Tuesday, December 4, 2018

Why India's Focus Must be Inclusive Growth

Last time crude dipped, India experimented with demonetization and GST. This time when crude has started dipping, India’s hands are full with the aftermath of the IL&FS crisis. Here is a look at the impact on various sectors, and on why India should focus only on totally inclusive growth.

Fortune is smiling at the world as well as at India again. The demand-supply fight between producers and consumers of crude oil is once again tipping in favour of consumers like India and most nations of the world, with crude losing more than 30% from its peak within the last six weeks.

Oil trade pundits who were harping on $100 per barrel oil is discussing about $50 per barrel oil, once again.

For Indian Government, this is an unprecedented opportunity to get its act together once again. Both Moodys and India Ratings have already warned that India may grow slower and that it may miss its fiscal deficit target. Rupee too had slipped to record levels, only to recoup some of the losses due to the recent fall in crude.

This opportunity is unprecedented not because it hasn’t happened before, but because the Government missed the bus the first time it happened due to demonetization and GST, and because no one expected crude to significantly correct so fast after what seemed like a strong and sustained rally.

The second anniversary of demonetisation passed off without much fanfare with even Prime Minister Modi choosing not to speak about it. However, some celebrity economists didn’t spare the opportunity to attack the controversial step.

Former RBI Governor Dr.Raghuram Rajan had this much to say recently about the move - "The two successive shocks of demonetisation and the GST had a serious impact on growth in India. Growth has fallen off interestingly at a time when growth in the global economy has been peaking up. What happened in 2017 is that even as the world picked up, India went down. That reflects the fact that these blows (demonetisation and GST) have been really really hard blows. Because of these headwinds we have been held back,” he said.

India’s former economist PM, Dr. Manmohan Singh had this much to say, “The deeper ramifications of notebandi are still unravelling. Small and medium businesses that are the cornerstone of India’s economy are yet to recover from the demonetisation shock. The financial markets are volatile as the liquidity crisis wrought by demonetisation is taking its eventual toll on infrastructure lenders and non-banking financial services firms. The full impact of demonetisation is yet to be understood and experienced.”

Some others like Dr.Amit Mitra, West Bengal’s economist Finance Minister was more vocal with the numbers, saying, "How much GDP has been lost to India due to demonetisation and GST? It is Rs 4.75 lakh crore. Economic growth has slowed down from 2015-16 onwards and to achieve that high level of growth, India would need at least four years.”

While the views of economists like Dr.Rajan, Dr.Singh and Dr.Mitra can be countered by the ruling BJP citing their political differences with Modi Government, it is another fact that their learned views cannot be dismissed outright.

On the other hand, to its credit, the Modi Government has indeed some major achievements to speak about. The net market capitalization of India Inc has surged since Modi assumed power and has remained high despite the recent correction of significant proportion. Secondly, under Modi Government, India has stayed on in the game to emerge as the world’s fastest growing large economy, making good the slowdown in China.

Will Modi Government be able to make use of the second opportunity it has got now by way of dipping crude prices, to grow India at a much faster pace as the country requires? This Government can do this, if it steers clear of debacles like its hasty GST implementation and the ill-advised demonetisation drive.

But unfortunately for India, the country is already facing a strong headwind in the aftermath of IL&FS going belly up. Once deemed to be too-big-to-fail, the diversified financial services major with its hand in most pies except for banking, built up an infrastructure financing empire on nearly 1 lakh crore of debt using a few hundreds of subsidiaries!

Of course, the Modi Government has acted swiftly and tried to contain the situation by taking over the company and appointing a new Board. But sadly, this is nothing more than what the Manmohan Singh Government did after the Satyam fiasco. They too acted swiftly, and had replaced the Satyam Board, which finally resulted in Tech Mahindra taking it over.

The really sad part is that nothing much has changed. Governments, regulators and bankers are ‘unable’ to detect the fraud when it is happening in broad daylight over the years, but the moment a scam surfaces after it becomes too big to hide, governments act swiftly.

Today, the effort is on to find out who all orchestrated the scam inside of IL&FS. But what should also be investigated is up to what extent did the promoters of IL&FS know about the fraudulent and high-risk activities of their child. And they are no ordinary promoters, being India’s largest life insurer, LIC; India’s largest bank, SBI and one of India’s largest NBFCs, HDFC.

Eerily, some of the most concerned players in this issue as well as in the rescue team including Vineet Nayyar are the same, in both Satyam and IL&FS. Obviously, the powers that be, know how to protect their best interests first.

