In recent months, there’s been active disagreement between India’s central bank and businesses on the issue of whether there’s a liquidity crisis. While the RBI has been insisting that systemic liquidity is ample after its LAF (Liquidity Adjustment Facility) and open market operations, businesses continue to crib about a liquidity drought. Data presented in the latest Monetary Policy Report explain this puzzle. They show that while liquidity conditions in India’s money market eased substantially in H1 of FY20, this made little difference to the commercial sector owing to a sharp shrinkage in credit flow.
Credit flow to the commercial sector shrank on two counts. One, despite sitting on ample liquidity from the RBI, Indian banks withdrew from commercial lending activities in this period. Non-food bank credit, which had expanded by ₹1.65 lakh crore in the first half of FY19, contracted by ₹93,688 crore in the first half of FY20. Banks stockpiling SLR securities (nearly 7 per cent more than the statutory norm) is evidence of their extreme risk aversion. Two, even as banks huddled in the safety of government securities, non-banks which were key credit providers to neglected borrowers in recent years also cut back. Incremental lending by housing finance companies and NBFCs saw a drastic shift from a positive ₹3.8 lakh crore last year to a negative ₹1.2 lakh crore this year. With NBFCs hamstrung by a dearth of funds and sharp spike in costs, this isn’t surprising. Overall, the data perhaps goes to show that RBI’s aggression in getting banks to transmit policy rate cuts through methods such as repo rate-linking, is having the unintended consequence of bankers stepping away from all difficult lending decisions. The RBI needs to shift focus from rate transmission to confidence-boosting measures on industrial debt, that can revive bankers’ risk appetite. The RBI’s benign neglect of the simmering NBFC crisis is also beginning to bleed the economy. Here, the RBI needs to move from tentative methods such as tinkering with bank risk weights, to more direct interventions that clearly identify and ring-fence NBFCs’ doubtful loans from their sound ones.
In this backdrop, it is certainly not reassuring that Indian firms are increasingly taking to the External Commercial Borrowing (ECB) route to meet their working capital needs, with a BusinessLine analysis finding that such borrowings jumped ten-fold in April-August 2019. While local firms seem to be drawn by the simple arbitrage between ultra-low interest rates in the developed markets and sky-high domestic lending rates, capitalising on this ‘opportunity’ requires them to cut corners on hedging forex risks. This would leave both their own balance sheets and India’s external debt position vulnerable to volatility. The RBI must rethink its recent dilution of mandatory hedging norms for corporates. Given that the Indian sovereign has just shelved plans for an overseas bond issue fearing global volatility, it is unwise to allow India Inc to binge on dollar debt.