Economic contraction and increase in NPAs

Economy headed for contraction, less fiscal space for big stimulus

From The Indian Express: “It is quite difficult to assess how the economy will react when the lights, which were turned off March 24 midnight, and remain so for 40 days (almost six weeks), are switched on again,” a senior official said. There are many variables: consumer behaviour post lockdown, fear of infection, persistence of social distancing, risk aversion at firm and individual level, the pandemic curve itself, and finally the depth and breadth of government intervention through fiscal measures, and RBI support on the monetary and credit front.

It is this huge uncertainty and “hysteresis” (the unknowns going forward on how the pandemic will play out), which render the exercise of making projections irrelevant. “In the middle of a storm, it is hard to make any assessment, because the task at hand is to ride the storm. Any kind of accuracy will be misleading,” the official told The Indian Express, without wishing to be named.

[...]The impact of an almost six-week lockdown until May 3, with the persistence of social distancing thereafter, and the knock-on effect of these two, will most likely see the Indian economy decelerate in 2020-21, said another analyst with a leading global financial services group. “After the lockdown is lifted, it will definitely not be business-as-usual. A sudden stop in cash flows has put small enterprises under tremendous pressure, with many on the verge of bankruptcy,” the analyst said.

“Salary cuts and job losses in the organized sector will adversely impact discretionary spending by individuals. Consumption, which is almost 60 per cent of GDP, will be severely hit. At the consumer level, discretionary purchases, shopping in malls, eating out, movie halls, travel, and home purchases, may not be forthcoming,” said another economist with a leading investment bank.

At the firm level, proprietorships, micro, mini and small enterprises, will first want to recoup their losses (having had to endure 12 months of costs on 10 months of revenues), and build a nest egg to ensure they are not adversely hit again. This is one big income shock, the economist said.

[...]But a government official said that India, unfortunately, cannot spend like developed economies. “With a BBB- sovereign rating, we still are investment grade. And unlike 2008 when the government’s fiscal was in order and it could manage to give a massive stimulus, it doesn’t have the cushion now. One notch below BBB-, and India will slip into ‘speculative’ grade rating,” he said.

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India’s Path Out of Pandemic Slump Hobbled by Shadow Bank Crisis

From Bloomberg: For India’s financial sector, the coronavirus freeze is just the latest headwind in a multi-year storm that’s dragged down consumption and seen the nation lose its crown as the world’s fastest-growing major economy. Now, if bad loans rise as many including the central bank expect, banks and shadow lenders are set to become ever more cautious just when credit is most needed to keep the economy going.

[...]“India’s financial system has had a rocky few years,” said Pranjul Bhandari, chief India economist at HSBC Securities and Capital Markets Pvt Ltd. in Mumbai. “The recognition and provisioning for high loads of bad debt at banks took a toll over 2015-2018, ending with a fallout at the shadow banks.” The seeds of stress were sown even earlier, in a debt-fueled economic boom between 2007 and 2012 when banks increased loans by 400%. When the economy began slowing, many companies struggled to repay debts, making banks reluctant to lend as bad loans piled up.

Some of the slack was then picked up by shadow banks -- lenders that don’t rely on deposits and are typically less regulated. But a default by one of the most prominent of those -- Infrastructure Leasing & Financial Services Ltd. -- in 2018 saw that lending dry up too.

The collapse triggered a credit crunch, forcing the Reserve Bank of India to step in to take control of another shadow lender, Dewan Housing Finance Corp., to contain the fallout. A smaller lender also failed in 2019 after allegedly duping investors about its exposure to a property developer. Then, in March this year, the central bank seized private-sector Yes Bank Ltd. in India’s biggest bank rescue.

[...]“Companies relying on either type of lender for funding, many of which have weak financials, will have difficulty in maintaining liquidity, which can result in defaults on loans from banks and shadow banks,” she said. “As loan losses at shadow banks increase and threaten their solvency, banks’ direct exposures to them can be at risk.” Desperate to avoid such a chain of events, the RBI has injected $6.5 billion into banks to promote lending to shadow banks and small borrowers, further relaxed bad-loan rules and barred lenders from paying dividends in the current fiscal year through March 31 so that they can preserve capital.

