Will Modi govt ever own up to real reasons for deceleration of economy?

Under normal circumstances, comprehensive and wide-ranging reforms undertaken for the economy during the last eight years would have accelerated India’s growth. But that was not to be. The ‘culprit’ is India’s ‘balance sheet stress’ caused by the ‘credit boom’ in previous years.

This scapegoat for deceleration of the Indian economy since Narendra Modi became Prime Minister of India in 2014 has been found by the Economic Survey 2022-23, as against the common perception of the people and independent economic analyst that the deceleration of the economy was the result of its mishandling and policy experiments – such as demonetisation of November 2016 and the implementation of GST in July 2017 without preparation.

The Economic Survey puts the blame on the previous government and says that the ‘twin balance sheet crisis’ was revealed in 2013. However, it admits, “unsurprisingly, the credit to the private non-financial sector as a per cent of GDP was consistently below its trend value for most of the second decade of the millennium, implying a negative credit gap to GDP ratio. The gap worsened to an unprecedented level of 25 per cent in 2017. A statistically significant negative correlation (-0.5) between the Gross NPAs and credit growth shows that the banks’ credit supply was severely constrained due to stress in their balance sheet during the second decade.

It says that as per data from the Bank for International Settlements, India’s non-financial private sector debt to GDP ratio went up from 72.9 per cent in March 2004 to 113.6 per cent by December 2010. That is an increase of 40.7 percentage points in just over six years.

In rupee terms, the amount of debt accumulated by the non-financial sector went up from nearly Rs 44 lakh crore to almost Rs 133 lakh crore. It trebled in six years.

Despite limited economic reforms, global capital flows and optimism about BRICS (Brazil, Russia, India, China and South Africa) triggered a domestic credit and investment boom that eventually proved unsustainable, as the twin deficit – fiscal and external – crisis of 2013 revealed.

Thereafter, the non-financial private sector debt to GDP ratio began to come down meaningfully only from 2015 onwards, dropping to a low of 83.8 per cent by December 2018. That is nearly a 30 percentage point reduction from 113.6 per cent in December 2010 over eight years.

As investments made by companies went sour, it impaired their ability to repay bank loans. Hence, banks’ non-performing assets began to rise. That set in motion a long period of repair of the financial and non-financial sector balance sheets in the second half of the last decade.

The government and the RBI took several policy initiatives to help the financial sector recoup the balance sheet stress during the 2010s.

Some of these such as the amendment to the SARFAESI Act 2002, implementation of the Insolvency and Bankruptcy Code (IBC), launch of ‘Asset Quality Review’ (AQR), introduction of prompt corrective action (PCA) framework, recapitalisation of Public Sector Banks (PSB), and merger of PSBs among others, helped in cleaning up the balance sheets of banks/corporates.

Even as the balance sheets of banks and companies began to mend and improve, came the collapse of the Infrastructure Finance and Leasing Services (IL&FS) in September 2018. It was a big non-banking financial company (NBFC) with a huge asset base.

Its collapse also had a huge ripple effect on other non-banking financial entities. Few housing finance companies went under as well.

Hence, housing loan disbursements were disrupted. Usually, non-banking finance companies lend to more borrowers and riskier borrowers than banks. They are refinanced by banks. Their re-financings came down in the wake of the collapse of IL&FS, a big NBFC, followed by the collapse of some housing finance companies.

Therefore, bank credit growth came down to single digits towards the end of 2019, continuing into 2020. Low credit growth and hence weaker capital formation impacted economic growth.

The government responded with several measures to stem the fallout of the collapse of IL&FS and housing finance companies, including a corporate tax cut in September 2019.

Soon thereafter, the pandemic struck, and the government had to address the emerging health, social and economic consequences of an unprecedented nature.

These back-to-back shocks have delayed the impact of the government’s momentous reforms measures on the economic growth.

After giving reasons of the poor performance of the economy under the sub-title ‘Shocks that the economy faced during 2014-22’, the Economic Survey compares the period 2014-2022 to 1998-2002.

Labelling the period 2014-2022 analogous to 1998-2002, the Economic Survey says that the transformative reforms were launched during 1998-2002 too but yielded lagged growth dividends. This phenomenon was attributed to a series of one-off shocks resulting from external factors and the domestic financial sector clean-up, which overshadows growth returns during that period.

As the shocks dissipated by 2003, India grew at a higher rate later, in the present context too, India economy is now well placed to grow at its potential in the coming decade, it claims.

In way of explanation of economic deceleration under Modi rule, the Economic Survey 2023-24 enumerates two shocks – Period of Banking, Non-Banking and Non-financial Corporate Sector Balance-sheet stress; and unprecedented pandemic shock followed by inflation, global commodity price shock, further followed by tightening of financial conditions.

(IPA Service)

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