The new monetary easing program of the European Central Bank (ECB), purportedly to ward off an Eurozone recession, has raised fears of a currency war among advanced economies, with US president Donald Trump hitting out at ECB for weakening the euro at the expense of the dollar (monetary easing serves to weaken the domestic currency). This comes in the midst of a trade-cum-currency war between the US and China, which continues to keep markets on edge.
As safe-haven assets such as gold and high-quality sovereign debt become the instruments of choice for investors, and fears of a global implosion rise, it is worth asking: is India better prepared to deal with a global shock than it was in 2008?
One metric that has worsened considerably is the state of corporate and bank balance sheets (the so-called twin balance sheet problem). Since the collapse of Lehman Brothers in Sep 2008 triggered a global recession, debt levels have risen globally and India is no exception to the trend. But in India’s case, the stress has been largely concentrated in the corporate and financial sector, even if triggered by state-sponsored stimulus policies.
In fact, part of the bad loan problem today is a result of the domestic stimulus provided in the wake of the 2008 crisis, which encouraged banks to lend more to industry and infrastructure. These loans have turned soar, raising the share of non-performing assets to historic highs.
To be sure, part of the increase in stressed assets of banks in recent years is due to regulatory changes which forced them to recognize the troubled assets. While it was hoped that the worst might be behind us, a recent Credit Suisse research report, dated 22nd August, warned that rising inter-creditor agreements (ICAs) signal a second wave of stress. ICAs are agreements among lenders -- banks, NBFCs, insurers and asset reconstruction companies -- to jointly work towards resolution of a stressed loan.
It is likely that the stressed assets to advances ratio for banks again worsened in the June quarter, after having improved in 2018-19. The same report also noted other pain points in corporate balance sheets. The interest coverage ratio, or the ability to meet interest expenses out of operating profit, is around a ten year-low for Nifty companies (excluding financials). And the total debt to net worth ratio of these companies has witnessed a sharp rise (worsened) in the past few years.
Given that the twin balance sheet problem today appears worse than during the last two episodes of global turbulence – 2013 and 2008 – the ability of private investments to respond to a stimulus might be correspondingly weaker. The ongoing slowdown in consumption demand only complicates matters. A global shock under these circumstances could trigger a new wave of bankruptcies, deepen the corporate debt crisis, and dry up animal spirits of Indian entrepreneurs altogether.Given the weakness of the private sector, the state is expected to take the commanding heights of the economy once again. And if a global shock hits us, it is the government that will have to step on the gas.
How much ammunition does the government have? Since 2014, the overall (general) government debt has remained more or less constant at around 72% of GDP, down from around 90% in 2007, suggesting that the government has some room to expand its borrowings.
However, it is worth noting that the past few years have seen a squeeze in financial savings, which means that the overall funds for the public and private sector to borrow has declined. Households’ financial savings currently account for around 11% of GDP, the lion’s share of which is already being gobbled up by the public sector (including state and central governments, and central PSE’s).
If the savings rate continues to decline, further borrowing will put pressure on our external metrics, raising imports and widening the trade deficit. The twin deficit (fiscal and current account deficit) problem which India tamed successfully after the 2013 mini-crisis, may be back in play. In the event of global energy shocks, such as the recent strike on a Suadi Arabian oil facility that has triggered a sharp jump in oil prices, concerns about India’s current account deficit only get heightened because of India’s high dependence on imported oil supplies, making investors jittery about investments in the country.
Although the current account deficit looks less threatening now, it worsened slightly over the past two years to reach 2.1% of GDP in 2018-19. Consequently, the dependence on volatile foreign inflows to plug the current account deficit [net of FDI] was 1% of GDP in the last fiscal, the highest since 2012-13.
If the flight to safety in the event (or even threat) of a global shock leads to an exodus from emerging markets, India could be in a vulnerable position. While India’s external metrics have improved since 2013, they are still in worse shape than in the pre-2008 era.
Overall, India seems to be better off than it was during the 2013 scare but worse off compared to 2008.
As India debates the way out of the current slump, it is worth asking of each policy proposal on the table: is this going to make the Indian economy more or less vulnerable to global turbulence in the months to come?