As growth takes a hit, a lot needs to be fixed

Growth in the Indian economy has taken a hit. The figures for the fourth quarter of 2016-17 presented by the government were dismal, recording the lowest growth in three years with GDP growth of only 6.1 per cent in the quarter ending March 2017. Growth in the financial year 2017 was at a three-year low of 7.1 per cent, compared to eight per cent in the previous year. The economy is likely to take a hit as the bad loans of Indian banks have led to stressed assets exceeding provisions for that by $93 billion. These trends present a scenario that is threatening to derail Prime Minister Modi’s economic plans. A major reason for the slowdown is the demonetisation undertaken by the government in November 2016. What was particularly hit was the slowdown in the construction sector, which shrank by 3.7 per cent compared to 3.4 per cent growth the previous quarter. Investment demand fell to a negative 2.1 per cent. The only redeeming feature was a rise in government expenditure, which grew a hefty 17 per cent. Stressed assets at India’s two-dozen state-backed banks have risen sharply. Driven first by delays in projects at industrial conglomerates, and then by collapsing global commodity prices, they have soared from six per cent in 2011 to 14 per cent this year. This is one of the worst levels in Asia. The World Bank estimates that only about 26 cents is recovered on a dollar of defaulted debt in India.

The banking sector has for many years been in crisis and this keeps getting worse. The bad debts keep increasing and have now surpassed the net worth of many banks, making them bankrupt. The government keeps pouring more money into these pillars of the economy, but only manages to push up the fiscal deficit. The problems range from bad investment decisions to falling commodity prices to businesses getting used to being bailed out. Various solutions have been proposed, from a “bad bank” to “Sustainable Structuring of Stressed Assets” and “Strategic Debt Restructuring”, none of which have so far worked. The RBI’s Financial Stability Report released in December 2016 recognised this when it said: “The gross NPAs ratio of SCBs increased to 9.1 per cent in September 2016 from 7.8 per cent in March, pushing the overall stressed advances ratio to 12.3 per cent from 11.5 per cent.” The lack of growth in bank advances is related to slow economic growth. The sectors that are hardest hit are power generation, steel, infrastructural development, telecom and textiles. The real crisis today is in investment. Gross capital investment fell by 2.1 per cent in the latest quarter indicating a low demand for bank credit. One solution to revive the economy is to lower interest rates but this poses other problems like falling incomes for people who keep their savings in banks. In a period of growth, bank credit grows by more than 20 per cent.

Two economists, C.P. Chandrasekhar and Jayati Ghosh recently said: “A major plank of the private sector-driven growth strategy is that the government would facilitate the process by ensuring investments in infrastructure. Unable to do this with its own resources because of the fiscal crunch that results from a business-friendly taxation and tax collection regime, it has been using public sector banks as the vehicles for financing the infrastructure push.” Thus, the banking crisis is a result of the government not investing in infrastructure projects and using public sector banks to sink money into these projects, many of which are unviable. The crisis in the banks is a reflection of the crisis in the economy but this would not at be obvious to anyone reflecting on the Indian economy. The government is very good at managing public opinion. But investment bankers are hard-nosed about money, and the way they have been flocking to the India story should indicate a greater analytical seriousness. The stock market boom is a worldwide phenomenon. This is happening at a time when stock prices are hitting a record high, overshooting economic fundamentals. When it breaks like it did in 2008, valuations could come down.