data in India is woefully poor and irregular, but according to Centre for Monitoring Indian Economic (CMIE) data, it has climbed to a 45 year high of 7.8% in Q3 2019, even if this data has been heavily disputed by the government. While far from being forensic, these data at least highlight the scale of the challenges that India faces.
Before considering the rather piecemeal government efforts to try and stimulate India’s economy, a quick look at India’s economic “elephant in the room” is required, namely its banking sector. The ‘demonetization shock’ to the economy certainly did not help the sector’s cause, but as the chart below of India’s atrocious and escalating non-performing loan (NPL) problem highlights, it was nothing more than an unnecessary ‘stone in the road’. Unnecessary from the aspect that having removed some 85% of all cash notes from the economy, and causing a lot of hardship for the poor and many in the agricultural sector, it made little or no difference to tax evasion, fake bank notes in circulation or tax collection, given that the rise in digital payments and tax collection effectively reverted to previously observed trends over the prior decade.
Chart 1: View India’s Non performing Loans Ratio from 1998 to 2018
This offers further context for the latest budget measures. From one specific aspect, the latest measures do offer something of a break with typical previous government responses, which have typically relied on raising taxes and increasing subsidies. This is in so far as the corporate tax cuts (to 22% from 30% for existing companies, and for new manufacturing sector companies to 15% from 25%) are contingent on companies not availing themselves of exemptions and incentives. In theory, this brings corporate taxation much more into line with the rest of Asia, thus making it more competitive. It should free up corporate cash for investment and job creation, allow for or increase dividend payments, and along with the cut in capital gains tax on listed equities (reversing the surcharge announced in the pre-election budget), also help to encourage rather more domestic inflows into equities, thus offsetting the hefty recent outflow of foreign funds. It is also hoped that higher profits net of tax may also incentivise companies to cut prices, with some also predicting that there will be further cuts to GST rates announced, on a targeted basis. How this all turns out in practice is a different question.
Source:
www.ceicdata.com | Reserve Bank of India
The pace at which this has escalated over the past 3 years is nothing less than alarming. It also attests as to why the RBI’s modest rate policy tightening in 2018 to combat the inflationary impact of a weaker INR and higher oil prices, and sustaining an overly tight policy stance into Q1 2019 exacerbated the NPL problem, of which the collapse of shadow infrastructure lender IL&FS was a further symptom. Equally, the corollary of this is that this year’s sequential 110 bps of RBI rate cuts to 5.40%, with further cuts expected, is thus far having limited impact on the economy, given that the monetary policy transmission mechanism is so clogged up. It is very debatable whether the proposed merger of ten Public Sector (PSU) Banks into four, reducing the overall number from 21 to 12, with an additional capital injection of INR 700 Bn aimed at boosting lending and improving liquidity, will have a sustained positive impact, without bank balance sheet reconciliation (also needed in private sector banks) and major reforms of lending practices. The fact that the recent McKinsey report ‘Signs of stress: Is Asia heading toward a debt crisis?’ highlighted that the share of long term debt of Indian corporates with an interest cover ratio of less than 1.5x was 43% (the highest among major Asian companies), in other words ‘under significant stress’, is a further illustration of the problem.
But all the various measures that have been announced will in the first instance serve to reduce tax revenues for a government, which was already running a budget deficit of 3.3%, which most assumed would in practice be higher given the economic slowdown, even without these measures, which could see the deficit rise as high as 3.8% for the current fiscal year. Remedying this with spending cuts is obviously not a realistic option, in light of an already weak economy. The fact that the current account deficit is also creeping higher (2.1% for the prior fiscal year), implies a rather too familiar risk of India running uncomfortably high ‘twin deficits’, which would come into very sharp focus, should tensions over Kashmir escalate and/or a further sustained rise in oil price due to tensions in the Gulf.
As such, the stakes are now very high for India. It is to be hoped the various fiscal packages start to get some traction swiftly, and that the vexed issue of its banking sector woes are also addressed decisively, to unclog the monetary transmission mechanism. For that to happen, it is of paramount importance that the judiciary does not continue to block efforts to reconcile sector balance sheets, as has been the case for far too long.
Marc Ostwald E:
marc.ostwald@admisi.com T: +44(0) 20 7716 8534
9 | ADMISI - The Ghost In The Machine | September/October 2019
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