This was inevitable. Andy Mukherjee of Bloomberg had suggested on 13th January that the Government of India (GoI) and the Reserve Bank of India (RBI) must bite the bullet but budget time-table came in the way, I guess. Even then another month had elapsed.
Hence, some are concerned that there could still be a big contagion like it happened in the case of the collapse of IL&FS in October 2018. Possible. One can never say never to things in fluid and rapidly evolving local and global situations.
However, there is an important difference between October 2018 and now. Then, RBI leadership took a rigid, uncompromising and doctrinaire approach to both liquidity provision and inflation targeting. Monetary policy was restrictive and liquidity provision was inadequate. Indeed, RBI had an important role to play in precipitating India’s economic slowdown in 2018.
The current RBI leadership is more pragmatic and less academic. Hence, the hope is that the repeat of the ripple effects of the collapse of IL&FS would be avoided now.
What follows are my (current) take-aways and the situation could evolve differently. I am aware.
(1) Since the financial system was already largely impaired and credit to non-financial industry was growing at below 5%, there cannot be a big incremental damage.
(2) Lenders to YES Bank and investors in YES Bank would take a hit. Mutual funds list is there. But, most of them have already marked down their exposure to zero value (see https://www.bloombergquint.com/business/heres-how-much-mutual-funds-are-exposed-to-yes-bank-debt)
(3) State Bank of India (SBI) has assets ten time (10.3x) the size of YES Bank (Ref: https://www.bloombergquint.com/global-economics/india-must-end-yes-bank-s-theater-of-the-absurd). Together, the Life Insurance Corporation of India (LIC) and SBI can absorb this.
Pl. read the excellent article by Aarati Krishnan of ‘BusinessLine’ on the portfolio of LIC and how secure it is.
(4) Some market commentators point to potential contagion effects. At this stage, the analysis is largely speculative. Withdrawal limit of Rupees 50,000.00 is reasonable for retail depositors and, in any case, and curbs on depositors’ withdrawals will likely go well before April 3.
As for loans to small and medium enterprises, as noted earlier, loans have already dried up and, hence, the incremental impact will be negligible, if at all.
Settlement of derivatives positions has to be clarified. I have no doubt that, before too long, RBI will issue necessary clarifications.
As for the impact on stock markets, they were unsettled even before this development, by global developments. One should not be worried by potential action in stock markets and further declines. Stock prices will become cheaper for long-term investors.
The real issue is how the clients of YES Bank would fund themselves going forward. While most of them would have made or attempted to make alternative arrangements in the last few months, this space has to be watched. Incremental credit crunch needs to be avoided.
(5) There is also a view circulating that meaningful reforms would happen in India only with personnel and leadership change in the Ministry of Finance. That is mischievous.
There have been corporate and personal income tax cuts; consolidation of public sector banks; government’s intent to get out of IDBI has been announced; the Finance Minister has followed through on de-criminalising many of the violations of the provisions of the Companies Act; the budget has improved transparency of the fiscal arithmetic, etc.
India’s economic growth slowdown is due to the financial sector crisis and history has it that all economies experience a deep and prolonged slowdown when the slowdown is set off by banking and financial sector crises. India is not experiencing uniquely severe slowdown.
Yes, this is an opportunity for meaningful reforms. Yes, it is an opportunity to redefine the balance between government-owned and privately owned commercial banks. But, the solution to all problems is not privatisation and privately-owned banks in advanced economies nearly collapsed the world economy in 2008 and might do so again. Indeed, the collapse of the YES Bank is a cautionary tale of the so-called superiority of the model of private ownership in financial institutions.
That said, the opportunity to improve the resilience of India’s financial system as much as possible remains to be grasped.
Availability of liquidity for Small and Medium Enterprises (SME) is largely a working capital issue and that is as much a failure of banks to make risk-based lending as it is that of large buyers of MSME supplies not paying on time – both government and non-government buyers. That is a systemic change and change in MoF leadership will not solve the issue.
(6) Covid-19, as of now, has had limited impact on India’s health system and the number of infections is exceedingly low, for a large country. India escaped SARS because, by February, India turns warm. It is no exception this time. I expect India to be less affected than most countries.
Covid-19 might also end up contributing to an improvement in India’s bilateral trade deficit with China. See the positive Cummins India story, for example. It could be repeated in other cases.
Overall balance of payments would be less affected as reduced investment flows would be offset by improved trade balance and I don’t see the current account deficit worsening, because of still-weak economic growth impulses and further likely delays in the recovery of investment demand. Further, crude oil prices will remain depressed for the year, helping keep India’s import bill under check. Recent rupee weakness is not a cause for worry and perhaps is, on balance, a good thing.
There will be supply chain disruptions to some industries. Some analysts wonder whether the impact of Covid-19 would be inflationary or deflationary in India. I think it would be mostly deflationary rather than inflationary and hence, allowing RBI room to continue to ease policy conventionally and unconventionally.
India’s economic growth rate for 2020-21 could be 5.5% (my personal central case) with downside risk all the way to 5%. That is the current estimated growth rate for 2019-20.
By the time the dust settles on Covid-19, it might turn out to have done a good deed for India for some of the migration of global supply chain out of China would not be easily reversed. For example, see this riveting story on how the incidence of swine flu conitnues to be suppressed in China. By now, it is common knowledge that the outbreak of Covid 19 had happened a month before the world came to know of it.
It is significant that a cross-party group of twenty senators has urged the UK government to reconsider granting Huawei a role in the country’s 5G telephone network.
(7) Finally, visible leadership from the very top and communication are essential. Such communication too should be non-defensive and non-reactive. They should merely aim to reassure and soothe rather than refute genuine or exaggerated criticisms.
Being a commentator in these times is far easier than to be a decision-maker. Arm-chair wisdom is relatively intellectually undemanding and most of it is with the benefit of hindsight too. In the rush to get their story out, commentators make big errors. Imagine how difficult it must be to make decisions in real-time under uncertainty often with imperfect and inadequate information?!
Decision-makers should ignore commentators and simply focus on communicating and taking decisions with only one consideration:
Help, if and only if possible, in the short-term, without sacrificing the medium to long-term growth prospects.
Overall, it is possible for India to end the year with a stronger and better base for faster growth with some reasonable steps combined with a calming and reassuring communication. Noise can and should be ignored.