India’s economy seems headed for ICU: Ex-economic advisor

Former Chief Economic Advisor Arvind Subramanian has said India's economy is currently experiencing a "second wave" of the Twin Balance Sheet (TBS) crisis which will soon turn into a "Great slowdown."

Subramanian said this in a draft working paper of the Harvard University's Centre for International Development, reports The Indian Express.

"Clearly, this is not an ordinary slowdown. It is India's Great Slowdown, where the economy seems headed for the intensive care unit," he said.

While Subramanian was the Chief Economic Advisor to the Narendra Modi government in 2014, he had highlighted the TBS problem.

In his new paper for the Harvard co-authored by the former head of the International Monetary Fund's India office Josh Felman, Subramanian presented a distinction between the original TBS and TBS-2.

TBS-1 was about bank loans made to steel, power and infrastructure sector companies during the investment boom of 2004-11 turning bad. TBS-2 is largely a post-demonetisation phenomenon involving non-banking financial companies (NBFCs) and real estate firms.

After demonetisation, considerable amounts of cash made their way to banks, who on-lent a major part of that to NBFCs. The NBFCs, in turn, channelled this money to the real estate sector. By 2017-18, NBFCs were accounting for roughly half of the estimated Rs 5,00,000 crore of outstanding real estate loans.

According to Subramanian, the collapse of IL&FS in September 2018 was a "seismic event" not only because of the Rs 90,000 crore-plus debts of the infrastructure-cum-lending behemoth, but also its "prompting markets to wake up and reassess the entire NBFC sector".

What the markets discovered was profoundly disturbing. A lot of NBFC lending in the recent period was concentrated in one particular industry — real estate — which itself was in a precarious situation. At the end of June 2019, the total number of unsold houses/flats in the top 8 cities was almost 10 lakh, valued at Rs8 lakh crore or equivalent to about 4 years' of sales.

Once the extent of their exposure to real estate became known after IL&FS went belly-up, banks, as well as mutual funds, virtually stopped lending to NBFCs. "In some ways, this may have been India's version of the US housing bubble," Subramanian and Felman argue.

Worse, it has created a new wave of stress for banks, some of whose credit to NBFCs amount to 10-14 per cent of their loan books. With banks turning cautious — on top of fund-starved NBFCs that had emerged as a key source of lending for small businesses and consumer durable purchases in the post-demonetisation period — flow of commercial credit has collapsed from a peak of Rs20 lakh crore in 2018-19 to "virtually nothing" in the first six months of this fiscal.

Subramanian and Felman say that India is now facing a situation of an unresolved legacy TBS problem along with a fresh TBS-2 crisis, both of which have pushed the economy into a downward spiral. "High rates and little credit are causing the economy to slow, thereby intensifying the stress on the corporate sector and on the financial system itself, "which then prompts the financial sector to become even more cautious".

The current slowdown, they note, is worrisome not just because GDP growth has slowed down to 4.5 per cent in the second quarter of 2019-20. Even more distressing is the disaggregated data. "The growth of consumer goods production has virtually ground to a halt; production of investment goods is falling. Indicators of exports, imports, and government revenues are all close to negative territory. These indicators suggest the economy's illness is severe…[this] slowdown seems closer to the 1991 balance of payments crisis,", they add.