The low GDP growth means FY21 tax collections will also be low, leaving the FM little to either raise government-spend or recapitalise banks meaningfully. Representational image

Even when many in the government criticised ex-chief economic advisor Arvind Subramanian for saying India’s GDP was overstated by 2.5 ppt, few could explain why, if GDP was growing so fast, other indices were growing so slowly. As India’s GDP has collapsed to 4.5% in Q2FY20, other indicators (see graphic) suggest that even this may be an overestimate. Even in FY94, when GDP grew at roughly the same rate as today, IIP grew at 6% vs 1.3% now, exports at 20.1% (-2.6% now), private consumption at 14.6% (7% now), and, the biggest surprise, while non-food credit was 5.7% then, it is -0.2% now; if everything is collapsing, how is GDP growing?

While many feel growth will come back soon, they ignore the fact that little has been done to fix India’s credit crisis; in a recent paper, Subramanian and Josh Felman (S&F) argue that India’s twin balance sheet crisis (banks and corporates with shot balance sheets) has morphed into a four balance sheet one (with NBFCs and real estate added). This is why, from Rs 20 lakh crore in FY19, commercial credit completely collapsed in FY20.

In the past, the collapse in credit—due to a huge rise in NPAs—was tackled by the government injecting lots of capital into bank balance sheets. Since the NDA came to power, it has injected Rs 3.5 lakh crore into PSU banks. But, with fresh loans turning bad and banks writing off Rs 7.2 lakh crore, NPAs are still a high 9.2%; and 12% in the case of PSU banks.

While S&F speak of Rs 2.5 lakh crore of stressed power loans that could turn into NPAs, other potential NPAs are the loans to NBFCs, real estate, and telecom (especially if Vodafone Idea shuts down, as is expected). And, with nominal GDP likely to grow at just 7-8% as compared to the 12% budgeted for, this will add to the stress; 40% of corporate loans in even Q1FY20 was to firms that couldn’t service it, and this rose to 45% in Q2.

This is what finance minister Nirmala Sitharaman has to deal with. She faces a possible Rs 2 lakh crore tax shortfall due to poor GDP growth and bad budgeting—instead of the actual FY19 tax collections of Rs 20.8 lakh crore, the budget estimated it at Rs 22.5 lakh crore; she also needs money to recapitalise banks, and to take over some NBFCs, so that credit starts flowing again. Had the government privatised some banks, it would need less recapitalisation money, but Modi refuses to do this.

The low GDP growth means FY21 tax collections will also be low, leaving the FM little to either raise government-spend or recapitalise banks meaningfully. Sitharaman’s challenge, in fact, is made worse by the fact that private consumption growth has been falling steadily, from 15.3% in FY14 to 7% in H1 this year. If government consumption can’t rise much due to budget constraints, the only hope has to be a rise in investment, but adverse government policy in many areas ensured nominal investment growth plummeted from 13.7% in FY19 to a mere 4% in H1FY20; as a share of GDP, investment levels fell from 31.3% just before Modi came to power to 28.8% in the first half of FY20.

There are many reasons for why India staved off a crisis despite the twin balance sheet problem morphing into a quadruple one; most revolve around a massive jump in government expenditure, aided by the dramatic collapse in oil prices in 2015 and 2016. As a result, nominal government expenditure grew faster than GDP in the Modi period (1.85 times vs 1.69 times); it was the opposite in the UPA decade, with government expenditure rising 3.26 times vs 3.46 times for GDP.

How, and whether the current crisis will turn into one like 1991 is not clear since forex reserves remain robust and inflation is very low, but it is clear India’s troubles are only deepening as—amazingly, given how GDP is plummeting—interest rates continue to remain so high. Since this prohibits both investment and consumption, ideally, as many argue, RBI should slash repo rates. But, even when it has done this, it has not resulted in lower interest rates as banks continue to face NPA stress and are also more risk-averse.

At a larger level, the lesson is that the government has no magic bullets left, it simply has to reform at breakneck speed in the hope that this will, over a few years, stimulate both investment and exports, and, as a result, also consumption. A speedy resolution of the telecom problem can, for instance, arrest the collapse in investment in the sector; slashing government levies and rapidly allocating mines could spur investment in the mining sector including oil/gas, fixing defence procurement procedures could give a big fillip to Make in India, finalising an incentive package to get the likes of Apple/Samsung to shift their vendor base to India will give a big fillip to exports …

Many argue that Modi doesn’t have the ability to push tough reforms—like privatising banks or allowing hire-and-fire—that require Parliament assent, and his failure over the land acquisition bill is often cited in this context. While many of the reforms—slashing levies in telecom and mining, or allowing FDI in multi-brand retail—don’t even require Parliamentary approval, too much is made of the lack of Rajya Sabha majority. When Modi wants it, as in the case of the citizenship law, he manages to get tough bills passed and, in cases like demonetisation, he brooks no opposition. The question, then, is when will Modi think economic issues are worth expending political capital on.