Ins & outs of fickle Indian financial system

The President of the World Bank said recently that the world economy had already entered into a recession that was likely to continue for many years. Another report said that the United States' banks had already suffered a 30 percent decline in their profits as in June 2020. Today the situation would be worse.

A report by global consultancy group Deloitte says that banks of Hong Kong are having to make large provisions to bear the expected losses due to the Covid-19 pandemic and their profits are under pressure. Our banks have bucked this global decline and our major public sector and private banks are showing higher profits. At the same time, our share market is buoyant and has touched historical peaks.

This golden situation of Indian banks comes along with certain caveats. A report by IIFL Finance says that construction, small industries and civil aviation sectors are under pressure. A shopkeeper from Uttarakhand said that business of schools and coaching centres had almost come to a standstill. Another said that borrowers were reducing their personal expenditures and repaying the loans to the banks because they were afraid of penal actions.

Yet another said that the borrowers were not able to have encashed the post-dated cheques given to lenders at the time of taking the loans. A small Chartered Accountant from Faridabad said that business of his clients had declined by about 30 percent. Small businesses that were paying Rs 1,000 to file the GST returns earlier were now paying on Rs 600 to Rs 700 for the same filing, he said. A number of global agencies have reckoned a decline in India's GDP this year to be around 10 percent.

Thus, we are confronted with two contrary indicators. On the one hand, global and ground reports tell of our economy and banking sector being under stress. On the other hand, our major banks are reaping profits and the Sensex is scaling historic highs.

The composition of lending by our banks helps us unravel this mystery. Our banks have lent 33 percent of their total loans to large corporates; 33 percent to retail borrowers; 13 percent to international borrowers; 12 percent to small industries; and 9 percent to agriculture. The large corporates, international borrowers and agriculture have been buoyant during the pandemic hence these lending is good. We need to look closely at the lending to the retail and small industry sectors.

One major component of the retail is vehicle loans. According to knowledgeable sources, 80 percent of these have been given to public sector employees. Second major component is personal loans. 94 percent of these are given to public sector employees. Third major component is home loans. 50 percent of these are given to public sector employees and 20 percent to employees of large corporations. The exposure of the banks to the "common man" or the non-public sector employees is relatively less. The public sector employees have continued to enjoy stable incomes during the pandemic; therefore, the retail lending portfolio of the banks does not show any distress.

Contrary to the ground reports, the lending to small industries also does not appear to be under stress. We should have expected small businesses in construction, tourism and coaching to default on their borrowings. There are three possible reason for the normalcy in these sectors. One, the government had placed a moratorium on loan repayments from March to August this year.

Borrowers have developed some cushion in this period and are repaying the loans from this backstop. Two, the Reserve Bank has asked banks to be liberal in rescheduling the repayment of the loans hence the repayment has been pushed into the future. Three, the government has guaranteed additional loans provided by the banks to small businesses. Thus, small businesses may be borrowing under this scheme to keep themselves afloat. The repayment crisis of small borrowers has been pushed back and not appeared in the open because of these steps.

This discussion means that the Indian economy has been divided into two sections. One section is of the sectors that are doing well. These include large corporates, international borrowers, and agriculture which are all doing well; and retail which is driven by public sector employees. Further, the trouble that may be brewing in the small industries' sector is also not visible at present because of the various steps taken by the government and the Reserve Bank.

This situation could remain stable for some time until the pain of the retail borrowing by the non-public sector employees, and the small industries begins to appear. Today the public sector employees constitute about two crores in numbers. They may account for about eight crore persons if their family members are counted.

The remaining 127 crore out of the 135 crores population do not have a comfortable income and may not be able to repay the loans taken for much time. The relief granted to small industries by moratorium, rescheduling and government guarantee too is temporary. Their incomes are down but this distress has been pushed into the future. The Indian economy is like oil floating on water making colourful patterns but hiding the stench in the water below.

Two possible scenarios can unfold here onwards. As of now, the Indian economy is showing rising Sensex and declining in GDP. The total, economy is shrinking while the share of big corporates is rising. The 127 crores people are unlikely to come out unscathed from the this declines in GDP brought by pandemic given the distress in employment-intensive sectors like tourism, coaching, small industries and construction.

Nevertheless, this situation could hide a beneficent future if the government is able to provide direct cash transfers to all the people to meet their basic needs. In that case, we will establish a golden economy where there will not be a need for every person to "work" — as Karl Marx had dreamt. On the other hand, this same could hold dangerous portents if the common man is left to fend for himself while the Sensex roars and banks make money. The common man will get agitated and the anger will erupt in one form or the other.

The buoyant performance of the Indian banking sector — contrary to both the ground reports and the global movements — is like a person moving cleverly to the high end of the sinking ship thinking that he will save himself. The challenge before the government is either to persuade the 127 crores people to accept their distress without demur; or to make direct cash transfers to enable them to meet their basic needs.

(The writer is formerly Professor of Economics at IIM, Bengaluru)