Nirupama Soundararajan & Manuj Joshi
Budget consultations must have begun in North Block. This is the last budget the Modi government has to make an impact before the general elections in 2019. Most believe that in view of the elections, the 2018 budget will be a populist one. While many measures may well be populist, the budget also gives the Modi government one final chance to trigger economic growth and employment. Many have attributed the slowdown in the economy to demonetisation, to GST’s disruptive effect and even to high interest rates. Each would have an impact on growth; but these cannot be the only or even the most significant reasons for the slowdown. The main reason is the slump in private investments, the impact of which has been accentuated by the disruptions of demonetisation and GST.
The credit off-take for banking in India has been slow. Overall lending has contracted by 4.3% from the peak of Rs 27,454 billion in April 2016 to Rs 26,279 billion in July 2017. Data clearly show that the credit to the industry as a whole has declined since March 2016, with the major brunt being observed in infrastructure sector, chemicals, and other metals. It is not without reason that the lending volumes have declined. The twin balance-sheet problem continues to take its toll on bank lending.
Many corporate borrowers have been notorious for not paying back their loans. The Financial Express had reported a total number of 5,632 wilful defaulters who cumulatively owe Rs 58,775.5 crore. To put it in perspective, while NPAs, as a percentage of GDP, amount to 11.2%, money owed by wilful defaulters makes for 1.9%. The twin balance-sheet problem is a vicious circle that has put the Indian economy in a precarious position. Banks are unwilling to lend because of growing NPAs in the corporate sector. The lack of credit is affecting private sector profitability, pushing many over the brink, into becoming NPAs. We need to break this vicious cycle. For this, there are two possible solutions.
The first and the more extreme measure is to allow banks to bottom out and recapitalise them completely so that they can make a fresh start even as insolvency proceedings continue to take place. This will certainly upset FRBM targets but this may be worth considering as a one-time measure to stimulate the banking sector. The second solution would be to reduce funding dependence on banking and turn to the capital markets. A liquid bond market, along with an efficient banking sector, can effectively meet the growing demands for long-term capital. Empirical studies suggest that bond financing can not only reduce economic vulnerability to shocks but can also significantly mitigate systemic risks through diversification of investment and credit risks. However, India, until recently, didn’t have a bond market worth mentioning.
There has been a recent surge of investments in the corporate bond market. Data show that the average daily corporate bond investments have been consistently rising since December 2016 and have achieved an approximate 42.3% increase as on date. In mid-September, the percentage utilisation of the limit for foreign portfolio investment in corporate bonds reached 99.99% indicating foreign investors’ confidence in the Indian market.
Recognising the demand and the need for investment flows, RBI shifted masala bonds from being part of FPI limits in corporate bonds to being subject to External Commercial Borrowing (ECB) limits. The additional 18% headroom created will be available for further investments by FPIs over the next two quarters. FPIs will also have a chance to invest more in masala bonds because of their new classification. The investment in masala bonds has increased approximately 6 times between October 2016 and August 2017.
But these are the changes of the recent past. What merits attention is the reason for this surge in FPI investments since December 2016. While there may be many market changes, a significant reason for this jump is the Insolvency and Bankruptcy Code (IBC). In a recent seminar in Mumbai organised by Pahle India Foundation and BSE, on “Managing NPAs through the Insolvency and Bankruptcy Board”, MS Sahoo, chairman of the Board, alluded to how the Code was drafted, passed and operationalised, all in a matter of 13 months, when even developed countries have taken years. That, within nine months, the Tribunal has admitted, heard, and resolved as many as 655 cases is reason enough for bond investors to rejoice since insolvency and bankruptcy can now be resolved in a timely manner.
The Ease of Doing Business data as published by World Bank show that it takes an average of 4.3 years for insolvency resolution with an average recovery rate of only 26%. The Code however is hopeful of initiating the Insolvency Resolution Process within 180 days of default. All consideration of restructuring of the company will happen in a time-bound manner rather than dragging on indefinitely.
Although the IBC is not for the purpose of recovery but to provide resolution and justice to all stakeholders, it is bound to increase recovery rates with the streamlined and time-bound process. Even though it is too soon to conduct any rigorous empirical study, at first glance, it seems evident that the IBC has had a positive impact in attracting investors into the bond market. Over the next few years, market customs, bylaws and case laws will develop which will only improve the functioning of the Code.
This would also mean more investments, domestic and foreign, into the Indian bond market, instilling the much needed liquidity that it has always lacked. Once India’s bond markets pick up, financing India’s growth will no longer fall on the sole shoulders of Indian banking system.
Soundararajan is senior fellow, and Joshi is research associate, Pahle India Foundation. Views are personal.