Impact of COVID-19 on migration and remittances

Excepts from Peter Gill's article in The Diplomat:

Nepali deaths and illnesses abroad portend long-term trouble for the Nepali economy at home. In the past, international labor migration has been an essential lifeline for Nepali families coping with domestic crises, from a civil war that raged from 1996-2006 to an earthquake that brought homes crashing to the ground in 2015. But the current crisis is unlikely to afford Nepalis this opportunity. Nations worldwide have erected barriers to human movement, and job opportunities from New York to Mumbai to Seoul will likely plummet in the aftermath. COVID-19’s long-term consequences could be devastating for Nepal. A recent World Bank report predicted a severe drop in GDP growth over the next three fiscal years, stating that “the risk of falling into poverty is high, and it will increase into 2020.”

It is difficult to overstate the importance of migration and remittances to millions of Nepali families.  Nepalis have long depended on seasonal agricultural and military work in India, and after 1990, increased access to passports opened up new types of work in destinations from the Middle East to Southeast Asia and beyond. Constructing high-rises in Dubai, guarding private homes in Kuwait, or working on assembly-lines in Penang often paid more than anything available in Nepal.

[...]Migration insinuated itself deep into the Nepali macroeconomy, becoming a keystone on which other sectors depended. “Remittances have been crucial to support growth, particularly by sustaining a high consumption level, which comprises over 85 percent of GDP,” says Chandan Sapkota, an economist at the Nepal Economic Forum. “Remittances have also been crucial in meeting a high revenue growth, as over 45 percent of government revenue is based on duties imposed on import of goods financed by remittance income. Remittances have been the major source of deposits in banks and liquidity.”

The COVID crisis has already put many Nepali migrants out of work. As fears of a pandemic spread in February and early March, a few hundred thousand workers returned to their hometowns and villages in Nepal. But most migrants were prevented from returning after the Nepali government announced a nationwide lockdown on March 24. Some were able to maintain their jobs abroad, but many others were fired or took unpaid leave and are living off meager savings. Reports have emerged of workers being forced into unsafe, crowded conditions in Malaysia and Qatar. In the United Arab Emirates, some Nepalis have been evicted from their homes. Meanwhile, hundreds of Nepalis remain stuck at the Indian border, having walked for hundreds of miles through the Indian lockdown only to be denied entry by the Nepali police. The government maintains that quarantine facilities are inadequate to cope with returnees from abroad.

Falling remittances could have knock-on effects in multiple areas of the domestic economy, harming government revenue and reducing liquidity in the banking industry, says Sapkota, the economist. Along with tourism — another sector sledgehammered by the crisis — remittances are a key source of foreign currency, crucial in an import-dependent country like Nepal. The national bank holds enough foreign exchange reserves to cover more than eight months’ worth of imports – a comfortable cushion in normal times, but then these are not normal times.

Import substitution in India and crowding out of corporate bonds due to high state borrowing

Indian government to chart plan for higher investments

From The Times of India: The government is beginning to reach out to domestic and global investors to work out a strategy for higher investments and reduced reliance on imports in the post-Covid-19 world. During the lockdown, the commerce and industry ministry has had detailed discussions with a group of CEOs on boosting local production of several items, which are currently imported in large quantities, with work on an initial blueprint having begun. Sources told TOI that segments such as mobiles, air-conditioners, auto parts, specialised steel and aluminum products, power equipment, wooden furniture, along with food processing (with potato and orange in focus) are on the table.

Separately, Invest India, the government’s investment promotion agency, had identified over 1,000 global companies across sectors, whom it was reaching out to as part of the “China+1” strategy. “Globally, companies are realising that there is a need to diversify their production bases and India is being pitched as a possible destination. Our plan had slowed down due to Covid-19 but we are in talks with some of them,” a senior government officer told TOI.

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State Govt borrowers are crowding out cash-strapped firms in raising funds

From The Hindu Business Line: Indian companies struggling against the coronavirus pandemic and a domestic credit crunch are facing another obstacle: competition from state governments to sell debt. States are planning to crank up bond sales by 18.2% this quarter from a year earlier to make up for a decline in tax revenue due to an economic slowdown. They usually have lower credit risks than companies, and are offering higher yields than before, which could entice investors. The corporate bond market was already suffering, prompting the RBI on Friday to again inject more money into it. The demand for longer tenor corporate bonds from insurers and pension funds is expected to fall as they shift allocations to state bonds after the recent surge in yields, said Manoj Jaju, chief investment officer at Bharti AXA General Insurance Co. “We too will have a bias toward state bonds over corporate debt now.

