Review of Indian Economy in 2019 & way forward

The year started with uncertainty in the global economy in the context of the trade war and the possible outcome of the 2019 General Elections. By the end of the year, the slowing economy was the most important fear. Depending on the political affinity, 2019 will be known as either the year when the economy gave a wakeup call or one that has reached a critical crossroad.

Hyderabad: Depending on the political affinity, 2019 the year gone by will be known as either the year when the economy gave a wakeup call or one that has reached a critical crossroad.

The year started with uncertainty in the global economy in the context of the trade war and the possible outcome of the 2019 General Elections. By the end of the year, the slowing economy was the most important fear. A large part of the second half of the year consisted of debates that centred not whether there was a slowdown but around whether the slowdown was ‘structural’ or ‘cyclical’ in nature.

Every important monthly indicator including those like electricity production, petroleum consumption statistics, industrial production, electronic payments, etc were indicating a slowdown that is gathering momentum by the day. However, it is important to note that almost everybody has missed the fundamental cause for the slowdown, which is increase in indebtedness across every segment in the country.

A factor that provided some breathing space for the government was that oil prices stabilised and that in turn halted the further deterioration of the trade balance and the currency. The government also pushed hard to kick-start the economy through measures like a reduction in tax cut to new companies at the rate of 15% and additional tax deduction of Rs 1.5 lakhs on purchase of electric vehicles.

Banking problems continue to fester

The year saw the continuing festering of banking problems. This despite the successive capitalisation of the public sector banks (PSBs) by the government – the most recent being Rs.70,000 crore recapitalisation announced after May 2019 elections. Though there is a marginal decline in Non-performing assets (NPAs) of the PSBs by the end of year, this decline is likely to a temporary phenomenon. The decline was possible because PSBs were simply either too cautious in lending or were not willing to lend.

Rising NPAs among Mudra loans is indicative of the future, likely rise in NPAs of PSBs. The marginal decline in NPAs of PSBs from 11.2% to 9.1% was accompanied by a rise in NPAs of private banks. The government has tried nearly every trick in the books to think of different solutions to the banking crisis. It has decided to merge 10 PSB into four entities thereby reducing the number of banks. IDBI bank which had nearly 25% NPAs was taken over by LIC which should help stabilise that bank due to the size of LIC. Unfortunately, none of these short-term solutions are going to solve the problem.

Governments need to be extremely cautious about the health of the banking sector. Though there are no problems related to solvency of the banking sector and the banks are safe for the moment they need to be careful and stay alert so that they are ready to avert any asset-liability mismatch that may arise due to the nature of the slowdown.

A major consequence of this festering long banking problems is that the Indian banks are in the weakest financial health among the emerging markets and the G-20 countries in terms of capital to risk-weighted assets ratio. Last year, only two other countries had more non-performing loans (in percentage terms) than the Indian banks: Greece (42% NPAs) and Russian Federation (10.1%).

This is not to claim that the banks are on the verge of collapse; instead, the banks are more healthy than most emerging markets because they have the lowest borrowings among the emerging markets and they have substantial money with the government or RBI in terms of either statutory liquidity ratio (SLR) and Cash Reserve Ratio (CRR) – which together are about 25% of the banks resources.

However, the festering banking crisis is impacting the broader economy. Reduced lending by the banks and NBFCs means that there is now an increased borrowing from abroad through the external commercial borrowings which has increased by about Rs.70,000 crores in the current financial year.

NBFC Crisis

This year will be remembered for the increasing economic bite that the crisis in the Non-banking finance sector (NBFCs) has had on the broader economy. About 40% of the NBFC loans are linked to different segments of the automobile industry and related purchases.

One reason why the larger economy did not slowdown more drastically in the past 3 years is due to the increased role of NBFCs in lending. By the end of March 2018, NBFCs the loans or assets had reached to Rs.30.85 lakh crores and further to Rs.32.57 lakh crores at the end of March 2019. By September 2019 their growth rates declined from a high of 26.8% by end of March 2018 to about 13.2% due to the slowdown in aggregate demand which combined with the IL&FS crisis'.

The year also saw a major consolidation in the form of the passage of welcome amendments to Insolvency Bankruptcy Code, Arbitration Act and consolidation various laws related to industrial relations in the form of Industrial Relations Code. An important economic event during the year is the increased realisation that the Telecom sector is in the midst of a massive turmoil.

