Recently published data on financial flows to the commercial sector confirms why growth sank to the depths it did last year—financing from all segments saw a breath-taking slide that is unprecedented!
Instead, the year ended with GDP growth plunging to 3.1% in the last quarter (Jan-March, 2020).
The 4.2% GDP growth in 2019-20 rattled everyone. The year had begun with expectations around 7%, above that in 2018-19, and an upturn after a two-year downswing. Growth was expected to be driven by higher financial flows to the commercial sector, monetary easing and improved transmission, a fillip from public spending in rural areas, amongst others. Instead, the year ended with GDP growth plunging to 3.1% in the last quarter (Jan-March, 2020). The slide, in defiance of all expectations—above all, the central bank’s—is often attributed to financial sector weakness, although remaining speculative. But now, recently published data on financial flows to the commercial sector confirms why growth sank to the depths it did last year—financing from all segments saw a breath-taking slide that is unprecedented! Besides illuminating the pre-Covid fall in growth, this new perspective raises concern about the pace of post-Covid recovery as well.
The accompanying graphic illustrates the severe contraction in financial resource flows to the business sector in 2019-20 from all segments, domestic and external. It is set in the context of almost a decade’s preceding trend. The depths to which these sank is startling: scaled to GDP, these were down to 7%, lowest in a decade and way below 11.6% averaged since 2011-12. At Rs 14.5 trillion last year, fund flows were Rs 9 trillion less than 2018-19, equalling 2012-13 levels.
The accompanying graphic shows how this fall is distributed across major financial system segments (domestic). Relative to 2018-19, financial resource flow from housing finance companies (HFCs) was 19x lower that by systemically important nonbanks (NBFCs-NDSIs) declined 9x! In rupee terms, HFCs funding flow was just Rs 85.7 billion; systemically important NBFCs (net of bank credit) did marginally better at Rs 135.7 billion! Bank credit (adjusted, non-food) flow ebbed by a factor of two in contrast—Rs 5.8 trillion from Rs 11.2 trillion the year before. For an economy sized Rs 203 trillion, this is an eye-popping collapse!
The accompanying graphic shows that the financial resource flows from NBFCs fell steeply despite that bank lending sustained its raised pace, 27% average and thrice the overall credit growth since 2017-18. However, bank support or doubled LIC investments and external commercial borrowings, 1.3x increase in foreign direct investment could not offset or stem the decline.
The question arises if funds flow slowed so severely because of low demand or risk-aversion, tighter lending standards, and liquidity crunch (NBFCs). It would be fair to assume both factors account for the slump, e.g., occasional statements of bank chiefs and real economic indications on the demand side, and consistent urging of banks to shed hesitation or fear of lending by RBI and government.
Against this backdrop, post-Covid policy responses providing liquidity, keep credit flowing are appropriate. On the borrowers’ side, the support ranges from regulatory measures to encourage credit flows (retail sector and MSMEs) to forbearance on asset classification (loans to MSMEs, real estate developers). The second prong targets businesses with the fully-guaranteed collateral-free lending programme, partially-guaranteed subordinate debt for stressed MSMEs, and pooled investment fund for equity infusion in MSMEs. Another arm provides partial credit guarantee to public sector banks on borrowings of NBFCs, HFCs, microfinance institutions (MFIs), and creates a fully-guaranteed special purpose vehicle, managed by a public sector bank, to buy the short-term debt of eligible NBFCs and HFCs.
The dependence upon financial intermediaries, chiefly public banks, for combating the Covid-19 shock and uplift the economy is obvious. The impact of these supportive measures has to be seen or visualised in the light of the severe collapse before Covid. An important question arising here is the financial strength of firms for eligibility of announced support, viz viable as on March 2020. How viable were businesses that banks or nonbanks were averse to financing before Covid-19? The role of demand-supply factors becomes crucial, given the weak funding flow before Covid. That risk-aversion or caution may not just carry over, but quite likely aggravate with the Covid shock.
How have agents responded until now? The period is too short to reckon progress. Virus infections are not yet contained, the spread adding to existing uncertainty of lenders and borrowers. However, basic sustenance needs of financially weak and vulnerable businesses, as well as partial recovering of production ought to provide the impetus.
Initial trends reflect tepidity. Less than half the amount of special liquidity scheme for stressed NBFCs (Rs 300 billion) that ended in September was approved (Rs 111.2 billion, 39 proposals); less than quarter of funds disbursed (Rs 72.3 billion). Reasons for this are reported to be consolidation, strict eligibility terms, short tenure, amongst others; most such apprehensions existed from the outset of the announcement. The partial credit guarantee (Rs 450 billion) to banks for NBFC lending appears to have elicited comparably better response—Rs 255.1 billion of bonds and commercial papers were bought as on September 25. And, under the Rs 3 trillion guaranteed emergency credit line ending this month, banks had sanctioned Rs 1.77 trillion loans to MSMEs and individuals and disbursed Rs 1.25 trillion as on September 21; private banks exceeded public ones. The unenthusiastic response here is reportedly due rejections by banks due to ineligibility and risk aversion, despite enhanced scope and coverage since the initial announcement.
These are narrow snapshots. Aggregate bank credit growth gives a broader picture: relative to this March, this contracted -1.8% in August with credit to NBFCs at -1.3%; both are significantly lower than the matching period last year. On an annual basis, total non-food credit pace slowed in August (6%) compared to July (6.75%); the slowing of credit to NBFCs is more pronounced at 17% in August compared to 25% averaged this June-July and less than half the pace in August 2019.
It is quite likely that seasonal and unlocking factors could increase the pace, dispel or reduce lenders’ cautiousness as more light is shed on the creditworthiness of borrowers, business trends and loan demand. The next quarter may provide important clues. Much also depends upon the advancement or evolution of the pandemic.
However, one must flag that any advancement or uplift in funds flow will be from their shocking pre-Covid collapse. There are risks to both lenders and borrowers from the additional stress, especially financial intermediaries, some of who may be unable to withstand or propagate more stress across the real economy. Policymakers are seized of these dangers no doubt. But, they are also extremely dependent upon the financial sector to drive the recovery. Superimposed upon last year’s trickle of financial resources, we just do not know what the pace or progress of recovery ahead could be.
The author is a New Delhi based macroeconomist Views are personal