The battle against the virus is likely to last several more months, implying prolonged curtailment of economic activity to ensure social distancing. The resultant economic pain has been, and is likely to be, broad-based, though it is most acutely felt by the indigent and small-scale enterprises. Not only is it necessary to support the worst-affected, but it is also necessary to preserve India’s economic growth potential, so that, once the restrictions are lifted, the economy quickly reverts to a rapid growth trajectory. The first package (‘How to minimise the damage’, IE, March 28) announced by the Union government focused on the poor, and the second rightly focuses on providing credit to smaller enterprises.
While assessing policy measures during the lockdown, where stimulating new activity has limited value, we believe there are two over-arching principles one must keep in mind. One, the flow of funds slows with economic activity; and two, firms do not go bankrupt because of insolvency, but because of lack of access to funds (also called liquidity). Policymakers the world over are pulling out all stops to make sure that the flow of credit continues. Of the Rs 20-lakh-crore economic support announced by the Prime Minister on May 12, we have details for about Rs 16 lakh crore. Monetary and financial interventions taken by the government and the RBI to provide credit to those who need it make up more than 90 per cent of it.
Most of the measures announced by the RBI earlier have not had the desired effect, with the quantum of cheap funds being made available being more or less the same as the increase in the amount being deposited in the RBI every night by banks. Heightened risk aversion in banks has meant that just reducing the cost of funds had no impact on the volume and cost of the credit they provided. At this stage of the cycle, this is not surprising.
The series of measures announced to provide credit support to the micro, small and medium enterprises (MSMEs) attempts to address this gap. We believe the largest of these schemes is likely to be the most effective, particularly as it comes without too many conditions. For standard MSMEs (that is, those that have been servicing their loans so far), new loans up to 20 per cent of the current outstanding credit will be fully backstopped by the government. That is, if there is a default, the government will pay the bank.
We expect this to drive immediate credit creation, as guarantees are available only for loans extended in the next six months, lenders have zero risk, and the borrowers are most likely stressed and would want these funds. It is possible if not likely that firms will use these loans to just pay interest and cover losses, but if so, that in a way is the purpose of this scheme — the government absorbing losses upfront rather than the (likely larger) lost taxes and potential bank bailouts if there is a bankruptcy. For the government, the costs of this guarantee would be spread over several years, with at most 10 per cent incurred in this fiscal year.
The two schemes together, targeting to provide Rs 75,000 crore of liquidity to non-banking finance companies (NBFCs), may be a bit less successful, however, in our view. The special purpose vehicle that is to provide liquidity to NBFCs provides funds for three months at a time, may be enough to prevent accidents (like an NBFC defaulting due to lack of liquidity). But it may not suffice to get them to grow. The partial credit guarantee given to banks’ loans to NBFCs may be more effective for a subset of NBFCs, but as it is only available to public sector banks, it would depend on their willingness and ability to extend new loans.
The Rs 50,000 crore fund to provide equity for MSMEs, with a corpus of Rs 10,000 crore being provided by the government, which would then be leveraged, is an interesting initiative. Losses incurred in the current lockdown are depleting risk capital, something that the country was short of even before this crisis. Replenishing if not growing that is paramount to restoring India’s growth potential. While global as well as local private equity and venture capital funds would continue to explore and invest in smaller firms, such a fund can scale up the funds availability significantly. Its efficacy though can be judged only after details emerge on the nature of the fund (like its duration, the investors it raises funds from), as well as how it would operate. A sharp increase in credit to farmers, through Kisan Credit Cards (extended to livestock farmers and fishermen) as well as special loans, should also help funds flow in the economy by increasing the quantum of new bank credit.
The natural limitation of the policy interventions thus far is that they only affect enterprises in the formal sector and in agriculture. As we are talking about taxpayer funds and formal savings, it may be unfair to allocate them to informal enterprises. Such measures (or say if the government provides GST credits for liquidity support) may be incentives for firms to formalise, but the pain in informal non-agricultural enterprises may stay unaddressed, and remain an overhang on growth.
While less than 10 per cent of the announcements thus far has been the fiscal cost, the remaining 4 lakh crores of the economic package may have a greater fiscal element, though at this stage it appears unlikely. One senses a fiscal caution in government measures that in our view is overdone, and could hurt more than it helps. By pre-announcing the additional bond issuance for the year, and giving an implicit assurance that additional deficits would be financed separately, bond market volatility has been minimised. Even though that potentially means the RBI purchasing government bonds, the rupee has been remarkably stable — there was fear that fiscal spending financed by the central bank would be frowned upon and drive currency weakness.
The road ahead remains unclear, but it is likely that the economic damage is already much larger than the measures undertaken so far. It is best to see this as the beginning of government action. The scale of government intervention may have to intensify in the coming months. We believe a continued focus on reforms and on sustaining India’s growth potential will be critical in preventing macroeconomic instability.
This article appeared in the print edition of May 15, 2020, under the title ‘The credit lifeline’. The writer is co-head of Asia Pacific Strategy and India Strategist for Credit Suisse