However what is starkly different between Satyam and IL&FS is that the former never had the potential to be a contagion whereas IL&FS has already proven that it can unleash the strongest contagion effect in the market as many many banks and many many NBFCs have either direct exposure to IL&FS or indirect exposure through IL&FS projects.

Here is a look at how different sectors are experiencing the current business environment, especially due to the impact of the IL&FS crisis:

Banking Sector:

Both public sector banks and private sector banks have significant exposure to IL&FS directly or indirectly. But the situation is graver for public sector banks as they were already reeling under the nearly ten year old NPA crisis. Credit growth had already moderated significantly in these banks over the last several years, and the IL&FS debacle will make the banks even more circumspect before giving corporate loans and in participating in infrastructure projects. Another reason why public sector banks are likely to feel more heat is that traditionally in India they have been the major players extending corporate credit whereas private banks are more of retail banks. The IL&FS crisis is likely to deepen the NPA crisis for both public and private sector banks and recently Dr.Raghuram Rajan had opined that India still doesn’t have the bad debt instruments to tackle the NPA crisis. It is noteworthy that Dr.Rajan was conveniently shunted out while he was in the process of formulating and delivering such bitter medicine to erring corporates.

NBFC Sector:

IL&FS’ largest operation being its flagship NBFC arm, non-banking financial companies indeed bore the maximum brunt when this scam unveiled itself. They fell in market value across the board and most of them haven’t regained valuations even after Government took over IL&FS. However, the retail focused NBFCs like in home loans, auto loans, gold loans and consumer durable financing have regained part of their market valuation as they have little exposure to IL&FS or other infrastructure projects, besides having a strong retail franchise. That said, all NBFCs are keeping their fingers crossed as most of them have upcoming redemptions for their commercial papers in these months and any default would spell literal doom for their operations. Home loan providers are feeling the heat, and some developers at least are divulging that some home loan providers are already delaying in remitting the EMIs collected from homebuyers. Infra NBFCs like IL&FS are experiencing the greatest pain and it is likely to continue until the clouds of uncertainties clear. There is a liquidity crunch across the board, and NBFCs are feeling the most of it.

Real Estate & Infrastructure Sector:

Infrastructure Development is going to have a lasting impact and lingering slowdown from the crisis. This is because IL&FS has been one of the largest financiers for the sector, and with they having landed up in serious trouble by funding many infra projects, all lenders from banks to NBFCs are already curtailing the loans to this sector. Fewer infra projects are likely to sail through in this environment. In the real estate development sector, at least for the time being, most developers are claiming that they are yet to feel any liquidity crunch. But then, these are the biggest players, while most smaller players are likely to be already experiencing moderate to severe liquidity crunch. Even some of the bigger players have flagged the market that they are watching the situation closely, and that some home financiers are already delaying to remit payments received from homebuyers. If the NBFC redemptions throw up any kind of surprises, it need not be said that realty would be one of the first sectors to be affected. Already, the liquidity crunch is affecting the sale of luxury or premium apartment sales as much of it is still speculation driven, and as such, a function of the economy. To counter this, most large developers are opting to build luxury projects outside India in destinations like UAE and UK, and focusing on affordable apartments back here in India.

Higher Education & Employment:

If India doesn’t contain the current crisis using emerging tailwinds like the falling crude prices, the greatest hit will be on the spiralling unemployment rates which will result in social unrest. Unemployment levels have risen in the last two years, reaching to 30 million unemployed youth alone, and with India adding 1 million job seekers to the pool every month, things can get out of hand if something innovative and dramatic is not done fast. And universities and colleges are already feeling the heat, with hundreds of engineering colleges going belly-up each year.

Central and State Governments:

The Central Government has been trying to inject liquidity into the market using some unconventional methods including tapping the huge reserves with India’s Central Bank, the RBI. However, this has met with stiff resistance from RBI top brass as it is a contingency reserve rarely used, and if at all it is to be used, RBI’s priority is to use it for the recapitalization of public sector banks. On the states front, incumbent governments in states going for elections are feeling the heat due to the rising unemployment on one hand and inadequate revenues from the new GST mechanism.

India should do well by capitalizing as much as possible on the fall in crude prices, and use this window to kick-start growth, not in the conventional sense, but for the masses. The first thing to be addressed in this regard is to focus on significantly reducing the rising income inequalities. Recent international studies point out that with each passing year, income inequality is getting worse in India, with the top 1% getting even more richer, followed by the next 9%, while the remaining 90% is getting poorer in comparison.

What the second-most populous nation in this world needs is not just GDP growth, but highly equitable growth for the majority of its people.

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