India’s structural growth story is well-known: GDP per capita is low relative to peers, the working age population is still growing and there is potential for labour mobility to be much higher.
But at the same time, the cyclical backdrop is more concerning.
Household savings have plunged, corporates are deleveraging and workers are leaving cities and heading back to agricultural work.
The financial sector is in trouble and this is weighing on credit growth, which provides a major headwind to the economy at large.
While the meaningful cyclical slowdown in 2019 should start to fade as policy measures put a floor under growth and base effects kick in, until the banking system regains confidence any upswing will be short lived and shallow.
Despite the major cyclical slowdown, there is no shortage of micro opportunities to be had in India.
But for this opportunity set to expand meaningfully, and indeed for the structural growth potential to take hold, there will need to be both the will and mechanism for improved policy making and implementation.
Nowhere is this more evident than in the banking sector, which has suffered an unprecedented crisis of confidence.
Credit growth has collapsed from 24.4 per cent in early 2011 to 8 per cent today, with the industrial sector hit particularly hard.
To compound the problem, banks had been lending to non-bank financial corporations with the view that the NBFCs were better able to assess the credit risk of end borrowers.
As it transpired, NBFCs were not better at seeking credit-worthy borrowers and non-performing loans have been on the rise.
The last straw was in 2018, when a large NBFC known as Infrastructure Leasing & Financial Services defaulted on a number of its obligations.
The company’s credit rating went from AAA to D overnight.
Necessary policy provisions, such as the Insolvency and Bankruptcy Code 2015 and the Asset Quality Review 2016 have hurt financial sector earnings, and non-performing assets at the banks are higher than originally thought.
Furthermore, the NBFCs were making long-duration loans funded by short-dated paper – a recipe for an asset-liability blow up.
The government and the Reserve Bank of India do appear to be taking the situation more seriously now, and, at the government’s direction, banks are lending enough to NBFCs such that they can roll over their debt, but not enough to generate new lending.
A concern is that the government is seeing the situation more as an aggregate demand collapse rather than a financial crisis and collapse of confidence.
Policy makers have injected debt capital into banks rather than equity, which would have been a more potent remedy. The RBI has also cut rates by 135 basis points so far this year, but transmission is especially weak in India and the lags are long.
But there are also cracks in the relationship between Prime Minister Narendra Modi’s government and the RBI that call into question the future policy direction.