Humpty Dumpty Economy

Outlook India, October 22, 2018

A falling rupee, a tumbling stock market wiping out the gains of the year, more bad news on the banks front, a deficient though well-spread monsoon, rising oil prices and increasing signs of discontent among farmers are but a few counts of unease on the horizon barely six months ahead of the crucial 2019 general elections. The une­ase persists despite the 8.2 per cent GDP growth recorded in the first quarter of 2018-19 fiscal year. Many of the issues are interlinked, while others are due to the policymakers’ faulty or unrealistic expectations—for example, that by merely announcing higher minimum support price, they can ensure farmers get rightful prices for their produce.

Even as the government grapples to come to grips with non-performing ass­ets (NPAs), and tries to recover the outstanding dues from some of the top loan defaulters, steps taken to stabilise infrastructure-funding major IL&FS is further eroding consumer confidence in banks. A recent study by online consumer group, LocalCircles, has found growing concern about the operations of both public-sector and private banks over NPAs and other issues. According to CUTS International fellow Amol Kulkarni, while consumer confidence in banks has been eroded to an extent, not enough is being done to edu­cate consumers about efficient alt­er­natives to invest their money in. “There are financial markets and other possibilities of investing funds, but they have not been adequately promoted, leaving consumers less aware of the options to non-performing and less-paying avenues in banks, which are at high risk bec­ause of NPAs and other areas of inadequate performance,” says Kulkarni.

Most consumers still bank with public sector banks (PSBs) due to the confidence that the government will not let them fail. After the merger of five subsidiaries with the State Bank of India (SBI), the government has been working on creating more such mega banks. Kulkarni argues that government backing for PSBs is an inefficient market practice as the market should determine whether a bank should be running or sent for liquidation “as that is how capital can be efficiently allocated”.

Mahesh Vyas, managing director and CEO of Centre for Monitoring Indian Economy (CMIE) Pvt Ltd, points out that there is no talk of banks not being financially sound or safe despite the consumer anger against bank scams. “Building confidence in banks is important as they are still the safest compared to any other institution such as the equity market, the debt market, the NBFCs (non-banking financial companies), gold or real estate,” says Vyas. Agreeing that banks remain the safest as they keep a large part of their money in government security CRISIL Limited chief economist Dharmakirti Joshi says, “We have seen a lot of muck come out, but that doesn’t mean it will be deleterious to the banking system. In fact, it will help the whole sector improve.”

Besides banks, another financial sector entity, the Life Insurance Corporation (LIC), has been in the news lately owing to links with the near-bankrupt IL&FS. The fact that the government treats this institution as a bailout entity—whether it is for helping a tottering PSU or in its so-called disinvestment exercise—has been a cause of much concern. While questioning policymakers’ moves, market experts are divided on LIC’s robustness in the long term.

Pankaj Murarka, founder, Renaissance Investment Managers, points out that LIC’s strength lies in being a government-run institution, with a large corpus of funds under its management that is invested in equity and debt markets. “While the recent credit event in IL&FS and LIC’s intention of participating in its revival plan cast a shadow on potential investment returns on the funds that LIC manages, we believe it doesn’t imp­act the long-term existence of the institution, given its size and government backing,” says Murarka. But Prof Raghav Gaiha of Global Development Institute, Univ­ersity of Manchester, has concerns about the long-term impact of LIC’s act­ions. “Unfortunately, it is not safe, given its huge exposure to state-owned banks overloaded with NPAs, their bailout and, more recently, the collapse of IL&FS. It is indeed alarming that LIC is saddled with financial burdens it is not equipped to overcome, putting at risk the savings of millions of small savers,” says Gaiha.

Vyas too argues that the LIC’s long-term strength is being compromised with the government dumping on it ­INS­titutions that cannot stand on their own. It has become the government’s bailout institution. “This will be very damaging for a very important financial insti­tution,” says Vyas.

At the current juncture, two major events are reflecting investor sentiments, not necessarily due to internal conditions, say experts. One is the volatility that has seen the stock market losing all the gains made during the year. The second is the continuing depreciation of the rupee, currently nudging past Rs 74 to a dollar. Both the events are interlinked in many ways. Joshi says the stock market slide is largely due to global factors—the US interest rates, very low for a very long time, have now started rising very fast. The bond holders, who look at different countries for higher returns, are investing in the US as the interest rates have risen from 1 to 3 per cent. In effect, the investors are getting a much better return in the US than in India. No wonder there is a sell-off not just in India but in all emerging markets.

