By Varushka Bhushan
India’s economic growth is at a six year low with GDP growth plummeting to 4.5% as of the July-September quarter of 2019-2020. What led to the slowdown of the world’s fastest-growing economy? The financial sector.
Infrastructure Leading & Financial Sectors is a non-banking financial company, more recently being called a shadow lender. NBFCs provide financial services similar to banks; however, they are not regulated like the banking sector. Thus, NBFCs can take higher and more long term risks than most banks. The lack of regulation is the one thing that enables heavy involvement in the real estate sector. Real estate projects are long term and high risk - they require large amounts of money and have no returns until the projects are functional.
Their high-risk investments with long term returns are only qualified if the project is a success: if the projects go bust, so do they. IL&FS started defaulting on its payments because it lent to too many real estate projects that went sour due to cost overruns because of major delays in land acquisition and approval.
IL&FS’ investors include banks, mutual funds and insurance companies (including two large overseas shareholders). The fall of a lending giant like IL&FS has led to a loss of confidence, steering investors away from other NBFCs and the real estate sector. This also leaves banks and mutual funds exposed. Banks have an exposure of over Rs.4.4 lakh crores and mutual funds have an exposure of around Rs. 2.65 lakh crores.
This has led to what economists are calling the “Twin Balance Sheet Problem (TBS)”. The TBS basically means that the companies have accumulated large amounts of debt that they are struggling to pay back, thus defaulting. Since these companies are defaulting on their payments, so are banks. The TBS problem soon became an FBS (four balance sheet problems) involving infrastructure companies, banks, NBFCs and real estate companies.
The crux of the situation is that there is no longer any liquidity in the economy as corporates and banks are in debt while the government runs a fiscal deficit (the government is spending more than it’s earning). This is having adverse effects on consumer expenditure and government investments, two major drivers of the economy.
This is a highly simplified version of what’s at the root of the issue, the real estate sector and the financial sector. While there are other factors like the global economic slowdown, economic policies, structural issues, etc. the government will have to first sort out stalled real estate projects and liquidate the financial sector.
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