NBFC crisis and its domino effect on Indian economy

NBFC crisis and its domino effect on Indian economy

The most important thing to do now is not to shock the system, give confidence to the industry, bring liquidity into the system and reduce interest rates.

What we see is a liquidity squeeze in the economy. Consumption has come down because of this. There is not enough liquidity in the system. What we see is a liquidity squeeze in the economy. Consumption has come down because of this. There is not enough liquidity in the system.

There is a decline in consumption which has led to a decline in the GDP growth. There is no recession because recession means two-quarters of negative growth. We don't have negative growth, we have a 5% growth rate. We have to go back to September 2018 when the IL&FS scandal happened.

When it happened those who got caught were debenture holders of the company-- pension fund, mutual fund and the lenders from the NBFCs who had lent to IL&FS. 40% of the incremental consumer financing last year was done by the NBFCS, not banks. 25 - 30% of the NBFC money was coming through funding or Mutual Funds spots.

Mutual Funds used to buy their (NBFCs) papers for 90-120 days and give them money and they used to roll over. Second, they used to place bonds or mutual fund spots in the market. 45-50% of the NBFC financing was coming from Mutual funds at that time. But, because mutual funds like DSP, HDFC and others were hit by the IL&FS scam, they stopped their funding to the NBFC. When they stopped funding, the NBFCs had to release the money to pay back whatever is maturing.

Also read: RBI bans NBFCs from charging loan foreclosure penalties from individual borrowers

The exposure to the NBFC sector came down hence IL&FS happened in the quarter of October-Dec, 2018 saw a decline in consumption and decline in its financing and subsequently, the GDP growth rate in Jan-March came down to 5.6 %. It saw the impact there. In the month of October, November and December, late former finance minister Arun Jaitley was not well, so there was not much of action happening. RBI was not even thinking about it because it was undergoing some changes.

In the month of January, February and March we had new a Finance Minister who was busy with the budget. Then the government went to election mode. In the months of April, May and June (2019) nothing happened, and after the NDA2 government was formed they had to make the budget and then the Kashmir problem happened, which kept the government occupied further. We had no action from the government all this while.

The market representatives went to meet the government to talk to it about the liquidity crisis they are faced with all the time. But, the RBI went on reducing interest rate saying that there was liquidity in the banking system.

Also read: NBFC crisis: Govt issues guidelines for Rs 1-lakh crore partial guarantee scheme to revive sector

The problem was that lending to consumers was not done by the banks, it was done by the NBFCs who from September last year till now (2019) have withdrawn Rs 3 lakh crore from the market, which means about Rs 1.5 to 2 lakh crore has been paid back by them towards their liabilities.

Reliance Capital itself paid back Rs 40,000 crore and DHFL also paid back Rs 40,000 crore and whatever money they were lending they were not getting back to lend further. So there has been a liquidity squeeze in the market.

Now how did liquidity squeeze manifest itself? It manifested itself in the lack of purchase of cars and autos, purchase of real estate and construction by real estate companies. Around 95% of vehicles may have been financed by the NBFCs or by agents.

How does it work?

You go to a dealership wanting to buy a car and seek finance for it. The NBFC official grants you a loan immediately. Where you can get a loan instantly by an NBFC, seeking a loan from a bank takes around 20 days. Hence, most of the financing was done by the NBFCs which they stopped. Due to this consumer car loans came down and car purchases also fell subsequently.

Secondly, the same thing happened in the case of two-wheelers. The two-wheeler companies in many parts of India were well-financed but their sales too were affected as the NBFCs were not financed adequately.

Thirdly, the real estate companies were getting money largely from the NBFCs because they were not getting any lending from the banks. The NBFCs were giving these companies funds to start new projects, construction and financing etc. However, after RERA, they could not divert the money given by house owners hence, they depended on NBFCs even for their working capital requirements.

The real estate companies are now stuck because the projects are not going ahead and subsequently shutting down due to the NBFC crisis. The realtors are not able to complete the projects.

Also read: Only 6 out of 28 NCD issues of NBFCs fully subscribed between Sept 2018 to June 2019

The NBFCs also finance car dealers and a part of the supply chain which has come down because the cars are not selling. As a result, the dealers are also shutting shop as they are not able to store the inventory and make money. They are also not getting enough financing to stock the cars and without stocking cars you cannot sell them off. Hence, there is a chain.