[...] But recent cases show how state debt may be more appealing than company securities, even with the extra policy support. Maharashtra state is a case in point. It auctioned 10-year debt on April 7 with an annualized yield of 7.98%, the highest for that tenor since January last year. The latest rate was 44 basis points more than the yield on similar maturity AAA corporate notes. On the same day, REC Ltd., a state-owned financial firm, scrapped plans to sell notes because market participants demanded higher yields.

State bonds are also attractive because they have better trading liquidity in the secondary market compared with corporate securities, said Jaju at Bharti AXA. The State notes are accepted as collateral at the central bank’s repurchase auctions, unlike corporate bonds, providing an added incentive for investors, he said.

Fiscal stimulus equivalent to 5% of GDP needed in India

Triple trouble: coronavirus, hunger, and the economy

Sudipto Mundle writes in Mint: A package to restart the economy was announced on 15 April, with some graded easing after 20 April. These supply-side measures are welcome. But we also need to stimulate demand to get the economy going. My initial back-of-the-envelope calculations suggest that without a massive stimulus, the shutdown with a phased reopening could reduce GDP by around 10%in 2020-21.

Providing 2% of GDP extra expenditure for medical equipment and for temporary low-skill health workers, 2% of GDP for income support, and another 1% for extra food allocations would add up to a 5% of GDP fiscal stimulus. West Bengal Chief Minister Mamata Banerjee has recommended a 6%-of-GDP package. The multiplier effect of this 5-6% of GDP stimulus would reduce the recessionary impact of the lockdown significantly.

If GDP declines, it will reduce government revenue even if the existing tax exemptions and concessions are pared. The reduction of non-merit subsidies, totalling 5% of GDP, would at best offset the revenue decline. Hence, a 5-6%-of-GDP fiscal stimulus would have to be financed mainly through extra borrowing. To enable this, the current Fiscal Responsibility and Budget Management limits on Central and state government borrowing will have to be suspended. Under present global conditions, extra borrowings will mainly have to be financed from domestic sources. Such risk-less sovereign debt should be attractive for institutional investors, and its impact on domestic bond yields muted, since private sector demand for funds remains weak. Only in the unlikely event of commercial banks, including public sector banks, declining these bonds should the Reserve Bank of India step beyond its remit and monetize the deficit by directly acquiring them.

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COVID-19 crisis: Stimulus of 5% of GDP needed, says NITI Aayog

From Financial Express: Estimating the economic cost of the Covid-19 epidemic to be huge, the NITI Aayog has proposed a massive fiscal stimulus of over Rs 10 lakh crore or 5% of the gross domestic product (GDP) to address the situation. The package envisaged by the think tank includes income support to the poor, equity support to corporate India, absorption of a portion of NPAs in MSME sector and additional investments in healthcare. While the potential decrease in GDP size itself will raise the Centre’s fiscal deficit expressed as fraction of it to 4% in FY21 from the budgeted 3.5%, the proposed fiscal stimulus could widen it to an unheard-of 10.5% of GDP.

Given that the Centre’s fiscal resources are constrained, the Reserve Bank of India (RBI) may need to finance a portion of this incremental government stimulus, the government think-tank said. The special spending could be ring-fenced within a special Covid-19 budget, rather than as part of the general budget, it added. “Not implementing a concerted stabilisation package in a timely fashion may lead to a far greater damage to livelihoods, the economy and the financial sector, with far worse macro-economic consequences… debt-to-GDP could still rise to 95-100% due to reduced GDP,” the think tank’s CEO Amitabh Kant said in a presentation to the CII.

