Stranger things

NBFCs are out and corporate lenders in, world is no longer flat and central banks causing turmoil rather than stability

A decade after the global economy suffered withdrawal pangs, the Indian financial markets are experiencing a relapse. It took a series of defaults beginning July by infrastructure financier and developer IL&FS to put the spotlight on the practice of non-banking financial services providers raising short-term funds to lend over a longer period to buyers of automobiles, consumer goods and homes. The US Federal Reserve began buying bonds within a month after credit dried up following the collapse of Lehman Brothers in September 2008. In contrast, the Reserve Bank of India is fretting if the finance ministry’s pressure to part with a portion of its bulging reserves is yet another blow to its autonomy. The earlier flare-ups were over creating a separate regulator for payments bank, initiating bankruptcy proceedings against defaulting power producers and allowing banks under preventive corrective action to resume normal operations to meet the needs of a growing economy. While the issue of taking away supervisory power over digital couriers of funds remains in abeyance, the Supreme Court permitting pass-through of fuel costs to distribution companies has extinguished the other irritant for the time being. The standoff between the monetary authority and elected policy makers is not new.  Former finance minister P Chidambaram was vocal about his frustration with the RBI’s reluctance to embrace a softer regime. US President Donald Trump has berated the Federal Reserve for making access to funds dearer. Foreign investors fled Turkey when its president warned the central bank against raising interest rates. What the controversy has done is to expose the lack of accountability of those regulating the banking system. Most follow rigid textbook prescription of tightening the flow of money to stick to the mandate of targeting inflation. To deal with the excesses of easy money, the Fed adopted a contrarian strategy. It took six years of expansion of the balance sheet from US$ 900 billion to US$ 4.5 trillion and seven years of near-zero interest rates to revive the US economy.

If the RBI’s resistance to respond to the market’s need for liquidity is strange, NBFCs going out fashion is even stranger. Till recently the flavor of the market due to the boom in rural consumption, concerns over their asset-liability mismatch triggered by the IL&FS episode is producing a tilt towards big-ticket lenders. Government spending on infrastructure is filling the order books of construction services providers and capital goods makers. Housing-for-all and a normal monsoon over most parts of the country have pushed up demand for items of mass consumption. Many producers are undertaking modernization and capacity enhancement. What has also spurred lending to companies is the resolution process for bad assets. Borrowers can no longer keep on refinancing their debt. To become eligible to take over Essar Steel, Arcelor Mittal had to clear SBI’s dues owed by Uttam Galva Steels, a company it had co-promoted before being sold to the other promoters for Re1. Pay or perish is the new slogan that is helping to clean up the balance sheets of banks. Even the original owners of insolvent entities are now ready to service their entire leverage. Instead of reacting with horror to the stepped up provisioning for bad loans, the exercise is now greeted enthusiastically as a fresh beginning.

Stranger than the changing contours in the lending space is the reshaping of the world. It is no longer flat and has turned nations into islands that suffer the adverse effects of someone else’s prosperity. Largely due to trade wars and surging crude oil prices, the impact of a strong dollar is not booming exports but weak domestic currencies.  If the IMF’s belt-tightening prescription for indigestion from reckless consumption caused social unrest, the outcome of central banks intervening to cap imported inflation is not likely to be much different. The puzzle is if supply not keeping pace with demand, that is triggered by easy availability of credit, is the cause of rise in prices, how is increasing the cost of money going to achieve the aim of matching output with usage. The recent correction in US equities captures the paradox perfectly. The preoccupation of investors seems to be with how low unemployment is consolidating the resolve of Fed to continue with hiking the policy rate rather than drawing up strategies to capture the opportunity presented by the buoyancy in jobs. Building up capacity to gain a bigger market share comes at a price. Dilution of equity even at exorbitant valuations calls for servicing obligation. Too much debt spoils the gearing ratio. Strangely, companies that have undertaken expensive expansion during a bullish phase spend the downturn in disposing of the assets at bargain prices to pay the creditors from whom they had acquired financing at a higher cost.     

-Mohan Sule