Competition within the sector and government demands has led to the sector wilting under huge amounts of debt. There is no doubt that consumers have benefitted from the telecom revolution in the country. The recent Supreme Court order on payment of Rs.92,000 crores as Adjusted Gross Revenue means that most of the telecom players are on the verge of bankruptcy.

Road Ahead

If the slowdown is allowed to fester and continues then it will mutate into a much more prolonged and structural slowdown. Invariably, at such time there will always be huge demands from various segments. So far the central government has done well not to succumb under pressure for bailouts.

The reduction in GST collections due to slowdown means that the state and central governments are attempting to squeeze out companies and households of the last drop. This is a big and common mistake. Instead what is need is for the government to consolidate its expenditure and invest cautiously so that it will help trigger growth in the future.

Since many state governments are in dire financial position and because they refuse to move away from gross wastage of resources through unproductive subsidies, it is now left to the Central Government to invest smartly for the future needs. The Central Government should not fall for the pressure of the states to increase GST rates since that will only worsen the problem. Instead it should ask the states to consolidate and even reduce their wasteful subsidies which are nothing but vote bank politics that will end up making the problem worse.

What India needs is to think about alternative models and come up with a new model of growth so that it can meet the challenges of a post-globalisation induced growth that fuelled consumption. Historically, in India it is important to note that each new phase of economic growth needs new industries for growth. In the 1970s and 1980s whatever little growth existed was fuelled by heavy industry while in the 1990s and 2000s it was fuelled by the growth of service sector, especially those in the information technology, telecom and media.

The economic growth in these segments combined with the spread of banking led to a massive growth in debt induced consumption which drove the economy and created jobs while offering revenues to the governments. Now that these are slowing down, it is important for the government to support a new set of industries that not only produce more but also are more efficient and are productive while being globally competitive.

The time has come for Central Government to consider the following:

All statistics related to Banking and NBFC sector are from Report on Trend and Progress of Banking In India 2018-19.

• The clock is ticking fast and it is time for the centre and the states to spend prudently and wisely: there is a huge increase in debt. The central government is borrowing at a rate of approximately Rs.1 lakh crores per month while all the states are borrowing at the rate of another nearly Rs.50,000 crores per month. This excludes borrowings by government companies, trusts and institutions. The governments need to be cautious because most of the debt is owned by public institutions like Banks, insurance companies, mutual funds, etc. Only about 10% of the total government debt is owned by either foreigners or individuals. Thus, if something goes wrong the people, especially middle classes will suffer the most
• Since large numbers of youth are joining the labour force there is a need to absorb them. The time has come to avoid spending enormous amounts of borrowed money on subsidies that do not enhance productivity or economic growth. It is impossible for the government to do everything and provide everything free. Instead, the government has to concentrate on investing for the future by developing the ecosystem that supports and encourages the growth new industries so that sufficient number of jobs can be created
• A good starting point would be to encourage an electric vehicle (EV) ecosystem for automotive industry backed by huge spending on other infrastructure, especially those useful ones related to water storage
• A major shock therapy or a radical alternative for the government is to stop or drastically reduce expenditure on subsidies for one or two years and use the money saved to undertake a drastic reform: take overall non-performing assets of the banks and drastically change the way banks operate so that the economy can recover earliest. In the worst-case scenario and in the context of the present slowdown such a drastic measure may cost the Central government about Rs.10-12 lakh crores. But, it could be the kind of radical therapy that the economy needs at this critical time. The government can then recover these loans. However, such a momentous reform will need huge amount of political will
• One important sector that needs support is the Telecom sector. The government should subsidise their investments in future technological needs including those like 5G. That will enable Indian businesses to become more productive in the long-term while being competitive
• Avoid throwing good money on schemes like Mudra loans, microfinance loans, etc and instead concentrate on supporting/funding future technological needs including those like funding network security architecture, those investing intellectual property, artificial intelligence, machine learning, advanced medical sciences, etc – just like China
• A crisis should never be wasted. So the best thing for the Central Government to do will be to offer funds only if governments (Central, State or local bodies) introduce productive linked benefit systems across the board – especially in government services and the education system).

(Authored by Dr.S.Ananth, Economic Expert)