It will be interesting to see how RBI manages the domino effect of debt default once the the moratorium on interest and principal repayment is over.
Finance Minister Nirmala Sitharaman needs to be applauded for presenting a well directed plan for reviving the small and medium scale industry. As the Finance Minister unveiled her six point program to revamp the MSME sector, one needs to add that the MSME sector is largely dependent on the bigger industries for business. A very large number of Small and Medium Scale Industries are B2B suppliers to larger industries who have the money power and the marketing clout to sell to retail consumers. That money source has suddenly gone dry.
Over the last four years banks have reduced lending to the industry to near zero levels, despite the many government circulars asking them to support the industry. You cannot fault them for their actions. They are caught in a dilemma of too many conflicting directives from the RBI and the government. There have been half a dozen packages announced by the Government including for the MSME sector previously, but none of the previous credit disbursal moves to the industry have succeeded. So the Finance Ministry and the RBI needs to do a rethink.
Banks shun industry, step up retail credit
New bank loans to the industry that was a little below 30% of the total loans in the year 2015 dropped by half next year following the implementation of Asset Quality Review in October 2015 by the banks. As the bankruptcy proceedings started and hundreds of companies were sent to the NCLT courts, the banks became more risk averse to industrial loans. It was pretty apparent that if safe lending practices were to be followed, the industry needed to reduce leverage if further default was to be averted. As per the RBI data there was near zero industrial loans sanctioned by banks in the financial year ending March 2017 and the percentage of new loans rose marginally to 3.3% in 2017-18.
The banks had literally no choice. If they had to reduce NPAs, they would have to steer clear of industrial loans which have a high risk factor. The bankruptcy courts though functioning offered little respite to the lenders during the initial years. Ever since 2015, the rate of recovery at the bankruptcy courts has been only around 10%, the highest being in the year 2015-16 when 14% of the Rs. 57,585 crores of bad loan were resolved and yielded Rs 8096 crores to the banks. The write-offs each year have been massive and are climbing. So the banks formulated their own survival strategy irrespective of what the Government said. A look at the overall non-food credit figures published by the RBI tells the story. The total outstanding amount lent by banks to the industry dropped from 40% to 35% and outstanding retail loans grew instead from 20% to 25% between 2015 to 2018, compensating for the drop in industry loans.
Lockdown 3.0 and beyond needs introspection
The industrial credit situation was already bleak and unlikely to improve in a hurry. Banks still had over a third of its capital stuck with industrial loans. This was the rather dismal situation even before Covid-19 pandemic and the extended lockdown. With the first two lockdowns that lasted for over a month it was fairly clear that the Coronavirus would not go away in a hurry and some casualties were inevitable. The health officials and the administrators had also breathing time to create infrastructure and the governments had a reasonable window to formulate a long term strategy.
Five days before lockdown 3.0 on 27th April 2020 the states of Delhi (AAP), Odisha (BJD), Maharashtra (Shivsena, NCP, Congress), Madhya Pradesh (BJP) , West Bengal ( TMC) and Punjab (Congress ) batted for an extended lockdown of two more weeks. The usually bickering political opponents were all on the same page possibly because the bureaucracy and the administration which still has the ‘control mentality’ of the licence permit raj, chose to lock down the nation for another two weeks. The Central Government instead of allowing those 6 states to implement a lockdown, imposed Lockdown 3.0 on all 36 states and Union Territories. It was a surprising decision, for the citizens had expected opening up of the economy with a small negative list. Whereas democratically elected leaders and their bureaucracy have the right to take such decisions, which one must respect, let us see what this means for the industry.
If industries default will banks survive?
Firstly, extended lockdown decisions sparked off a massive wave of job losses and migration of nearly 3 million factory workers. Besides it will also cause serious debt defaults devastating both the industry and the banking sector when the lockdowns are removed. Already the lockdown has demonstrated a zero risk lending tendency of the risk averse banking sector. Banks that used to deposit around Rs 3 lakh crore daily with the RBI started depositing Rs 7 lakh crore daily with the RBI under the reverse repo window, with a bare minimum 1% margin but at no risk.
There is liquidity in the system but no bank is ready to lend money to industries. The industry is today struggling. Three out of four units are expected to make losses this year and almost 50% of the industries may turn sick due to this prolonged lockdown. It will be similar to getting back from strikes and lockouts of the sixties era. The banks are no longer offering fresh credit to industries. But will the banks be able to survive if 50% of their industrial borrowers turn sick. With 35% of their outstanding debt to the industry, banks must watch their back as they squeeze out industrial credit. It will be interesting to see how RBI manages the domino effect of debt default once the the moratorium on interest and principal repayment is over.
(Views expressed by the author are his own and not of economictimes.com)