[...]Niti Aayog cautioned that unemployment risk and social unrest could rise materially with possible displacement of over 3 crore workers. It also warned that solvency risk to the financial system is high if the economic impact is not mitigated in the next 2-3 months. With incremental NPA across banks and NBFCs to be Rs 8.1 lakh crore or 7.3% (of advances) if lockdown continues till mid-May (the government has already extended it till May 3), the NITI Aayog said the core Tier 1 capital of banks will be around 12% or only slightly more than net unprovided NPAs of 10.9%.

[...]The Niti Aayog suggested income support programme of Rs 3.1 lakh crore to 6 crore permanent and contractual workers in the corporate sector and 13.5 crore informal workers and contractors. It also estimated Rs 70,000 crore additional expenditure in healthcare. Among other big fiscal sops, it suggested Rs 2.3 lakh crore capital support (preferably equity) to large corporates in a troubled asset relief programme (TARP) and Rs 1.7 lakh crore credit guarantee fund to absorb likely NPA slippage and credit costs. Certain proposals with no fiscal impact suggested include Rs 2.5 lakh crore RBI forbearance to reduce capital constraints (by rolling back capital conservation buffers) and Rs 1 lakh crore equity support to banks, housing finance companies and NBFCs via a TARP.

Besides the fiscal stimulus, shortfall of Rs 2 lakh crore in tax revenues, Rs 1.1 lakh crore in disinvestment receipts and additional stimulus in the form of payment of governments’ unpaid dues, will push the Centre’s fiscal deficit to Rs 21.1 lakh crore in FY21, the Niti Aayog said. With states’ projected fiscal deficit at 2.6% (to rise significantly as they will spend more and revenues will falter), the combined fiscal deficit of the Centre and states would be 13.1% in FY21, it added. The combined deficit should have been less than 6% in business-as-usual scenario.

RBI announces further measures to boost liquidity

Since February 2020, the RBI has rolled out plans to inject liquidity equivalent to 3.2% of GDP. The RBI has also undertaken targeted long term repo operations (TLTRO), which allows banks to borrow one to three year funds from RBI at the repo rate by providing government securities with similar or higher maturity as collateral.

Here are the additional measures taken by the RBI on 17 April 2020 to maintain adequate liquidity, facilitate and incentivize bank credit flows, ease financial stress, and enable normal functioning of markets. 

Liquidity management

• TLTRO 2.0: INR 50,000 crore of TLTRO in tranches of appropriate sizes. The funds availed by banks under TLTRO 2.0 should be invested in investment grade bonds, commercial paper, and non-convertible debentures of NBFCs, with at least 50 per cent of the total amount availed going to small and mid-sized NBFCs and MFIs. Investments made by banks under this facility will be classified as held to maturity (HTM) even in excess of 25 per cent of total investment permitted to be included in the HTM portfolio.
• Refinancing facilities for All India Financial Institutions (AIFIs): Special refinance facilities for a total amount of INR 50,000 crore to National Bank for Agriculture and Rural Development (NABARD), Small Industries Development Bank of India (SIDBI), and  National Housing Bank (NHB) to enable them to meet sectoral credit needs. Specifically, INR 25,000 crore to NABARD for refinancing regional rural banks (RBBs), cooprative banks and micro finance institutions. INR 15,000 crore to SIDBI for on-lending/refinancing. INR 10,000 crore to NHB for supporting housing finance companies. Charges set at RBI's policy repo rate. 
• Liquidity adjustment facility: Fixed rate reverse repo rate: Reduce fixed rate repo rate under LAF by 25 basis point from 4% to 3.75%, which will encourage banks to use surplus funds in investments and loans in productive sectors. Due to various liquidity enhancement measures taken by RBI, banks now have surplus liquidity. On April 15, it absorbed INR 6.9 lack crore through reverse repo operations. No change in policy repo rate (4.4%), and MSF and bank rate (both at 4.65%).
• Ways and means advances for states: WMA limit of states increased by 60% over and above the level as on 21 March 2020. On April 2, the RBI set it at 30%. This will be available till September end. 

