 "bad loans")
According to the Bank of England, financial markets exist to bring people together so money flows where it is needed the most. Businesses in need of capital should be able to raise it from these markets and repay when no longer in need. In theory, financial markets act as gatekeepers of people’s money. But as Yogi Berra famously said: “In theory, there is no difference between theory and practice. In practice, there is.”
Of late, the situation in India has been the opposite. Businesses find it difficult to raise capital as debt is funding personal consumption and equity funds invest in businesses with strong cash flows. The genesis of this situation can be traced to banks slowing loan growth after being forced to recognise bad loans, and the meteoric rise and subsequent collapse of non-banking financial companies (NBFCs). The flow of credit to the economy has slowed considerably. The equity market’s conundrum is of too much money chasing fewer companies, partly due to change in the mandate and largely because ‘nothing succeeds like success’.
It started with the massive surge in private investments in India during 2006-08 when global economic growth was strong. Bad loans (non-performing assets or NPA) at the time were below 3 per cent. However, the 2008 global financial crisis marked the turning point. Growth slowed materially and rendered many projects, which previously looked attractive, unviable. In the absence of effective bankruptcy code, Indian banks resorted to many schemes (JLF, SDR and S4A) to combat rising bad loans, but failed. By 2015, NPA rose over 4 per cent, but the Reserve Bank of India (RBI) still believed that banks were not recognising all bad loans; an asset quality review (AQR) was conducted.
Banks were forced to recognise bad loans and NPA started piling up (it would eventually rise to 11.5 per cent by 2018). Banks curtailed loan growth and focussed on personal loans. Industry, which had about 44 per cent of all bank loans in 2015, received only 9 per cent of incremental loans between 2015 and 2019; personal loans (at 19 per cent of loans in 2015) got a whopping 41 per cent.
Industry’s appetite for loans had waned, but banks left even those wanting to invest credit-starved. NBFCs, which were glad to fill the void left by banks got the ammunition when the currency was demonetised (in 2016). This took the shine off of real estate investments and households started moving from physical to financial savings. Mutual funds’ non-equity assets under management (AUM) jumped from Rs 5.8 trillion in 2015 to Rs 12.2 trillion in 2019, a majority of which was invested in NBFC debt (commercial papers and non-convertible debentures). Between 2015 and 2018, mutual funds became the largest suppliers of credit to NBFCs (42 per cent of funding), replacing banks (37 per cent) and insurance firms (21 per cent).
NBFC loans, which were at about 15 per cent of banking loans in 2014, garnered a third of incremental loans between 2015 and 2019. Nevertheless, asset quality was often poor and many NBFCs turned a blind eye to matching asset and liability durations. This and the subsequent IL&FS collapse in September 2018 created a liquidity crunch. Credit markets froze, making it challenging for all NBFCs to raise fresh debt; and a few could not even refinance their loans. Low liquidity has taken a toll on consumer sentiment — sales of discretionary goods (vehicles, white goods) are down and even staples sales are now at threat.
Equity mutual funds did little to counter this. In 2014, about 60 per cent of domestic equity investments (mutual fund and insurance) were in the top-50 companies by market cap. Between 2014 and 2019, three-fourths of incremental money went to these 50 companies, with the other listed companies receiving little investment.
The Securities and Exchange Board of India (Sebi) categorising mutual fund schemes by market cap in 2017 forced them to sell some mid-caps in existing funds. By 2018, provident and pension funds had decided to invest up to 15 per cent in equity, but in the same 50-stock index. Supply of new paper is limited, and it is quickly becoming a case of too much money chasing a few stocks. The Nifty50 index is down about 5 per cent from its all-time high, but more than 80 per cent of stocks are down more than 20 per cent and 50 per cent stocks have halved. A stock that has halved will face a tough time raising equity.
But it’s not all bad — India now has a bankruptcy code and resolutions have started. A few battered NBFCs could end up with new managements or with stronger partners, thereby stemming the rot. Nevertheless, the cost of capital in India is too high. Despite policy rates falling 75 bps, the borrowing cost has not come off. The small savings rate still yields over 7.5 per cent; it needs to come down. Also, Sebi should allow mutual funds to invest a larger proportion of their funds across market caps and provident funds must consider investing in a broader index.
If financial markets fail to help businesses raise money, economic growth will suffer. Participants in financial markets are the gatekeepers of people’s money; a more frequent reminder will help.
The writer is director at Buoyant Capital
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
