|Demand of the question
Introduction. Contextual introduction.
Body. About the four balance sheet. Various reasons for the same.
Conclusion. Way forward.
India is undergoing economic slowdown and the Four balance sheet problem. While twin balance sheet was about bank loans made to steel, power, and infrastructure sector companies during the investment boom of 2004-11 turning bad, four balance sheet is largely a post-demonetisation phenomenon, involving non-banking financial companies (NBFCs) and real estate firms. As a result, the GDP is growing down.
About the problem of Four balance sheet: The economic Slowdown resulted from a balance sheet crisis arrived in two waves:
- The Twin Balance Sheet crisis: Encompassing banks and infrastructure companies
The problem began after the global financial crisis, when the world economy slowed down.
- NBFC and real estate sector crisis: The second wave of crisis includedcollapse of a credit boom, led by NBFCs, and the real estate sector. NBFC-led credit boom financed unsustainable real estate inventory accumulation, inflating a bubble that finally burst in 2019. Thus, consumption too has now decreased, causing growth to collapse. As a result, India is now facing a Four Balance Sheet challenge, the original two sectors, plus NBFCs and real estate companies. The collapse owed to the recognition that the boom involved unsustainable financing of a rising inventory of unsold housing.
Reasons for 4-balance sheet problem:
- Big consumption fall: The reason for 4-balance sheet problem is a slump in consumption, or demand. The slide is bigger in rural areas. The 75th round of the Consumer Expenditure Survey 2017-18 showed that average spending by a person had fallen 3.7% to Rs 1,446 per month in 2017-18- the steepest fall in more than four decades.
- Less private expenditure: Only government spending is keeping the economy afloat. Government’s final consumption expenditure grew by 15.6% from 8.8% in one year. Due to balance sheet issues and incurring heavy operational losses, companies are taking lesser risks.
- Income effect: Multiple indicators, such as slowing rural wages and consumption, point to either a fall in incomes or slower growth in personal incomes. The Indian consumer has turned skeptical because costs have gone up and incomes have stagnated.
- Credit crunch: It is an immutable law that economic growth depends on investment and exports. A credit crunch by shadow banks or non-banking financial corporations (NBFCs) has had a reverse multiplier effect, meaning the pool of ‘loan-able’ funds has shrunk, leading to high borrowing costs and drying up of new investments and jobs.
Challenges before the government to solve the 4-balance sheet problem:
- Limitation of the RBI’s monetary policy: Monetary policy is limited due to non-transmission of benefits to customers by banks, which impedes the pass-through of cuts in policy rates to lending rates. The rising non-performing assets (NPAs), led to banking system not passing on the benefits of easing monetary policy to its customers.
- No Scope for Fiscal stimulus: Fiscal deficit is already high. Larger bond issues will only further crowd out the private sector, by pushing up already-high interest rates. Strengthened IBC cannot solve the crisis in power-sector and real estate. Also fiscal deficit target is breached, therefore limiting space for fiscal spending.
- Difficulty of private sector-led solution: The viability of power assets is inextricably entwined with government policies. For example, demand for power depends on whether the state electricity boards are financially strong enough to buy the power that the public is demanding. There has also been a crowding out effect due to large public borrowings by the government. Government spending has failed to increase overall aggregate demand because higher government spending caused an equivalent fall in private sector spending and investment.
- Policies measures need to focus on recognising and conducting a new Asset Quality Review to cover banks and NBFC.
- It is important to make changes to the IBC to ensure that participants actually have incentives to solve the problem and ultimately lead to resolution of the balance sheet crisis. 3. There is a need to create public sector asset restructuring companies (bad banks), one each for the real estate and power sectors.
- It is important to focus on strengthening regulation and oversight, especially of NBFCs with stringent norms.
In the short-term, the government will have to boost three growth pillars, personal incomes, demand and government spending. As well as giving industrial stimuli like the recent corporate tax rate cut, the government also needs to put more money directly into the hands of people. Clearly, action must be taken to stabilise the economy and get it back on the path of rapid growth.