With India’s economy growing at the slowest pace in six years, many wonder why consumers, companies and even the public sector can’t set it right. Why can’t households buy more? Why can’t corporates invest more? Why can’t the government spend more?

The answer can be traced back to the debt-laden balance sheets of Indian corporations from around 2010. The heavy borrowing of those days spilled over to the balance sheets of banks, which lent heavily and often to those who struggled to pay back.

This balance sheet malaise has not been fully overcome. For a time, it was forgotten as India’s economy got a welcome boost from falling oil prices, a surge in lending from shadow banks, and a rise in public sector investment. But these positives were temporary. Oil prices stabilized, alarm grew over the unsustainable growth model of shadow banks, and a sharp rise in public sector debt raised borrowing costs.

Meanwhile, corporates remained over-leveraged, while the elevated stock of non-performing loans at banks prevented them from lending efficiently. All this manifested itself in the form of weak investment growth and a sluggish labour market over the last decade. This, in turn, has led to the demand problem that we are now witnessing with wages weak and consumption slowing.

Moreover, because of these stretched balance sheets, major players in the economy—namely companies, banks, households and the government—are now unable to spend their way out of the ongoing slowdown.

Let’s highlight the major balance sheet issues that need to be resolved.

At first glance, companies appear to be deleveraging. After having risen sharply, the debt-to-gross domestic product (GDP) ratio has been falling since 2016. But this ratio does not fully reflect the actual stress that corporations are facing. When we look at the debt-to-equity ratio—a more company-specific indicator—we find that the indebtedness of Indian firms has been rising, and is also high compared to their regional peers.

Banks’ balance sheets have not been completely repaired. Non-performing loans remain elevated; and they still bear a large exposure to non-banking financial companies (NBFCs), which took up the slack in lending aggressively, but have since struggled with funding issues. Consequently, banks are not likely to lend excessively.

Consumption had become the key driver of economic growth over the last few years, despite weak household income growth. This is noteworthy because the only way consumption can grow when incomes are weak is by consumers taking on debt and essentially leveraging up. Already, household debt has been rising and is now notably higher than the long-term average. But if incomes continue to remain weak, consumers may not be keen to take on new debt, fearful of finding it tough to repay loans in the future. Households, therefore, cannot be counted upon to spend their way out of the current slowdown.

The government’s fiscal situation is tight, too. Public sector borrowing is elevated at 8% of GDP. Besides, the central and state governments are likely to run higher-than-budgeted fiscal deficits in 2019-20. All this hurts growth, as the strains of heavy borrowing keep borrowing rates elevated even though the central bank is cutting key rates.

One lesson, therefore, has become clear. Because the roots of the current slowdown are closely linked to the supply side (i.e. impaired balance sheets), even if the government were to try boosting demand—say, through tax cuts—this must be accompanied by measures to ease the supply side, or else any growth recovery will be short-lived. So, what are the solutions?

One is to strengthen the new bankruptcy regime to ensure it resolves the deluge of stressed assets that burden corporate and bank balance sheets faster. This will also help credit to start flowing to the right places .

Another is to untangle all the stalled investment projects that litter the country. One-third of them are on hold due to policy-related problems such as land acquisition, limited access to raw material like coal, and environmental approvals.

A comprehensive strategy for what role banks and NBFCs should play is critical, too. For banks, corporate governance issues need to be ironed out and the number of government mandates reduced. For NBFCs, the government has already taken an important step by announcing a stimulus package to revive stalled housing projects. But a second step may also be needed. Given the deep interlinks with the rest of the economy, some NBFCs and real estate developers may need a direct search-and-rescue operation. For instance, the government or Reserve Bank of India could identify the more systemically important firms, supervise them more closely, and find buyers or get owners to recapitalize them, while also making sure that private shareholders shoulder losses.

Finally, divesting government stakes in companies and selling various government-owned assets, such as roads, ports and airports, will also improve the health of the government’s balance sheet.

The good news is that none of these initiatives are new. They are already being debated and implemented at varying levels. The challenge, then, is to have them taken up on a war footing. Pushing them through to completion will not only clean up the economy’s balance sheet, so to speak, but also reunite the country with the higher growth it deserves.

Pranjul Bhandari is chief India economist at HSBC

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