(Refiles with correction to punctuation in headline)
(The author is a Reuters Breakingviews columnist. The
opinions expressed are his own)
By Andy Mukherjee
SINGAPORE, Nov 20 (Reuters Breakingviews) - The slowing
Indian economy is not responding to shock therapy. The stock
market rally that began in September after the government
unveiled its high-decibel reforms programme is fizzling out.
The country's benchmark index failed this month to surpass
its October peak - a bearish sign for chart watchers. The rupee
has weakened 7 percent since Oct. 4.
In some ways, the Indian selloff mirrors the fate of risky
securities globally. The MSCI Emerging Markets Index is now
lower than when the Federal Reserve launched its third round of
quantitative easing on Sept. 13.
Fears of untimely fiscal cutbacks in the United States and a
deepening of the sclerosis in the euro zone are weighing on
sentiment. But skittish investors are only one part of the
story. A much bigger challenge for India is the deteriorating
financial cycle. A Breakingviews analysis of 16 years of monthly
bank loan data shows that - after stripping out trend growth and
seasonal fluctuations - the cyclical downturn in credit that
began in early 2008 is yet to level off, let alone begin a
That's hardly unusual. Financial downturns tend to last
several years, while a typical business cycle recession tends to
be over in about 12 months, according to a study by Bank for
International Settlements researchers Mathias Drehmann, Claudio
Borio and Kostas Tsatsaronis.
In a bank-dominated financial system like India's, the
lending and borrowing cycle is of particular relevance to
investors. The benchmark Nifty equity index more than quadrupled
during the credit boom that began in late 2003 and lasted
through early 2008. It is currently trading 11 percent below its
January 2008 high.
By pruning fuel subsidies, and announcing its decision to
open up retail, aviation and insurance industries to greater
foreign participation, the government has stoked expectations of
an investment-led revival in an economy that grew as little as
5.5 percent in the June quarter, its worst fiscal first-quarter
performance in a decade.
But recent economic data from New Delhi belie expectations
of a quick recovery. Capital goods production, which has been
lacklustre for almost a year now, collapsed in September even as
the country's trade deficit widened to a staggering 14 percent
of GDP on an annualized basis last month. With consumer prices
rising about 10 percent year-on-year in October, investors are
not expecting more than a couple of quarter-percentage-point
interest rate cuts in the first half of next year.
A token reduction in the central bank's policy rate of 8
percent will have some impact on borrowing decisions; but it
will be small and come with a considerable lag. Meanwhile, more
existing bank loans will go bad. By March next year, 10 percent
or more of Indian lenders' loan books will consist of either
non-performing or restructured debt, according to Fitch Ratings.
It isn't easy to revive investments when lenders, especially
state-run banks, are struggling to cope with past mistakes.
Borrowers, too, are in dire straits. The most intrepid
investors between 2004 and 2007 were home-grown entrepreneurs
and business families. They behaved very differently from
government-owned companies and multinationals by gallantly
expanding into industries about which they knew little. These
"growth champions" are today among the most indebted Indian
businesses, according to research by brokerage firm Jefferies.
One obvious solution is for the government to inject fresh
capital into state-run banks. The $3 billion that the government
has set aside for this purpose in this year's federal budget is
inadequate. Just one debtor - Kingfisher Airlines - owes lenders
more than $1 billion. If the grounded carrier doesn't fly again,
very little of this amount may be recovered.
As the controlling shareholder, the government should do
much more to bolster the balance sheets of state banks. But it
is also cash-strapped. A recent auction of telecom spectrum
fetched the exchequer less than a fourth of the $7 billion
revenue target. The annual budget deficit is at risk of wildly
overshooting finance minister P Chidambaram's revised goal of
5.3 percent of GDP.
Chidambaram is trying a different strategy to end the credit
downturn. He has asked the central bank to start giving out new
banking licences quickly. Tactically, it is a smart ploy. New
private lenders will bring in fresh equity and give the jaded
banking system an additional loss-absorbing cushion.
But the Reserve Bank of India, which hasn't issued any new
banking licences in 10 years, is holding up the finance
ministry's plan, and for good reasons. Before it allows new
deposit-taking institutions to be set up, including by
non-financial corporate groups, the RBI, which is also the
country's banking supervisor, wants the legal authority to sack
rogue bank boards. Amendments to the country's banking laws that
would have accorded the monetary authority such wide-ranging
powers were introduced in parliament seven years ago. They were
never passed. The central bank is quite right to be circumspect,
even at the cost of annoying the finance minister.
Pending an infusion of new capital into the banking system,
the government is seeking to counter the cyclical downturn by
cajoling cash-rich state-owned firms to speed up investments. A
better strategy would be for the government to curtail its own
consumption expenditure and reduce its borrowings. More
household savings would then be freed up for corporate
investments, and not just by state-controlled companies. But
fiscal consolidation in a slowing economy has to be gradual,
lest it makes the short-term growth challenge worse.
It's already been about five years since the end of the last
big credit boom in India. On present evidence, seven lean years
is not a far-fetched proposition.
- Graphic - India's deepening downturn: link.reuters.com/quz93t
- Reuters: Indian officials concede new deficit target
already looking doubtful
- For previous columns by the author, Reuters customers can
(Editing by Peter Thal Larsen and Katrina Hamlin)