Updated: November 23, 2020 10:15:56 am
If this economy grows at an average annual rate of only 5 percent (instead of 8 percent) from year 3 onwards, it will take more than three years to reach the level of 116.6 units of GDP.
Over the past few weeks, there has been a lot of talk about how the Indian economy is rapidly coming out of its technical recession. Such hopes are not without substantial justification, both in terms of the revival of economic activity within India and in the news from Vaccines for COVID-19 being discovered.
There is an expectation that even if the Indian economy contracts in the current financial year, say by 10 percent, perhaps it will grow by roughly the same percentage in the next financial year, 2021-22.
But it is important to remember that in times of such sharp contractions and growth, one should not only focus on GDP growth rates, but also the absolute level of GDP. [The GDP or the gross domestic product is the money value of all goods and services produced within the country in a financial year.]
For example, if the GDP of an economic contraction of 10 percent – from 100 to 90 units – in year 1 and then grow by 10 percent in year 2 – from 90 to 99, then to the end of the second year, the absolute level of GDP will remain lower than two years ago.
If the initial contraction had not occurred, the GDP of this economy would have been 116.6 units, assuming an average annual growth of 8%, at the end of year 2.
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However, from 99 units in year 2, even if the economy resumes its growth momentum 8% as soon as entering Year 3, it would take two more years to come even mark 116.6 units.
But after a crisis, an economy can struggle to regain its growth momentum. This may be especially true if the economy was losing momentum even before the crisis and / or if the response to the crisis was not adequate for the economy to quickly regain lost momentum.
If this economy grows at an average annual rate of only 5 percent (instead of 8 percent) from year 3 onwards, then it will take more than three years to reach the level of 116.6 units of GDP.
A new Oxford Economics report suggests that something similar is happening to the Indian economy. Oxford Economics has forecast that India’s potential growth is likely to average just 4.5% between 2020-2025, as opposed to its pre-virus forecast of 6.5%. It is important to note here that 6.5% is already lower than the average annual growth (6.8%) achieved by India since economic liberalization in 1992.
The main culprit for this drop, from 6.5 to 4.5 percent, in the potential growth rate, according to Oxford Economics, is India’s weak fiscal response, which magnified structural difficulties. In other words, because the Indian government did not spend enough directly to boost the economy, the recovery would be slower.
As a result, India will likely be the worst hit among the world’s major economies.
“GDP per capita will be 12% below our pre-virus baseline even in 2025, implying the most scarring of any major global economy,” the analysis notes.
“Headwinds already hampering growth before 2020, such as stressed corporate balance sheets, high NPAs for banks, fallout from non-bank finance companies (NBFC), and market weakness are likely to work worse, ”said Priyanka Kishore, Director of Economics for India and Southeast Asia.
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A woman and child walk out of a music store as a rental sign is displayed on a floor below that the tenant recently vacated in Bengaluru (AP Photo / Aijaz Rahi)
These assessments and forecasts are important as the Union Ministry of Finance has just started the process to frame its next annual budget.
However, most of last week’s attention was focused on the state of banking in India. On the one hand, the collapse of Lakshmi Vilas Bank and its proposed merger with DBS Bank shook both depositors and investors in the stock market.
The banking sector regulator, the Reserve Bank of India, took some relief when it became the world’s first central bank to have a million followers on Twitter.
But the biggest news from RBI was the report of an Internal Working Group (IWG), which was formed in June to review existing guidelines regarding ownership of Indian private banks. The IWG has made several recommendations that are expected to increase prudential standards in Indian private banks. 📣 Click to follow Express Explained on Telegram
These include suggestions like
- not allowing bank promoters to pledge their shares in such a way as to breach the prescribed minimum threshold
- no longer allow ADR / GDR (negotiable certificates that function as a representative of shares in foreign markets) issued by banks to be used by any shareholder to indirectly improve their voting power
- increase the minimum initial capital requirement for new banks
- tightening of the requirement that banks be listed on stock exchanges
- asking banks, which run parallel businesses such as insurance and mutual funds, to protect their banking operations by adopting a financial holding company structure.
Almost all of these are expected to make private banks operate more securely.
The IWG has also recommended that regulatory standards be harmonized between entities. In other words, if the initial capital requirement for a new bank is increased, all existing banks must also meet the higher standard.
However, there are a couple of recommendations that could generate some debate.
The first relates to the limit that RBI imposes on the participation of a private bank promoter after a period of 15 years. Currently, this limit is 15 percent of the paid-up voting share capital. But some are not happy with this limit. Most notably, Kotak Mahindra Bank had even taken the RBI to Bombay High Court on this matter.
The second refers to allowing large companies and industrial houses to become promoters of banking. Linked to this is the suggestion to allow the transformation into banks of Non-Banking Financial Companies promoted by large corporations.
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Customers wearing protective masks shop during the Dhanteras festival at Lajpat Nagar Market in New Delh (Photographer: Prashanth Vishwanthan / Bloomberg)
Allowing large companies to create a bank has always been a sore subject. Most major economies, except the United States, do not prohibit them. But India doesn’t allow them to float banks and, at first glance, for good reason.
On the one hand, many experts believe that corporate governance in India is still not good enough and it is quite possible that a promoter’s non-financial business and transactions will negatively affect the operation of said bank. IWG undoubtedly contacted their group of experts and found that “all the experts except one were of the opinion that large corporate / industrial companies should not be able to promote a bank.”
The obvious converse, however, is that if we allow NBFC from similar companies, why not banks? After all, banks are more strictly regulated than NBFCs.
The main underlying concern these two proposals is to balance the need for growth and new banking prudential standard way to have a more diversified ownership in private banks for a dominant owner does not abuse the system to the detriment of many.
These IWG recommendations are likely to continue to spark conversations about stroke in the weeks to come.
Stay safe,
Udit
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