Regulatory measures

• Asset classification: Institutions granting moratorium or deferment of loans can exclude the moratorium period from the 90-day NPA norm, i.e. there would be an asset classification standstill for all such accounts from March 1 to May 31, 2020. NBFCs can provide such relief to their borrowers too. However, to reduce building up of risk in banks' balance sheets, they they will have to maintain higher provision of 10% on all such accounts under the standstill, spread over two quarters, i.e., March, 2020 and June, 2020. These provisions can be adjusted later on against the provisioning requirements for actual slippages in such accounts.
• Resolution timeline extension: The period for resolution of stressed assets extended by 90 days. Currently, all banks, AIFIs, and NBFCs are required to hold an additional 20% if a resolution plan has not been implemented within 210 days form the date of default.
• Dividend distribution: Scheduled commercial banks and cooperative banks are not allowed to make any further dividend payouts from profits pertaining to the financial year ended March 31, 2020 until further instructions. This is done to maintain enough capital to absorb losses amidst heightened uncertainty.
• Liquidity coverage ratio: LCR requirement for Scheduled Commercial Banks is being brought down from 100 per cent to 80 per cent with immediate effect. The requirement shall be gradually restored back in two phases – 90 per cent by October 1, 2020 and 100 per cent by April 1, 2021. 
• Relief for NBFCs on real estate sector loans: Date of commencement of commercial operations can be extended by one year over and above teh one-year extension permitted during normal times without treating them as restructuring. This facility was earlier available to banks only.

On 26 March, the government announced $23 billion Pradhan Mantri Garib Kalyan Yojana to targeting the vulnerable groups.

Spend on the poor now and do not worry much about fiscal cost

Amartya Sen, Raghuram Rajan, Abhijit Banerjee write in The Indian Express that a combination of loss of livelihoods and interruptions in standard delivery mechanisms will push a huge number of people into dire poverty. The core message is that the government should expand social protection measures (food subsidy, cash transfers) and not worry about cost right now. Perhaps, as Paul Samuelson said "every good cause is worth some inefficiency". 

Here is excerpt from their article:

[...]As it becomes clear that the lockdown will go on for quite a while, in a total or a more localized version, the biggest worry right now, by far, is that a huge number of people will be pushed into dire poverty or even starvation by the combination of the loss of their livelihoods and interruptions in the standard delivery mechanisms. That is a tragedy in itself and, moreover, opens up the risk that we see large-scale defiance of lockdown orders — starving people, after all, have little to lose. We need to do what it takes to reassure people that the society does care and that their minimum well-being should be secure.

We have the resources to do this; the stocks of food at the Food Corporation of India stood at 77 million tons in March 2020 — higher than ever at that time of the year, and more than three times the “buffer stock norms”. This is likely to grow over the next weeks as the Rabi crop comes in. The government, recognizing the disruptions to the agricultural markets from the lockdown, is more than usually active in buying the stocks that the farmers need to get rid of. Giving away some of the existing stock, at a time of national emergency, makes perfect sense; any sensible public accounting system should not portray it as inordinately costly.

[...]More importantly, a substantial fraction of the poor are excluded from the PDS rolls, for one reason or another (such as identification barriers to get a ration card that turn out to be hard to overcome), and this supplementary provision only applies to those who are already on it. For example, even in the small state of Jharkhand, there are, we are told, 7 lakh pending applications for ration cards. There is also evidence that there are a lot of bona fide applications (for example of old-age pensioners) held up in the verification process, partly because the responsible local authorities try to avoid letting anybody in by mistake to avoid any appearance of malfeasance. Such punctiliousness has its merits, but not in the middle of a crisis. The correct response is to issue temporary ration cards — perhaps for six months — with minimal checks to everyone who wants one and is willing to stand in line to collect their card and their monthly allocations. The cost of missing many of those who are in dire need vastly exceeds the social cost of letting in some who could perhaps do without it.

[...]Starvation is just one of the worries; the unexpected loss of income and savings can have serious consequences, even if the meals are secured for now: farmers need money to buy seeds and fertilizer for the next planting season; shopkeepers need to decide how they will fill their shelves again; many others have to worry how they would repay the loan that is already due. There is no reason why, as a society, we should ignore these concerns.

[...] as a part of the commitment to not miss the needy, there has to be funding available that state and local governments can use to find effective ways to reach those who suffer from extreme deprivation.