Murarka says that apart from a combination of factors, including spike in crude oil prices and rupee depreciation, “the tightness in system liquidity post the September 15 advance tax payment has led to the market correction. The fall has been accentuated by the recent credit event in IL&FS and the resultant risk-off in NBFCs and banks.” Agreeing that the stock market turmoil is a long-awaited market correction, Vyas points out that we have seen earnings fail and the price multiples going up through the past few years, resulting in the multiples going way too high.

According to the market expert, people had been expecting magic when Narendra Modi became PM and were willing to give it a long shot. Generally, the honeymoon period lasts six months to a year; this time it went on for three to four years. “But it can’t be forever,” says Vyas. “There has to be a correction and now that elections are around the corner, people are saying ‘no more honeymoon’, leading to a relook at the stocks. So other excuses like things going bad in the international market, foreign investors (FPI) going back or the US doing very well are all incidental. The main thing is that the Indian equity markets are very expensive and the confidence that the earnings will match up to the multiples has wilted.”

However, optimistic that system liquidity should improve in October on the back of government spending and open market operations by the RBI, Murarka says the market trajectory from here onwards would be a function of crude oil price movement and developments pertaining to state and general elections.

Let’s now look at the rupee. Among factors influencing the Indian curr­ency, according to CRISIL’s Joshi, is India’s current account deficit. “Countries that have a current account deficit get punished more where currencies are concerned. Then there are the non-deliverable forward (NDF) markets outside India for the rupee, which also creates volatility,” he says. Over a long period of time, the rupee has been depreciating at 2-2.5 per cent per year. This trend was reversed over the past three or four years. So part of the weakness of the currency is normal and part of it is due to the global bond market sell-off. India is also very vulnerable to high oil prices—when prices go up, the risk is seen as higher in India from the inflation point of view, the fiscal point of view and also in terms of the currency. When oil prices shoot up, we need more dollars to meet our import demand, and the value of the rupee is largely influenced by the dem­and and supply of dollars.

Observer Research Foundation chairman Sunjoy Joshi, an energy expert, exp­ects further dip in the rupee “as we are very vulnerable to our import dem­and for oil. If there is any crisis in the global oil markets, we are always the first to be hit. We have not found any answers to this vulnerability so far.” As a result, there is a crisis every time the rupee falls or the oil prices rise as our current account deficit and fiscal deficit immediately surge. A collateral damage of any bad news for the economy is the impact on stock market sentiment, resulting in share prices falling. It is all interlinked.

Like many times in the past, this year too the government’s res­ponses have been kneejerk, undoing a whole series of reforms undertaken over the past few years. For instance, the ­gov­ernment recently unravelled the entire oil sector reforms by intervening in the wrong things at the wrong time to force oil companies to offer subsidy on transport fuels. Subsidy of less than Rs 3 may make very little difference to consumers as the prices of petrol and diesel are at unprecedented levels, but for oil companies it is a roll back to the subsidy era.

On the infrastructure front, a major facilitator of employment besides manufacturing, things have started looking up, according to Shashi­kant Hegde, CEO, ProjectsToday. Based on a ProjectsToday survey, Hegde says private-sector investment has shown an improvement in the last two quarters. There was 21 per cent quarter on quarter improvement in the first quarter, and there has been a 35.5 per cent imp­rovement in the second.

“There is some sign of revival, but we cannot say capacity addition or announcement of new projects have started in earnest,” says Hegde. “In the last two quarters, we have seen announcements of investments in steel, cement, electronics and construction. Revival in construction is a very good thing as it is where most employment is generated, like in manufacturing.”

While new projects in steel and cem­ent are being announced, there is no overlooking the fact that many among the existing companies are facing bankruptcy or are loan defaulters. The most pathetic condition is in the thermal power sector as many companies are facing coal shortage and have no power purchase pacts, while the discoms are defaulting on dues. They have huge debts, while the banks are refusing to lend further. It’s no surprise then that the RBI’s latest consumer confidence index survey, conducted in September, shows worsening of consumers’ perception of the general economic situation and the employment scenario.


  • Consumer confidence in both public-sector and private banks is getting eroded over issues such as non-performing assets.
  • The government treats LIC as a bailout ­entity for tottering PSUs or in its ­disinvestment exercise.
  • Volatility has seen the stock market lose all the gains during the year, and the rupee has fallen beyond Rs 74 to a dollar.

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