India’s ‘Balance Sheet Slowdown’ Requires Unapologetic Government SpendingBloombergQuintOpinion
Amidst the many economic woes that India is currently facing is a problem that is not entirely new, but is still awaiting resolution. This is a problem which dates back to 2011 and is one of the key structural constraints India faces as it tries to recover from the 5 percent GDP growth rate recorded in the first quarter of 2019-20.
The current slowdown has several characteristics that are similar to what is termed as a ‘balance sheet recession’. However, given the current growth rate in the economy, the intensity of these signs is not as full-blown balance sheet recession. So, let’s call it a ‘balance-sheet slowdown’. This is a different kind of slowdown, which requires different handling altogether.
An inadequate and misdirected response, however well-intentioned, can quickly aggravate the situation, placing the economy in a low growth trajectory for years to come.
The Writing Is On The Charts
The seeds of India’s balance sheet slowdown were sown in the 2010-11 to 2014-15 period, when corporates were gradually waking up to the hangover of debt excesses of previous years. What has happened since is well-known—corporates have been forced to deleverage, corporate insolvencies have picked up and banks have been saddled with bad loans.
The problem was identified first in the Mid-Year Economic Analysis 2014-15, which spoke of the ‘Balance Sheet Syndrome With Indian Characteristics’. Subsequently, the Economic Survey of 2016-17 spoke of the ‘Twin Balance Sheet Syndrome’. It referred to weak balance sheets of both Indian corporates and banks and their consequent inability to propel growth.
The fears of this balance sheet slowdown are now clearly visible in data.
An analysis of 400 listed companies, with the largest debt on their books, suggests that debt growth continued to be modest for the fourth consecutive year in FY19. This, despite the fact that between 2013 and 2019, lending rates fell 150-250 basis points.
The deleveraging bias, to an extent, also gets captured in the higher cash growth in these balance sheets.
Balance Sheet Slowdown Versus Cyclical Slowdown
There are reasons why the focus of policymakers needs to shift back to this balance sheet slowdown, along with looking at the cyclical aspects of the current bout of economic weakness.
The normal ‘textbook variety’ cyclical slowdown usually arises from a short-to-medium term mismatch between supply and demand.
At the risk of over-simplification let us consider two cases:
In one, businesses may have over-invested in capacity building while demand may not have caught up. To address such a scenario, central banks reduce interest rates, which boosts consumption and ultimately the economy.
In another case, in order to reign in an over-heated economy and ensuing inflation expectations, central banks increase interest rates. This, in turn, cuts down demand, leading to an inventory pile-up, which suppresses capacity expansion plans, ultimately leading to slowdown.
However, in both these scenarios the private corporate sector, as a whole, is not over-leveraged and its ability and appetite for expansion and debt remains largely intact.
In a balance sheet slowdown, the private sector is either unable or unwilling to take on debt to rev up growth. In such a situation, even if interest rates are reduced, there will be no takers since appetite for capacity expansion is negligible. The private sector focuses on conserving cash and restricts the level of debt. The onus then shifts to the government to rev up the economy, either by triggering massive investments and/or consumption.
In this context, it is also important to understand the inevitability of debt.
In a modern economy, the major source of capital and growth remains debt. Any growth would, per se, imply that among the three sectors in an economy—government, business and consumer—one or more has to ramp up on debt so that real assets or financial assets gets created in the economy.
On a system wise-basis, one sector’s debt becomes another sector’s asset.
For example, when the government borrows the government bonds become assets on the balance sheet of the private sector.
What Must Be Done
Going by the current corporate behaviour, the efficacy of interest rate cuts is itself uncertain. However, if rate cuts are the chosen tool, then there needs to be a sharp cut of 75-150 basis points with clear messaging that floor of interest rates has been reached. The current approach of calibrated rate cuts, would cause the private sector to wait for the bottom of the interest cycle to even think of ramping up debt and capex.
Meanwhile, a more decisive push from the government is required. Some options could be:
- Large infrastructure spending.
- Fine-tune and broad base distributive polices to support consumption.
- While the Insolvency and Bankruptcy Code was much needed, a bad bank-like structure must still be considered to clean up bank balance sheets.
- Corporates should be given a freer hand, long-awaited labour and land reforms must be pushed, tax complexities should be reduced and tax rules should stabilise.
- Efforts should be made to de-criminalise corporate defaults, so that entrepreneurs can take risks without fear of criminal proceedings.
What of the fiscal constraints, you ask?
Any significant government push will inevitably increase the fiscal deficit. But not doing so will also aggravate fiscal deficit due to weaker nominal growth.
Fiscal austerity, at this point, may trigger a vicious cycle of lower nominal and real growth, which may not be conducive to attract domestic and foreign capital.
With lower real interest rates and limited growth options, receding foreign capital will also put pressure on the currency.
As such, the government must take the hard decision of veering away from the predetermined fiscal path. What the government must ensure is that the spending creates real assets in the economy and addresses supply-side constraints. This will restrict inflation when the growth revives, while maintaining India’s attractiveness as an investment destination.
Deep Narayan Mukherjee is a financial services professional and a visiting faculty on risk management at Indian Institute of Management, Calcutta. The author would like to thank Priyanka Poddar & Soumyajit Niyogi for their discussions.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.