What has been the impact on auto sector?

According to a Kotak Mahindra report, the total auto and car sales figure in the country is about Rs 5 lakh crores. The monthly sales may be around Rs 40,000 crore. Now a 20% decline in the Rs 5 lakh crore sales figure would sum up to about Rs 1 lakh crore which is financing.

Hence, there is negative growth. Although, around Rs 60,000 crore financing has come back, out of which dealership may be around Rs 10,000 to Rs 15,000 crore and the NBFC sector has built a Rs 1 lakh crore liquidity in its balance sheet. Liquidity in the balance sheet means the NBFCs keep the money to pay back their liabilities.

They are not lending but they are paying back their liabilities. And since they are paying back their liabilities, there is a problem. Since the NBFCs are building the liquidity to pay back their liabilities so that they do not default, the money is not going to the market.

What should be done?

The government has to come out with a scheme where the NBFCs can sell their assets and raise liquidity but if they sell goods, their balance will shrink and they will have to put up margins. The better thing is to find out which are the good NBFCs to which banks can give good credit lines to lend, particularly to the auto and real estate sector where they can put up 25% of their money and get 75% in return. The banks can explore receivables so that the money that comes can be used to payback the bank loans and not diverted.

We need liquidity to be pumped up at the point of lending which is an NBFC. Now, that is not happening as the SBI Chairman Rajnish Kumar said very clearly that he has Rs 1 lakh crore surplus money which he is not ready to lend. However, the problem is that he cannot lend. He is scared to do so because he has to lend to the NBFCs only and has to find out which ones to lend to and give the lines of credit to. That's how it has to be done.

What we see is a liquidity squeeze in the economy. Consumption has come down because of this. There is not enough liquidity in the system. At present, the total bank lending in the system is Rs 97 lakh crore out which the total NBFC book is Rs 24 lakh crore.

The RBI should monitor the total lending including NBFCs apart from the banks on a fortnightly basis. The apex bank only monitors banks currently. It should also oversee the NBFCs and look at the system liquidity including both NBFCs and banks so that the borrowings can pick up in the economy. This, however, is a challenge the government has to address urgently. Unless the NBFCs are given the lines of credit, they are not going to pick up pace.

Talking about the Iron & Steel industry, the auto and real estate sectors are the biggest consumers of building material like cement which is used by a lot of companies and creates a lot of jobs. Hence, jobs could also come down in other sectors of the economy.

The situation is such that now even the consumption of the FMCG products is coming down but that's not a valid argument because that is seasonal. Soumya Kanti, Chief Economic Advisor, SBI has written an article where he has given data to explain all this. However, the bigger problem is the big consumption items and that is where the government has to apply its mind.

But first, the government needs to solve the liquidity problem. Secondly, what it has to do is to assure the industries that it is not going to shock them anymore. Industries do not have the capacity to take any kind of shock anymore. They were shocked with demonetisation, GST, RERA and IBC and now they got the NBFC liquidity shock. Most industries are giving up as they don't know what to do as nobody is listening to them.

On the top of all this is tax terrorism which is a very big thing because in the last 5 years, the tax disputes in NDA 1 have doubled around Rs 3.5 lakh crore to 6 lakh crore. Tax authorities are losing 80% of the cases at the appeal stage which are all found to be bogus claims. Why bogus claims because the targets are too high. The government couldn't meet the target last year and the target for this year is very high.

When the economy is growing at 8% including inflation, expecting the tax collection to go up by 16-17% is difficult. Hence, the tax authorities go ahead and extort people as they are under pressure to achieve their targets.

The Central Board of Direct Taxes (CBDT) terrorises tax officers who then turn to the citizens. This is becoming a big problem everywhere. Refunds in the tax system are not coming through, GST refunds are not coming and on top of that everybody wants to meet their targets.

Also read: As NBFC crisis lingers on, SBI comes to aid to the aid of MSMEs

Also read: RBI Governor Shaktikanta Das rules out plan to conduct asset quality review of NBFCs