Recently a lot of discussion is going on the four balance sheet problem currently faced in India probably as an extended form of the relatively well known twin balance sheet problem that was largely related to the worsening of the balance sheets of the banks and the infra companies facing project commencement or completion delays due to various reasons including the policy logjam of the yester years wherein the bank’s money got trapped in.
The Four balance sheet problem has probably been discussed first in the report titled ‘India’s Great Slowdown’: What happened? What’s the way out?” by Arvind Subramanian, former Chief Economic Adviser to the Government of India along with IMF’s former India head Josh Felman published in December 2019. Here they talk about two more sectors whose balance sheets are stuck in similar fashion and they are the NFBCs and the real estate companies.
But how do they make it a four-balance problem? Well, the Banks, of late have been a major source of finance to NBFCs and many of these gave it out to real estate and infra structure sector as loan disbursements. The infra structure sector had its own stock of problems but then there were troubles seen as mounting in the real estate sector too where huge inventory of unsold premises piled up because of lack of demand as the infra development or increase in incomes of prospective buyers could not speed up as the builders probably thought they would or simply due to lack of investment motive. And so, the four sectors are now stuck together and their financial health is deteriorating due the intricate web of relationship that they hold together.
NBFC growth story reversed in last two years
NBFC crisis is a more recent phenomenon. They have otherwise been doing quite well say up till a couple of years before, surpassing even the banks in the arena of disbursement of loans and eating into their market share as the banks rather slowed down. Particularly, the loan disbursement rate of the banks tanked from 14 percent in the year 2014 to 10 percent in the year 2018 whereas the growth of the NBFCs improved their ratios from 14.8 percent to 19 percent during the same time period.
It seems but natural that we wonder what has happened in the short span of the last two years that NBFCs are seeing a massive drop in their business. The problem has become more vivid especially in the second half of fiscal year 2019. Clearly the NBFCs are constrained by the tight liquidity conditions which further intensified due to the deteriorating balance sheets of their clients in the real estate sector. NBFCs woes were exposed after the IL&FS crisis followed by a mess at DHFL and some real estate companies. The immediate repercussion of this fear psychosis was that the Banks scaled down their exposures to the NBFCs, further aggravating NBFCs’ liquidity constraints.
The trickle down effect of the NBFC-crisis
The four balance sheet problem unfortunately may have gone out of proportion so much and so severe as to infect the rest of the economy as its growth rate slowed to 4.5% in the second quarter of this fiscal. Essentially it is neither just a twin nor a four balance-sheet problem. I think the problem is bigger than either of them as NBFCs loan disbursements are availed by a lot more sectors in the economy. They reach out to the automobile, fast moving consumer goods and practically the entire spectrum of activities in which the MSME industries operate. While it is pertinent to ponder whether the real estate or power sector caused the trickle down effect on the rest of the economy or it is rather the slow pace of growth of the economy or bad corporate governance practices that led to the mess created in these sectors, it is equally important to know whether sector specific or general prescriptions would help for the purposes of reforms, resolution or recapitalization.
Short term prescription for structural problem is a bad idea
The paper talks about the issue of “creating bad banks” for power and real estate. While referring to the plight of the prospective owners in cases where the builders go bankrupt without completing the projects which they have pre-sold collecting huge amounts of advance money from them; he explains how the resolution process at the IBC may not help them much. The recoveries may be slow or at little but some resolution is better than none! And if bad government companies are suggested to be closed down or shrink, so should bad private sector players be weeded out. Ultimately the question essentially relates to improving corporate governance at all levels, be it Banks, NBFCs or their clients irrespective of large, medium or small sector and regardless of being in public or private sectors.
Similarly in the power sector he talks about creating holding companies by the government with the sole objective of selling them in a matter of five years. On one hand he explains that the essence of the problem is that there cannot be a private sector led solution as the viability of power assets is inextricably entwined with government policies, but on the other hand he suggests that the government takes the bad loans of the tune of 2.5 trillion off the books of the Banks relieving their balance sheets and allowing their management to focus on their core business of supporting economic growth.
Well I think any solution that suggests a short cut prescription for a structural or even cyclical problem is a bad idea. Power and infra sectors are fundamental to economic growth. The mess created in these sectors is not a recent phenomenon. It has a long past. The public sector banks have to improve their risk management and governance mechanisms before they can play any useful role in boosting up economic growth. If there were surplus resources, they ought to be deployed for improving the viability of the power projects through modernization , cost cutting and better management and not just create a holding company to manage them so as to make them seem viable to the private sector in order to sell them off.
No need to panic: We are growing still.
Ultimately the government has to support economic growth. And government in a democratic socialist state has some larger objectives to pursue. The pace of economic growth may have slowed down, but the economy has not stopped growing as yet. We need to infuse liquidity into the system. We have to take measures to boost income in the rural areas. We have to give incentives to farmers to increase their yield and we have to provide more jobs. The improvement in the incomes of farmers and the youth may revive slump in the auto and FMCG sector. Incentives to corporates in terms of reduced tax rates may improve their ability to service their debts.
Part of the present crisis is related to a general slow down in the world economy. The recent corona virus issue is another challenge to reckon with. In a country like the United States a 3 percent rate of growth is laudable. After all it is a huge economy. While there is a cause of concern rightly raised by Paper, I simply suggest not to panic as long as the size of the economy is growing in critical times as the Indian economy after all is a part of the new globalised world order and so is affected by also how the other economies perform in the rest of the world.
To conclude, in a developing country like India where there still exist huge gaps across income groups, rural and urban development levels, and massive unemployment of men and resources, we should continue with long term growth objectives and continue with structural reforms. If the government is able to give a push to incomes through various budgetary measures and continues its focus on creation of jobs in urban and rural areas, there is a fair possibility that the magic of NBFCs would work again. If the corona virus is contained, as expected, by the end of April, I expect a huge recovery in the Chinese and world trade in percentage terms and that will again revive investment sentiment back home in the medium term.