A gen­eral elec­tion year with a liq­uid­ity twist and eco­nomic growth

Mint ST - - NEWS -

com­pany (NBFC) sec­tor made the most of this sit­u­a­tion by in­di­rectly bor­row­ing short from the In­dian saver and lend­ing long.

The re­sult was un­sur­pris­ing. The In­dian econ­omy’s reliance on credit, whose pric­ing was re­liant on pre­vail­ing mar­ket in­ter­est rates which were low then, shot up. Con­se­quently, NBFCS’ share in to­tal credit out­stand­ing shot up from 13% in FY13 to 18% in FY18. As a re­sult, the econ­omy re­ceived a fil­lip as the weighted cost of debt cap­i­tal fell.

If NBFCS have to deal with a 50-100bps in­crease in the cost of funds, then the cost of debt cap­i­tal for the econ­omy is likely to rise. Costlier short­term cap­i­tal, when the econ­omy’s reliance on Nbfc-ex­tended debt has in­creased, is likely to re­sult in lower credit growth be­ing pow­ered by this sec­tor, thereby re­sult­ing in lower eco­nomic ac­tiv­ity lev­els.

More im­por­tantly, NBFCS lend mean­ing­fully to crit­i­cal seg­ments where banks lack reach or do not want to lend, such as fi­nanc­ing of com­mer­cial ve­hi­cles, or sub-prime bor­row­ers in the home and auto space. Even as­sum­ing banks clean their books by FY20 and are in a po­si­tion to start re­gain­ing mar­ket share, th­ese se­lect pock­ets are still likely to suf­fer from in­ad­e­quate ac­cess to credit.

Be­sides the higher cost of NBFC debt re­sult­ing in slower growth, GDP growth could be funds, de­vel­op­ers may have to start pric­ing-down in­ven­tory which could af­fect the vi­a­bil­ity of smaller de­vel­op­ers. recorded in the pre­vi­ous two years lead­ing to a gen­eral elec­tion.

This slow­down in cen­tral gov­ern­ment rev­enue ex­pen­di­ture mat­ters be­cause the gov­ern­ment con­sump­tion ex­pen­di­ture com­po­nent of GDP ac­counts for 11% of to­tal GDP and its cor­re­la­tion with cen­tral rev­enue ex­pen­di­ture growth amounts to 71%.

More­over, it is well-known that pre-elec­tion free­bies dis­trib­uted by po­lit­i­cal par­ties, which in­clude durables and non­durables, as well as hard cash, play a mean­ing­ful role in boost­ing con­sump­tion growth ahead of an elec­tion.

Thus, post elec­tions, it is likely that gov­ern­ment sup­port to GDP growth will abate in FY20. This means that an­other tail­wind that is sup­port­ing growth in FY19 will turn into a head­wind by FY20. De­spite some crit­i­cal pieces of struc­tural re­form that the cur­rent dis­pen­sa­tion has un­der­taken dur­ing its ten­ure, GDP growth is likely to slow down by 90-100bps in FY20 be­cause of th­ese rea­sons.

So what can the state do to mit­i­gate the ef­fects of tighter liq­uid­ity con­di­tions and of the po­lit­i­cal econ­omy cy­cle? While proac­tive reg­u­la­tion can help, it is im­per­a­tive for the Re­serve Bank of In­dia (RBI) and the min­istry of fi­nance to put up a solid, united front. This be­comes es­pe­cially im­por­tant given that the RBI’S ca­pa­bil­ity to in­fuse liq­uid­ity is con­strained by its cur­rency con­cerns. The state must work to foster the be­lief that it will move ex­pe­di­tiously and with near-per­fect co­or­di­na­tion among its var­i­ous arms to stem any likely cri­sis of con­fi­dence.

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