As you ring in the New Year, record-high share prices and a stable Indian rupee indicate optimism. It appears that foreign and domestic institutional investors in the equity and currency markets are expecting better days for the Indian economy. Financial markets put a value today on expectations for tomorrow.
The big picture
If you go by the economic data, 2020 begins on a sombre note though. The year 2019 ends with the weakest economic performance in recent years. Arvind Subramanian, a former economic advisor to the Modi government, has described the situation as a “great Indian slowdown”. He has highlighted that India’s ‘twin balance sheet’ problem will continue to hurt the economy.
The dichotomy in the markets and economy is there for everyone to see. The consumer inflation in the economy would remain stable if not low if one goes by the assessment of the Reserve Bank of India. As a result, interest rates are likely to stay flat. A fundamental issue bothering all experts is not about these headline numbers. It is about low interest rates translating into a higher borrowing by the corporate sector for investments. The twin balance sheet problem highlighted by Subramanian can derail that effort. The twin balance sheet problem refers to the weak balance sheets of banks and those of corporates.
Between the significant expansion of 2004 to 2011, India’s government-owned banks lent to steel and other infrastructure companies. They have accumulated non-performing loans that hurt their balance sheets. As a result, the government had to put taxpayers money into them to help them tide over the situation. Banks that have your savings and fixed deposits cannot run out of money. The government has to ensure that there is always money available if depositors want to withdraw it. All of that slowed the lending process to businesses that deserve to grow.
Subramanian then highlights the second wave that was triggered by the demonetisation and lending to real estate companies. The housing sector contributes significantly to economic activity. The severe slowdown in this sector has hurt India’s economy.
Your finances in 2020
Taking note of the gloomy backdrop, the year ahead could be another roller coaster. When a severe economic crisis hit India in 2011-12, weak bank and corporate balance sheets, as well as
a poor state of government finances, were equally responsible. As a result, the consumer price inflation rate went through the roof. A positive takeaway at this point of time is that there is no runaway inflation. India’s finances are much stronger than they were earlier. However, there are worries about the government falling short of tax revenue and not able to meet fiscal deficit targets set in the budget of 2019. The International Monetary Fund’s assessment for India puts a cautious outlook for economic growth and the country’s ability to manage finances well.
The fund advises the Indian government to enhance tax revenue. That runs straight into the recent tax cuts announced by the government for corporates as well as expected tax cuts for individuals to stimulate growth. The idea is that if consumers have more money in their hand, they could spend more and trigger demand for goods and services. For a slowing economy, this can stimulate economic growth. However, there is also a risk of the government unable to afford such giveaways and resorting to additional borrowing. All of this means that interest rates may not rise but may not fall significantly too. Do not expect your fixed deposit rates to rise. At the same time, it may be an excellent time to borrow and buy a new home to take advantage of low interest rates.
Financial markets seem to have discounted any concerns flagged by the economic data in 2019. Shares of financial services companies led the rally in financial markets in 2019 despite considerable problems. They contributed to nearly two-thirds of the growth in profits of 50 companies that form the NSE Nifty, according to one analysis. Private sector banks led the most gains in 2019. If you are active in equity markets, the outlook for the banking sector in 2020 matters. Maharashtra recently announced a new loan waiver. The state already has agricultural loans to the tune of Rs 1,10,000 crore, with public sector banks accounting for half of them and co-operative banks for 24 per cent. A loan waiver scheme hurts public sector bank balance sheets further. Investing in banking shares needs caution in 2020.
(The author is editor-in-chief at www.moneyminute.in)