutiny since 2016 – were keen to shed, to improve their own balance sheets – through a classic financed buy-out transaction.  

The one-time partial, credit guarantee of Rs 1trillion for the better-placed NBFCs provided by the government in this year’s budget through public sector banks to the better-placed NBFCs is targeted to enhance their credibility. 

Periodic growth downturns sound familiar

It is instructive to remember that real growth dipped from 9.3 per cent in FY 2008-09 to 6.7 per cent in FY 2009-10 – a drop of 2.5 percentage points, about the same as the drop in growth today. Repo rates were immediately adjusted downwards from a high of 9 per cent to 8 per cent on October 20, 2008. They continued to be progressively reduced and by April 21, 2009 (just after the end of that financial year) were down to 4.75 per cent. Growth revived and over the subsequent two year, FY 2010 and 2011 was 8.6 and 8.9 per cent. 

Responsive monetary policy leads the growth restoration package

The bottom line is that significant reductions in interest rates do work to stimulate demand and corporate investments. RBI Governor Das and his new team have done well to recognise the writing on the wall and bring the Repo (Bank) rate down since February 2018 by 1.10 percentage points to 5.4 per cent. With inflation contained at 3.5 per cent per annum, a repo rate of 4.75 per cent is conceivable. A low-interest rate environment does wonders for investment and consumption.

Public Sector Banks should show some risk taking mojo and offer innovative loans for boosting consumer durable sales

The Vice-Chairman of NITI Aayog has spoken about the lack of trust between private players as the key reason for the current slowdown. One way of compensating for such “private distrust” would be to encourage public sector banks (PSB) to take calculated risks. 

PSB should be innovative and offer an asymmetric, three-year loan for consumption and purchase of white goods linked to the declining repo rates. The FM had assured in her Press conference on August 23 that a repo linked loan product would be launched.

The marketing twist that the finance minister should consider is an “asymmetric regulatory risk-sharing mechanism” which will pull in those consumers who are waiting and gaming for the trough in repo rate to be reached before they take a loan and yet fear that the trough may be short-lived. 

PSB should offer that on all repo linked loans up to a period of three years from approval, PSB would bear 50 per cent of interest cost due to an increase in the repo rate during the pendency of the loan but would automatically pass-on all the reductions to the borrower.  

Better budget execution can get public money to where it is needed most

More needs to be done to revive demand beyond making cheaper loans available and providing tax breaks like accelerated depreciation to liquidate the 45 days unsold stock of new vehicles sitting with vehicle manufacturers.  

We need to improve budget execution so sanctioned money is not left sitting in the budget whilst field agencies are starved for funds. Consider that by the end of the Q1 (April to June 2019) we had m spent just 18.8 per cent of the annual budgeted capital expenditure as against 29 per cent in the previous year. Similarly, revenue expenditure was just 26.9 per cent of the budgeted annual amount as against a spend of 29 per cent the previous year. 

What are we to conclude from poor budget execution? Is there a shortage of cash with the government? This is entirely possible. Total non-debt receipts in Q1 of this year were just 13.9 per cent of the annual target as compared to the achievement of 15.3 per cent last year. 

Remain braced with your seat belt on

Things could get worse on the back of lower growth expected at an average 5.5 per cent against the budgeted target for real growth of 7.5 per cent for FY 2018-20. Tax receipt expectations need to be scaled down sharply in line with the already lower receipts in Q1. Doing so requires re-fixing the budget framework to acknowledge that we have no option except to increase the targeted fiscal deficit whilst cutting low priority expenditure. This will also end the resort to off-balance-sheet financing by publicly-owned entities of government programs, which impairs the credibility of the budget data. 

Finally, stock markets are not the final arbiters of an economy’s health, especially when less than 20 per cent of households are invested in them. Also net inflows of foreign capital which keep the INR “strong” and mask the real cost of imports only paper over an imbalanced external merchandise trade account. This can only be a “temporary” solution and not the basis for sustained equitable growth.

Adapted version also available at TOI Blogs August 25, 2019 https://timesofindia.indiatimes.com/blogs/opinion-india/who-moved-my-demand-curve/

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