A general election year with a liquidity twist and economic growth
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.