IMA Analysis

Monday June 1, 2020

A Balance Sheet Crisis May 2020

Speaker:  Adit Jain,Editorial Director, IMA India May 2020

Disfigured balance sheets

During his briefing at a recent CEO Forum, Richard Martin, Managing Director of our sister company IMA Asia, explained the relevance of balance sheets on demand and economic output. The four balance sheets in question include those of households, corporates, banks and the government. Richard explained that if two of these were damaged, demand and growth might still be sustained albeit hesitantly, if the other two were healthy. For instance, during the global financial crisis of 2008, banks and household balance sheets were in dire straits and consequently governments stepped in with a host of initiatives, which included very loose monetary policies and fiscal sops. USD 11 trillion were printed by the world’s major central banks in the hope of pump-priming the economy and avoid a painful and prolonged recession.

But in the wake of Covid 19 and the consequent lockdown across the country, all four balance sheets in India, are likely to slip into distress. This may result in collapsing demand, dwindling investments and subsequently a situation where there are few painless options to pick from, as a response strategy. India’s consumption engine began to falter in June 2019 and analysts had hoped that this was a blip and a revival in consumer demand may restart rapidly. However, that did not happen. Interestingly, growth in household disposable incomes actually stalled in 2012 – it was 5% below levels of the previous five years. Initially, consumption fell but not quite at the pace as incomes did, largely on the easier availability of finance. Households were consuming 80% of disposable incomes against 70% previously, resulting in a regression in savings.

But by 2019, the decrease in consumption became more blatant with rising levels of household debt. This is currently estimated to be 31% of GDP and frankly, the sums could be even higher if one were to include informal sources of borrowings, for instance, from money lenders. More recently, the collapse in asset prices would depress consumption even more, as household balance sheets weaken further. Job insecurities and lower wages effect the ability to spend. Monetary tools such as lower interest rates have a marginal impact, if at all, on household consumption. What works is fiscal policy – lower rates of direct taxation as well as those of GST. The balance sheets of banks and financial institutions, in no fine shape to begin with pre-Covid 19, will worsen as loan defaults mount. Some estimates suggest that non-performing assets may rise to about 20% of outstanding debt, specifically from small and medium enterprises. With collapsing demand, high fixed costs and a wages burden to contend with, a large number of firms may go belly-up and consequently be unable to service their debt obligations. Corporate balance sheets of those that survive will undoubtedly weaken, as revenues shrink. Capital investment will vanish as existing capacities become surplus.

The last recourse is the government but here again, the ammunition accessible is limited. The national dissaving last year was 9.7% of GDP and there is a limit to the sums the government can spend without inflation escalating beyond reasonable limits. The fact is high government spends will only increase imports. What is required is a serious bout of structural reforms in the three factor markets to allow – flexibility in labour policies; the ability to quickly and cheaply acquire land; and finally, ways to create greater depth in markets that allow savings to be transmitted through better intermediation, more banking licences and greater competition. When balance sheets are damaged and can no longer support growth, the choice falls upon the more politically arduous and painful options. Perhaps, under compulsions, these may be forced upon us.