The government has shown a consistent commitment towards boosting India’s GDP to $5 trillion by 2025. That is unlikely to happen unless the financial sector is taken care of. Here is why! Firstly, it is the lubricant that keeps the wheels of the economy churning. Secondly, financial services account for nearly 42% of the Nifty, and hence, value creation is contingent on this sector. Lastly, this sector is closely linked to consumption and easy financing options are the key to the growth of sectors like automobiles, realty and consumer durables.
Here are five agenda items for Budget 2020 to boost the financial sector
Special package for NBFCs and real estate
The NBFC sector has been in trouble since the middle of 2018 when the IL&FS fiasco first exploded. In the last two years, we had two major bankruptcies in the form of IL&FS and DHFL along with a number of smaller ones. For the Indian financial sector to stabilize, it is essential to arrest the downtrend in the NBFC sector. This sector not only provides last-mile funding for banks, but is the key to the growth of the real estate sector. The budget needs to ensure three things. Firstly, the NBFCs that can be revived or restructured need urgent access to finance at reasonable cost. Secondly, the bankruptcy of IL&FS and DHFL needs to be handled deftly to avoid contagion. Lastly, the government must look to subsidize NBFC loans to realty sector as that would hit two birds with one stone.
Banks need to be recapitalized
The government has sunk in Rs70,000cr in the last fiscal and may have to do one more round of recapitalization to enable PSU banks to start lending in a big way. They are still constrained on credit creation due to limited capital. Bank mergers have to be activated this year and the government has to take a call on banks where NPA levels are sticky. The earlier this decision is taken, the quicker the government can move ahead with banking reforms. Of course, the RBI and the government also need to take a quick call on stressed banks in the private sector like Yes Bank which could pose a systemic risk.
Time to review the FRDI Bill
It may be recollected that the FRDI Bill (Financial Resolution and Deposit Insurance) 1999 proposed financial resolution and deposit insurance under one roof. Indian depositors had reacted negatively to the “bail in” provision since depositors did not want to participate in bankruptcy losses. In the past, the government managed to rescue large and systemically important banks through directed mergers but that is not feasible in the long run. PMC Bank highlights this problem. It is time for the FRDI Bill to provide clarity that depositors need to acknowledge their risk in the event of bankruptcy.
Catalyzing credit growth must be the priority
In the last few years, the RBI had observed that bank credit growth had fallen to a multi-year low. That is not the sign of a healthy economy. While disintermediation is part of the problem, there is also lack of credit demand. That is partly due to borrowers turning circumspect and partly due to high cost of funds. Today, credit pick-up is not happening despite the RBI cutting repo rates by 135bps during 2019. High returns on small savings have put a limit on rate transmission. To catalyze credit growth by banks, Budget 2020 will have to address the twin challenges of cutting rates on small savings and boosting credit demand through consumption.
Ensure that fiscal discipline is not breached
Now, that looks like a tightrope walk! How to keep fiscal deficit in check when the government needs to boost consumption? The NK Singh Committee had permitted a 50bps leeway to the fiscal deficit and that may be used this year only as an exception. Higher fiscal deficit has other consequences. It leads to crowding out of private borrowings and increases the bond yields in the market. That is hardly conducive to credit growth. Secondly, it has been observed in the past that foreign portfolio investors and rating agencies look at fiscal discipline favourably and India cannot afford to displease them. The government is planning to raise $28 billion off the budget but that is the kind of accounting jugglery that does not go down well with global investors.
Revival in growth is unlikely unless the banks and NBFCs become robust once again. That will be a major challenge for Budget 2020.