IMA Analysis

Wednesday July 24, 2019

The Credit Dilemma

Speaker: Adit Jain, Editorial Director, IMA India

The lending dilemma

The lending crisis amongst small businesses is ostensibly worse than many recognise. Non Banking Financial Companies (NBFCs) provide the bulk of funding within this segment and in the wake of the IL&FS crisis circumstances have changed radically. Unable to access funds either for expansion or even working capital, thousands of small businesses and consumers have been affected. NBFCs delivered about a quarter of all new credit in the form of modest loans and, following a few high profile defaults, their asset books have now come under scrutiny. Credit from mutual funds and banks has largely evaporated. Growth in bank credit to medium enterprises has fallen from 11% prior to the IL&FS crisis to about 3% now, while for micro enterprises the figures read 2% and 1% respectively. This is a systemic blow, affecting both retail consumption and investment. Economic output slowed to 5.8% in the January quarter and it seems likely that the scores for the April one, will not be much better.

The most tangible impact has been in the automotive industry, which shrank 18% in April 2019, the largest decline in nearly a decade. With a new thrust on electric vehicles by the government, auto companies are in a panic with rising inventories and reduced production. About 40% of new vehicle loans were provided by NBFCs. Consequently, over 300 automobile dealerships have shut shop mostly in metropolitan cities where administrative expenses are understandably higher. The impact is not limited here – consumer durables and real estate are also under threat as modes of financing for these sectors come under pressure. Retail credit from NBFCs has virtually buckled. The problem extends to other FMCG segments, with companies issuing warnings of a decline in growth. Rural markets, once the backbone of retail consumption, have shrunk.

Over the past week or so, financial markets have gone into a tailspin with about Rs 8 trillion of investor wealth being wiped out. This is likely to impact consumption amongst middle classes – they now provide the bulk of funding to mutual funds – a consequence of the negative wealth effect. The market collapse will also affect new investment as businesses become cautious. With capacity utilisation rates under 80% and shrinking demand, the financial risks of new capacity additions are likely to be considered greater than the risk of a loss in market share. Many multinational companies have deferred investment plans until the situation begins to stabilise. It therefore seems possible that aggregate investment will fall in the coming few quarters. These are worrying signs.

The government in its Finance Budget 2019, possibly in recognition of these challenges, allocated funds to recapitalise banks and offered certain sops to NBFCs. It however remains to be seen if that would be enough to bring things on track. The source of the problem lies in the rapid expansion in credit over the past few years. NBFCs in order to cut costs were raising money through the offering of short-term commercial paper and subsequently lending to luxury real estate, which comes with lengthy exposures. An asset liability mismatch was one reason they got into trouble. The other was the expected off take in housing markets did not happen. Builders were left carrying unduly large stocks of inventory and they simply ran out of cash. Their inability to honour loan obligations sent a contagion across financial markets. In turn NBFCs defaulted on their commitments to mutual funds and banks and consequently, the market for credit evaporated. The government more recently encouraged state owned banks to lend, but the problem is systemic and the sums for a suitable bailout are simply too large. The problem will take time to fix and until then consumption and investment may moderate. The next few months bear close watching.


Adit Jain’s articles and opinions can be found on his blog at This content is the intellectual property of IMA India and is copyright protected and legally privileged. Unauthorised copying, reproduction or distribution of this information would amount to an infringement of law and would invite applicable penalties.