The death of trust

The slowdown blues have not only started to bite but also hurt, and rather badly. The flow of bad news continues uninterrupted despite the slew of economic measures announced by finance minister Nirmala Sitharaman at three separate press conferences. The latest round of negative data came from the World Bank after it reduced India’s gross domestic product (GDP) growth forecast to 6%, in line with the Reserve Bank of India decision to bring the growth figure down from 6.9% to 6.1%. The global credit rating agency, Moody’s, went even further limiting India’s growth story from 6.2% to 5.8% for FY20.

Unfortunately, if FY20 is turning out to be a bad year, things are unlikely to get any better next year. The latest Monetary Policy Report of the central bank shows that fund flows to the corporate sector between April and mid- September 2019, was down to ₹90,995 crore from ₹7,36,087 crore in the same period last year, adding to India Inc.‘s unwillingness to invest in the current economic scenario. Corporate India will continue to deleverage its balance sheet, and wait for better times before making those investments. Banks too have continued to adopt a cautious approach in its lending policies.

Ever since the Central Statistics Office came out with the dismal GDP growth figure of 5% for the first quarter of FY20, things have only gone from bad to worse. Except inflation, all other growth numbers like the Index of Industrial Production—which tracks growth rates of different industry groups—export figures, tax collections, and core sector data have all shown a downward spiral.

For instance, the goods and service tax (GST) collections in September 2019 was less than ₹92,000 crore, the lowest since March 2018, and way below the psychological figure of ₹1 lakh crore. The three major sectors responsible for the lower tax collection were the auto, cement, and steel sectors, a result of the demand slowdown.

So the real question is: Why has the finance minister failed to bring back the feel-good factor in the Indian economy, or ensure a pick-up in corporate investments or consumption despite three announcements, which virtually rewrote the earlier Budget 2019-20? Part of the answer lies in the lack of trust among the various stakeholders in society.

First, many economists and corporate bosses have shown little trust in the government’s numbers or in its constantly changing policy proposals. The GDP numbers announced every quarter find few takers because they do not seem to align with the results coming from other economic parameters of the country like export growth, corporate profitability, investment and savings rate, consumption demand etc.

Similarly, as the Comptroller and Auditor General pointed out before the Finance Commission, the real fiscal deficit of the government in FY19 was not 3.4% but 5.85% of the GDP, because a lot of its own financing had been passed on to government agencies. So, even the fiscal deficit number has to be taken with a pinch of salt.

With the government introducing new laws and constantly changing policy guidelines, changes in income-tax and GST rates for various products in different sectors, India Inc. finds itself in a bind. It is finding it extremely difficult to price its products or the amount to invest in new projects so that the projects can turn profitable in a reasonable time frame. Regular policy changes have also seen foreign portfolio investors moving to other emerging markets.

Secondly, the fear that even if their repayments are delayed by a day, their names will be put in the defaulters list and their businesses dragged into the National Company Law Tribunal is also preventing many companies from making fresh investments. They are also worried that they may be hounded by tax authorities for not paying taxes on time, even though the reasons for such delay could be because of circumstances beyond their control.

While liquidity may not be an issue for banks, with the government infusing ₹3.19 lakh crore in the past five years and another ₹70,000 crore in September 2019, banks are finding it difficult to lend to the right players, again because of the trust factor. The fiscally- sound companies or those with triple A rating are not interested because they already have excess capacity and are unsure of the demand pick-up in the near future; the more needy ones, but with poor ratings, are denied by the banks.

Despite recent government assurances, senior managers of the public sector banks are afraid to take risks, because of the fear of adding to the existing NPAs, and also being questioned by the Central Bureau of Investigation, the Central Vigilance Commission etc, in case these loans were to turn bad even after many years. It is better to be safe than sorry seems to be the motto today.

The government, on its part, has become increasingly wary of the business models of India Inc. and their mission and vision statements, as more and more skeletons tumble out of their closets. The sudden meltdown of one of India’s largest NBFCs, Infrastructure Leasing & Financing Services (IL&FS), and the alleged collusion of auditors, rating agencies, independent directors on the board and top management, came as a shock to the government and it was forced to take immediate corrective steps to prevent the contagion spreading to the entire financial sector.

Defaults on their repayment dues by other NBFCs like DHFL have not helped matters, but has only strengthened the government’s suspicion that many corporates are cooking up their books to shore up their balance sheets, while at the same time siphoning off money from their legitimate businesses. And there are innumerable examples of such cases. The most recent example is the arrest of the brothers Malvinder and Shivinder Singh, former promoters of Religare Enterprises and Fortis Healthcare, on charges of fund diversion and fraud of about ₹2,400 crore by the Economic Offences Wing of the government.

The IL&FS fiasco has created deep distrust in the minds of the banks, which are directly lending to NBFCs, and mutual funds which were subscribing to their corporate bonds and non-convertible bonds, about the credit worthiness of these entities. If such a thing could happen to a player like IL&FS, anything can happen with the other NBFCs, is the refrain. So banks have become far more selective and stopped lending to those with poor credit rating and started evaluating their existing investments. However, such a decision is having adverse consequences for the NBFCs. Not only do they find themselves starved of funds, but are also suffering because many of the projects they had invested in are in no position to return the money.

And when the spotlight shifted to the role of auditors and credit rating agencies in such scams, they were found wanting in the discharge of duties. The government found that it could no longer trust these agencies to give a fair assessment. The Securities and the Exchange Board of India, the regulator for the capital markets and credit rating agencies, came up with stringent measures to block every loophole that was used by these rating agencies to give higher rating to these companies. Auditors suddenly find themselves not only being tried and punished for their failures, but the rules becoming far more stringent and a new regulatory body coming into play to set guidelines and monitor the performance of these audit firms.

Today, even the common investor has lost his trust in these agencies, including the board members, and realizes that he cannot take their words for granted. He has to remain circumspect of every positive statement and always remain on guard. There is nothing that is sacrosanct today.

Again, the rising tide NPA levels in the banks—private and public—and the implosion of the Punjab and Maharashtra Co-operative Bank has raised serious doubts on the RBI’s ability to scrutinize the books of banks and raise red flags when necessary. The government’s earlier criticism of the RBI’s role in failing to curb NPA levels did lead to much heated debate between the finance ministry and the central bank. But the recent PMC failure has put the spotlight on the central bank again.

While it is true that the central bank and the state governments run these co-operative banks jointly, but just ticking the right boxes by the RBI is not really the solution, especially when the fate of so many individuals are at stake. The failure of the RBI and the state government to properly monitor the functioning of the bank has come at a huge cost to the poor depositor, who finds limits set on his withdrawals.

The only way to resolve the complex issue is to kick-start the economy. While it calls for a host of reforms, including reducing land acquisition costs, having a more flexible labour policy, re-training workers for the new age, ensuring that farmers get the right price for their produce, building trust among the various stakeholders in the society is equally important, if not the most important part of the changes which are needed.

Only then will the tide turn.