IIP growth: Why banks have to rework strategies, make capital available

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New Delhi | Published: July 19, 2017 3:57:39 AM

Banks have to rework their strategies to make arrangements for capital. This will also mean putting their books in order and working hard to use the IBC-NCLT combination.

IIP growth, Narendra Modi Government, GST, industrial growth The government so far has done well on administrative reforms, which, as has been seen, are unable to push the economy forward.

The industrial growth number for May is quite disappointing as it does indicate that there are still few signs of the expected economic turnaround. Add to this the fact that the Goods and services tax GST has been introduced and there is some uncertainty on how the economy will fare. While an upward movement will definitely take place, the timing and pace are uncertain given the potential disruption that could be caused by the GST in the production cycles.

As usual with low industrial growth and low consumer inflation (Consumer price index) prevailing, it is but natural for the government to ask Reserve Bank of India to lower interest rates in August policy. But, will it work? The problem in India is an acute shortage of demand which had led to the build-up of excess capacity where making more investment does not make sense. Further, with the NPA resolution still in the initial stages, banks would not be willing to be aggressive in lending. Therefore, forcing the central bank to lower rates may not really work, but only provide an inadequate cover for a more deeply ingrained problem that exists today.

RBI has lowered the interest rate last year and also gotten banks to improve the transmission process. Yet, credit growth has been tardy as demand has been limited (or migrated to the debt market). It is not surprising that banks are sitting on around `3 lakh crore of surplus funds which came in during the time of demonetisation being unable to deploy these resources. Hence, there is an anomaly in the market where banks are being compensated through the reverse-repo auctions (daily and term) and paid around 6.25% by RBI, or else they would end up making a loss on these funds.

The stalemate in the country has been caused by the government prodding RBI to lower rates, which is not happening as RBI has to take a forward looking stance on inflation, where the signs do indicate an upward trajectory. This is so because of higher vegetable prices, increase in the rental component in the CPI due to the implementation of the Seventh Pay Commission recommendations on ‘allowances’, GST impact on service prices and some manufactured products like clothing in the CPI and the good chance of higher fiscal deficits of states on account of the loan-waiver schemes the headline inflation trajectory would be upwards once the base effect wears off.

On the other hand, the government has virtually refused to compromise on the fiscal target. It has been stated clearly that the centre would not support the states on waivers and that the latter will have to adjust from their budgets. In this situation, it is unlikely that the deficit target of 3.2% will be breached, and hence there will not be any impetus coming in from the centre.
Where does that leave the economy? A strong demand-side problem cannot be addressed by lowering rates and this is something which must be appreciated. Making such a demand sounds logical considering that the CPI numbers are less than 2%, which is the lower band level set by the monetary policy committee (MPC). Government spending, today, is limited to around `3 lakh crore on capex this year as per the budget which on its own will not be able to provide the impetus. States cannot support this push as they would be forced to lower their capex in order to meet the deficit targets after adjusting for loan waivers. There is, hence, an impasse here.

The government so far has done well on administrative reforms, which, as has been seen, are unable to push the economy forward. This also means that any clean-up in the system makes the ‘business of business’ easier, but can do little to increase production. A direct push is required through aggressive spending. The private sector has to play a large dominant role but is constrained to a significant extent by the non-performing assets (NPA) problem. Infrastructure travails remain, and while the government has done well with national highways and railways, the other segments still require large doses of investment. This implies that the growth process will only be gradual this year and a sudden revival looks unlikely.

The GST is a disruption as one is not sure how it will work out. As it is supposed to be a revenue neutral and non-inflationary system, it needs to be seen how the two will be matched. It has led to a large quantum of de-stocking in the months of April and May, which will affect growth numbers in June-July. However, as companies do maintain certain levels of inventories during the year which can range between 15-25% depending on the industry, it can be hoped that re-stocking would start in the months of August-September onwards, which will help to push up growth and start the virtuous backwards link with the rest of the economy.

The other factor is the Kharif prospects, which appear to be good today. A good crop like in the last year will help to revive rural spending, in turn, providing a push for consumer demand.
As both the process of re-stocking and consumer spending would begin roughly at the same time from September onwards, this would be a critical period for the economy if it is to recover from the low-growth trap that it got into ever since demonetisation. Hence, the second half of the year will be critical as it will guide future prospects. The psychological mark of 8% growth has been elusive for long (the 8% number for FY16 has come in only as a revision which makes it less satisfactory) ever since the new base year was used for calculating gross domestic product (GDP) from 2011-12 onwards.

While this process is on, the financial sector has to be geared to meet this demand, and banks, in particular, will have to rework their strategies to make the arrangements especially in terms of arranging for capital. This will also mean putting their books in order and working hard to use the Insolvency and Bankruptcy Code (IBC)-National Company Law Tribunal (NCLT) combination to resolve the NPA issue. It may be hoped that this would be completed in this fiscal so that FY19 could start off on a better plank with both higher growth and a robust financial system.

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