Arvind Subramanian, former chief economic adviser to the Indian government. Photo: AFP
Arvind Subramanian, former chief economic adviser to the Indian government. Photo: AFP

India is battling an ongoing economic downturn, which former chief economic adviser Arvind Subramanian has described as a “great slowdown” in an academic paper.

Subramanian served during Narendra Modi’s first term from October 2014 to June 2018 and now teaches at the Harvard Kennedy School in the US.

“Clearly, this is not an ordinary slowdown. It is India’s Great Slowdown, where the economy seems headed for the intensive care unit,” Subramanian said in a draft working paper for the Harvard University’s Centre for International Development, the Indian Express reported.

He co-authored the paper with John Felman, the former head of the International Monetary Fund’s India office.

Subramanian said the Indian economy is now experiencing a “second wave” of the Twin Balance Sheet crisis, which is behind what he terms a “Great Slowdown.” He described the crisis as debts accumulated by private corporates becoming the non-performing assets of banks.

According to Subramanian, the first wave of this crisis happened when bank loans extended to steel, power and infrastructure sector companies during the investment boom of 2004-11 turned bad. The second crisis is largely a post-demonetization phenomenon involving non-banking financial companies, or shadow banks and real estate firms.

After high-value currency notes were banned, considerable amounts of cash made their way to banks, who lent a major part of that to shadow banks. They channeled this money to the real estate sector.

By 2017-18, the shadow banks were accounting for roughly half the estimated 5,000 billion rupees (US$70.6 billion) of outstanding real estate loans.

Subramanian said the collapse of the country’s largest shadow bank, IL&FS, in September 2018 was a “seismic event” which was responsible for “prompting markets to wake up and reassess the entire NBFC (non-bank financial company) sector.”

What the markets discovered was profoundly disturbing. A lot of NBFC lending in the recent period was concentrated in one particular industry – real estate – which itself was in a precarious situation. At the end of June 2019, the total number of unsold houses and flats in the top eight cities was almost one million, valued at 8 trillion rupees ($113 billion), or the equivalent to about four years of sales.

Once the extent of their exposure to real estate became known after IL&FS went belly-up, banks, as well as mutual funds, virtually stopped lending to NBFCs. “In some ways, this may have been India’s version of the US housing bubble,” Subramanian and Felman argue.

Worse, it has created a new wave of stress for banks, some of whose credit to shadow banks amount to 10-14% of their loan books. With banks turning cautious – on top of fund-starved NBFCs that had emerged as a key source of lending for small businesses and consumer durable purchases in the post-demonetization period – the flow of commercial credit has collapsed from a peak of 20 trillion rupees in 2018-19 to “virtually nothing” in the first six months of this fiscal year.

Subramanian and Felman say India is now facing a situation of an unresolved legacy balance sheet problem along with a fresh crisis, both of which have pushed the economy into a downward spiral.

The paper says high rates and little credit are causing the economy to slow, thereby intensifying the stress on the corporate sector and on the financial system itself. This has made the financial sector exercise greater caution while lending.

The current slowdown, they note, is worrisome, not only because gross domestic product growth has slowed to 4.5% in the second quarter of 2019-20. Even more distressing is the disaggregated data.

“The growth of consumer goods production has virtually ground to a halt, production of investment goods is falling. Indicators of exports, imports and government revenues are all close to negative territory. These indicators suggest the economy’s illness is severe … [this] slowdown seems closer to the 1991 balance of payments crisis,” they stated.

Second quarter growth of 4.5% was propped up by a 15.64% increase in government expenditure. If that component is left out from gross domestic product, the economy actually grew 3.05%. This non-government part – private consumption expenditure, investment and net exports – forms 87-92% of the economy.

The crisis in 1991 mentioned by Subramanian is considered the worst in independent India’s economic history. The country ran large deficits, accumulated over a long period of time, and as a result faced the balance of payment.

India had to pledge gold reserves, take loans from the IMF and carry other structural adjustments to its economy, sponsored by the IMF and World Bank. The country also changed its economic policies with a greater emphasis on private sector participation and did away with many controls. Various tax reforms were carried out with a view to promoting investment.

Former prime minister Manmohan Singh, the finance minister during that period, was instrumental in framing the new economic policies, which helped the country come out of the crisis as a stronger and more resilient economic power.

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