India’s slowdown, US Subprime crisis: Learning lessons

The recent S&P ‘Stress test’ which put Indian non-banking finance companies (NBFCs) at the risk of contagion is of serious concern. It does not augur well at a time when the economy is reeling under the pressure of a slowdown. The close association between the financial sector (banks, NBFCs, other financial institutions) and the real sector (goods and services markets) indicates that any stress in the financial sector will spill over to the real sector, albeit with some lag.

The loss of confidence in financial institutions, followed by a liquidity crunch and evaporation of credit for the real sector, leading to a slashing of jobs and an overall reduction in output has, of course, happened before and has happened in greater severity. It was called the Subprime crisis, which began in September 2008 and continued well into the summer of 2009. The cost of this crisis from 2008 to 2018 on the GDP of the United States was estimated to be $7.6 trillion, and a lifetime present value income loss of $70,000 for every American. India could benefit by taking into cognizance the similarities and dissimilarities between the two economies and the applicability of the lessons learnt a decade ago.

The IF&LS crisis, which triggered a panic over the state of the NBFC sector, is akin to the crash of Lehman Brothers in the US. The Lehman crash sent other shadow banks, such as AIG, Merrill-Lynch and Wachovia, into deep waters. Similarly, the contagion of IF&LS spread to Reliance ADAG, DHFL and others who began defaulting on their repayments as well. The crisis in the US financial system was due to the large-scale home loans disbursed without proper checking of credit repayment capacity. In the Indian scenario, loans provided to real estate builders without checking whether they had clearances to the titles of the lands and squandering the savings of the common man by providing credit to enterprises with connections to the banks, all will cost the Indian citizen dearly.

The spill-over of financial sector distress leads to evaporation of corporate credit, affecting the working capital requirements and expansion plans of manufacturing industries. The scaling back of manufacturing activities leads to job and income losses, having a direct bearing on the demand for goods and services, thus creating a vicious cycle of lower demand leading to further cuts in production and supply. India’s data on job losses suggests nearly 1.2 million jobs were lost in the auto and auto-component manufacturing sector as of July, which had risen to 1.35 million jobs by August. According to the NSSO labour force survey (2017-18), the overall unemployment had already risen to 6.1%, the highest in 45 years, with higher unemployment rates among urban youth.

There are other internal and external factors that plague the Indian economy at present. The back-to-back implementation of demonetization and GST has left the economy gasping for air. The large unskilled and uneducated population with low productivity is already a major cause of concern not just for the present but also for the future. It seems very likely that India is going to miss reaping its demographic dividend with the future generations also languishing due to malnutrition and stunting. In addition, ‘slowbalisation’ is already leaving its impact on the Indian economy. India’s exports and imports shrunk by 6.6% and 13.9% in September this year.

Steps to combat crisis

The US overcame its crisis by exploiting both its fiscal and monetary powers. The monetary policy included, firstly, bringing the interest rates to zero and implementing the troubled assets relief program (TARP) to remove the toxic assets (NPAs) from the balance sheets of banks; and secondly, the quantitative easing (QE) program to induce large swathes of liquidity into the economy. The fiscal stimulus included tax cuts, increased push for public works and increased finances to state governments. The entire fiscal stimulus amounted to 3.4% of the country’s GDP from 2008 to 2012.

India has, on similar lines, infused Rs 1.6 lakh crore into public sector banks in 2017-18 and followed it up with a further infusion of Rs 70,000 for 2019-20. The RBI’s repo rate has been slashed to a decadal low of 5.15% to induce economic activity. Large-scale mergers of public sector banks, a proposal for stronger control of NBFCs by bringing them under the purview of the RBI are steps taken to stabilize the financial sector. The release of RBI reserves to the tune of Rs 1.76 lakh crore in 2018-19 may also ease the fiscal constraints, if utilized prudently.

The government has also cut corporate taxes and disbursed credit through loan melas. Yet, the steps taken so far may not be sufficient to overcome the slowdown.

Implementing lessons learnt

The government needs to accept that the Indian economy is in dire straits, and that cosmetic improvements will not solve our issues. It needs all the political will and financial support it can muster to throttle the economy forward. The main lesson that can be learnt from the US crisis management is transparency, which is the key to solving these issues.

On the monetary front, stress tests for all banks would reduce the problem of moral hazard, and assistance can be extended to the ones that need it, rather than creating a run on all banks. One could also consider the issuance of NRI bonds, which can increase the fund available to be invested in productive assets for the economy.

On the fiscal front, expanding the reach of MGNREGA could help rebuild rural infrastructure, especially that battered by floods, and put money into the hands of the rural sector to boost consumption. The key to revival is increasing domestic demand, which can be achieved by increasing the disposable income through tax cuts and fixing the GST slabs at lower bounds.

In the medium term, the government and the RBI need to combat the economic slowdown, yet at the same time focus on the long-term goal of developing human capital so as to benefit from the demographic dividend through increased attention to nutrition, healthcare and education. These challenging times suggest an increased spending by the government to uplift the people and its economy, rather than strict adherence to fiscal targets which may not augur well for reviving growth.

(The writer is Research Fellow, Fiscal Policy Institute, Bengaluru)