MSMEs in India, microfinance institutions in trouble and more

India: Bring in the MSME relief package

From The Economic Times: The MSME sector accounts for about 40% of exports and almost a third of national output, and it is critical to address loss of revenue so as to purposefully avoid closure of units and damage to livelihoods. An estimated 6.3 crore MSME units employ 11 crore persons across the country, and it is only fitting that the sector is provided credit guarantees and interest subventions to survive the lockdown. True, the Small Industries Development Bank of India (Sidbi) has announced emergency loans at a concessional interest of 5%, but these are only meant for MSMEs manufacturing products or delivering services to fight the coronavirus pandemic. A far more comprehensive coverage is surely warranted. It has also been reported that public sector banks are extending emergency lines of credit to MSME borrowers, of up to 10% of their working capital limits. But much larger loans are required to tide over the present crisis in earnings capacity.

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Moratorium on loans critical for microfinance institutions: Icra

From Mint: Microfinance institutions (MFIs) could be heading for troubled times. If they don’t get a moratorium on their loans, their debt-servicing obligations could be severely impacted, according to a note released by credit rating agency Icra. The credit rating agency analyzed a sample of 29 MFIs, which makes up for 70% of the industry portfolio.

Collectively, these institutions have operation expenditures and repayment obligations of ₹8,000 crore in the first quarter of the financial year 2021. However, their on-balance sheet liquidity buffer stood at ₹5,400 crore. These institutions are facing a shortfall of ₹2,600 crore in the absence of any external funding support. “As the collections from borrowers could remain muted for some time post the lockdown is eased, the industry stares at a cash shortfall of ₹2,600 crore, according to our estimates," the Icra note said.

[...]The strain on borrowers’ cash flows will lead to a build-up of arrears, dilution of credit discipline, migration of borrowers owing to loss of livelihoods and the possibility of local, or political issues.

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Fiscal and monetary policy: It takes two to tango

Sajjid Z. Chinoy writes in Mint: Fiscal-monetary coordination is often misconstrued to simply mean a monetization of the deficit. In India, any monetization remains an academic debate for now. Amid unprecedented uncertainty, without knowing the size of the economic shock, how automatic stabilizers on the budget will react, and what the absorptive capacity of the market will be, it’s virtually impossible to assess any funding gap. But that’s not to say fiscal and monetary don’t have other opportunities to co-ordinate in the interim. There are a plethora of opportunities and synergies.

The first task should be to enable the Centre and states to borrow from markets in a non-disruptive manner. Here, there’s some disquieting news. Three weeks after the Reserve Bank of India (RBI) unleashed its bazooka, monetary conditions have begun to tighten again. The glut of interbank liquidity (almost ₹7 trillion) has pushed interbank overnight rates to just 2-3%. Yet, the 10-year GSec recently hardened to a 2-month high of 6.5%. This is now the steepest yield curve in a decade. Meanwhile state yields have firmed to the 7.7-8% range—twice the typical spread over GSec yields.

Given the abundant system liquidity and weak credit growth, what explains this? It’s because in recent years, banks have revealed a growing aversion to long-dated government bonds (“duration risk"). This is because banks’ holding of bonds is much above statutory limits (the corollary of soft credit growth in recent years), exposing them to interest rate risk. The longer the duration, the greater the “mark-to-market" risk—losses which impinge upon (often scarce) banking capital. It’s this disinclination to buy “duration", a behaviour exacerbated by increased market volatility, that underpins the hardening of yields.

What can policy do? 

• First, given the unprecedented uncertainty, policymakers could consider granting temporary forbearance to banks on their “mark-to-market" accounting (e.g. temporarily increase “hold-to-maturity" on which there is no interest rate risk).
• Second, the “ways and means" advances for states could temporarily be increased further so that states’ near-term market borrowing temporarily reduces. 
• Third, RBI often needs to buy government bonds to create base money just to support activity in the normal course of events.As households begin to hoard cash, we expect “currency-in-circulation" to rise by 1% of GDP this year. So RBI will have potentially meaningful space to buy government bonds 
• Expenditure will therefore have to be ruthlessly prioritized, akin to a “war-time" effort, and must focus squarely on boosting healthcare capacity, support for the needy (in cash and kind), funding automatic stabilizers like the Mahatma Gandhi Rural Employment Guarantee Act scheme, and back-stopping the financial sector (credit guarantee and re-capitalization funds).