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By V.P. Nandakumar
Economists often use the term “ceteris paribus”, Latin for "all other things held constant" when positing their theories or making predictions based on their models. I am not an economist but as the CEO of a large NBFC, I take a keen interest in India’s economic performance, mainly to get a sense of where things are headed. After all, the wider performance of the economy has a crucial bearing on business performance. But these days, we are in the midst of an unprecedented situation where even near-term predictions are difficult to make because we have no clue about how the COVID-19 pandemic will play out.
When Unlock 1.0 began in May, we were hopeful of returning to normalcy within a couple of months. However, three months down the line, the situation continues to be dire as we head back to more of localised lockdowns and curfews. Most of our states are reporting an increasingly higher number of positive cases than before.
As we come to grips with the ground realities, the one good news is that India has ramped up its testing capacity and that nearly two crore people have been tested so far. In the meantime, work on developing a vaccine is going on at a frenetic pace. India is also in the race to develop a vaccine with trials of our Covid-19 vaccine, Covaxin, having started at 8 sites. Meanwhile, the medical profession is working tirelessly to develop a treatment protocol that would cure the disease and cut down on the fatality rates.
While we are grateful to our medical professionals, and even as we hope for the best, we must simultaneously work to get the economy back on track. Otherwise, we may fail ourselves by saving the lives of our citizens but destroying their livelihoods. It is increasingly clear that a lockdown is not a real solution as it only buys time at best. In that sense, it’s no better than kicking the can down the road. What’s more, it comes at a steep cost to the livelihoods of some of our poorest and most vulnerable sections.
Therefore, what we need is to balance the precautionary measures with measures to support economic activity that would preserve livelihoods. Governments have a responsibility to protect both lives and livelihood. In this context, lockdowns serve one purpose very well but at the cost of the other. We have now seen for ourselves how lockdowns destroy the livelihoods of the poor and marginalised people, be it labourers, shopkeepers, traders or MSMEs.
There is also a widely shared view among economists that the Indian government’s fiscal response to the economic crisis has been inadequate. According to this view, the government should ramp up spending without heed to the deficit financing it would entail so that the most vulnerable sections get direct monetary support from the state to preserve their (already precarious) standards of living. Now is not the time to bother about deficits or be afraid of rating downgrades. What India needs is a much larger economic stimulus that would put more money in the hands of the people. They argue that this would lead to economic recovery by stimulating demand. Considering that the collapse of income for large sections directly affects business and industry, there is considerable merit to the idea of a stimulus on the demand side.
However, the Indian government has been relatively cautious so far, perhaps conscious of its stretched fiscal position, and the fear that a ratings downgrade that will likely follow from elevated fiscal deficits would have long term negative consequences for the Indian economy, such as the flight of capital, not to mention the high inflation stoked by a high fiscal deficit. Moreover, the experience of how India dealt with the global financial crisis of 2008-09 is still fresh in our minds. On that occasion, the fiscal tap was turned on and the government largely succeeded in cushioning the economy from the impact of global meltdown. However, the failure to unwind, to get out of the stimulus mode in time, also set the economy up for high inflation and the currency crisis of 2013 when the rupee depreciated by close to 50 per cent in a matter of months.
At the same time, there are a few measures specific to the financial services sector which the policymakers can consider and which won’t cost even a rupee. There’s no doubt that India’s banks and NBFCs will see their asset quality deteriorate, especially after August (when the extended moratorium ends) and this will be true for corporates, SMEs and even the retail segments. It is worth noting that over the last few years, at least among retail borrowers, there has been a marked improvement in credit culture. People are much more conscious of the need to maintain their credit scores and instances of wilful default are fewer in the retail segment. A moratorium, in this context, is not an advisable solution as it is costly and destroys the hard-earned credit culture. A better way would be to permit a one-time restructuring of loans that would conserve capital and allow borrowers to rebuild their income generation capability.
Policymakers should encourage asset-backed lending and appreciate that there is little point in tying up lenders in cumbersome regulations and then expect credit growth to pick up. For example, an NBFC can give out unsecured loans without restrictions but a loan against gold jewellery is legally capped at 75% of the value of the gold (an asset liquid as cash and which does not depreciate). These rules were last revised by RBI in 2014 and it is time for a fresh look. Similarly, restoration of priority sector lending (PSL) status to eligible gold loans disbursed by NBFCs making them on par with the banks would be another welcome step. Nearly 30% of the Banking Sector’s Agriculture Loan book is in the form of gold loans. There is a need to remove this regulatory arbitrage between banks and non-banks for gold loan. After all, banks already enjoy get the benefit of lower capital charge on their gold loan book, and they face no restrictions in opening branches. Further, they enjoy the PSL benefit on a large part of their gold loan book classified under agricultural lending.
In times of economic uncertainty and stress in the financial sector, there is an understandable hesitation to lend on the part of banks and NBFCs alike. Even borrowers tend to hold back as they are not sure if their venture would succeed given the prevailing economic uncertainty. In such times, lending against gold jewellery is a very good business to be in. The two major tailwinds for gold loans are the lifetime high gold prices and the heightened risk aversion of banks and NBFCs. That is why a lot of banks and NBFCs are planning to get into the gold loan business.
After every crisis, there is shakeout and consolidation. Over the next few quarters and the next few years, I expect to see a lot more of mergers and acquisitions (M&As) happening in the financial space, and I won’t be surprised if the weaker players get weeded out. Now that the RBI has been made the sole regulator of the financial sector including Co-Operative Banks, all three major lending institutions (Banks, NBFCs/HFCs, and Co-Operative Banks) have come under the supervision of a single regulator. I expect harmonisation of many regulations thereby wiping out the regulatory arbitrage enjoyed by a few. With the blurring of boundaries, weaker players would have to go out of business or be taken over by larger entities. It will cause some pain in the short term but, over the longer term, it will be better for everyone.
Published in Unique Times Magazine, August 2020
(V.P. Nandakumar is MD & CEO of Manappuram Finance Ltd. Views are personal.)