The Indian economy has been under severe stress ever since the coronavirus pandemic broke, bringing in its wake lockdowns and the resultant total freeze in economic activity. But things are likely to get even worse a few months down the line.

The government is laying store by what it sees as the ‘green shoots’ of recovery. But at least a part of the revival in demand is due to the release of pent-up demand enabled by the unlocking phase. There is no knowing what shape demand will take once this pent-up demand plays itself out. So the future remains wide open.

Imminent NPAs

The apprehension stems from the foreboding over what will happen to the financial sector once the six months’ moratorium on repayment of loans ends next month. When the time to resume repayment comes, there are likely to be significant defaults by borrowers, which may cause a sharp rise in NPA levels.

Analysts are expecting 5 per cent of loans to turn non-performing, and Standard & Poor’s foresees Indian banks’ gross NPAs rising from 8.5 per cent in FY20 to 14 per cent in FY21. If this were to happen, it would be the second episode of a sharp rise in bank NPAs in half a decade. The first was through the Prompt Corrective Action ordered by Raghuram Rajan when he was Governor of the Reserve Bank of India, which for the first time made India’s largely government-owned banking sector come clean on how messy most banks’ loan portfolios were in reality.

If this is a likely scenario at the top of the financial sector pyramid, the situation at the bottom is probably worse. Small and medium NBFCs have largely failed to benefit from the RBI’s repo window, partial credit guarantee and special liquidity. These have been availed of only by larger entities with decent ratings.

What small and medium NBFCs want is a dedicated that which will offer loans for three-five years on the basis of financial parameters and not credit rating. If the future of these NBFCs themselves is in doubt, then it will create a bigger crisis for their borrowers.

The only bright spot in this otherwise bleak scenario is an upbeat rural India. A good start in the monsoon has raised sowing, holding promise of a good kharif crop. Plus, the government has announced several key reform measures for the agricultural sector, which have improved sentiments across the entire agricultural supply chain. A manifestation of the upbeat mood in rural India is a revival in demand for tractors and that primary mover of rural India, the motorbike.

But the outlook for urban India remains fraught, with the financial sector in deep trouble. If, as apprehended, banks see a sharp jump in NPAs post moratorium, they will become more averse to fresh lending — putting the entire prospect of economic recovery under a cloud. Plus, the trouble faced by small and medium NBFCs will mean a drying up of funds for the more vulnerable section of micro, small and medium enterprises (MSMEs). This will result in their closure and social distress at the bottom of the pyramid.

Fiscal support

With this kind of a scenario facing the economy, it is urgently necessary for the government to come up with a revival plan as the year progresses. But here again, there is a major hurdle in the way. The revival plan has to be anchored on fiscal support, but the government is apprehensive on what this will do to the fiscal deficit and the debt-GDP ratio, and resultantly, India’s credit rating. But Rajan has deprecated this reasoning, pointing out that what is relevant is not the debt but the existence of a plan to get out of that debt.

Goldman Sachs has said that what is of concern to the rating agencies is not the short-term debt and fiscal position, but whether India has the administrative and fiscal capacity to implement large fiscal support. What will deter further downgrades is a strategy to revive growth, backed by a credible medium term fiscal plan.

First must come the will to do right. In May, India announced a much-hyped fiscal support of ₹20-lakh-crore, or 10 per cent of GDP, but the actual spending has turned out to be a mere 1.8 per cent of GDP. For a fiscal stimulus to be effective, it has to be big enough to make an impact and reach the poor and the small businesses.

The poor are supposed to be reached through Jan Dhan accounts, but that route does not fully work and effort is on to speed up the ‘one nation one ration card’ project. The idea of instituting a universal basic income keeps being discussed. As for small businesses, the future of many small and medium NBFCs, which are supposed to be the conduit for credit, is itself in doubt.

In this scenario, the government is reportedly watching the impact of the earlier stimulus, laying store by the first signs of recovery, before taking a decision on a fresh one. Only prompt informed action based on proper economic insight into the whole matter can save the day.

The writer is a senior journalist