Small Need Big Support

Source: The Hitavada      Date: 14 Nov 2018 12:39:20

By Anjan Roy,

From the layman’s point of view there are apparently three main issues which need to be resolved with a general consensus among the policy makers. The liquidity crisis and particularly the funding of small and medium sectors from non-banking financial companies in the aftermath of the debacle of the IL&FS, justifiably the country’s largest such non-banking financial company.


RUNNING battle between the country’s central bank and the Union Finance Ministry is a matter which should not ordinarily concern the common man. It should however become a cause for worry if these start hitting the nation’s economy. From the present indications, unfortunately this is what is beginning to happen. Another meeting of the RBI board is set for November 19 and the central bank and the members of the board might clash once again.

From the layman’s point of view there are apparently three main issues which need to be resolved with a general consensus among the policy makers. The liquidity crisis, particularly the funding of small and medium sectors from non-banking financial companies in the aftermath of the debacle of the IL&FS, the country’s largest such non-banking financial company, need immediate resolution.

The financial sector is a complex maze like a neural network where players are connected to each other through constant flow of finance back and forth. The name of the game is to maintain the flow. Any disruption of the movement of funds from one player to another, particularly if the flow is not just a dribble but larger, can thus cause a systemic seize up. Something similar is brewing.

IL&FS failed to redeem its pledges of loan repayment and other dues and has resulted in constriction of the arteries carrying the next free flows. Mutual funds used to offer funds to the NBFCs which in turn lent to the small and medium sector units which do not always have ready access to bank funds. Thus, their operations have started getting hurt. Mind you, the small and medium units are the backbone of the Indian economy, not in terms of overall output but for maintaining employment.

This sector, the smaller players, has already been hurt badly on account of demonetisation and introduction of GST earlier. Their output had fallen and so did employment from these frontal blows. Now that they have recovered from those disruptions somewhat, suddenly has come the vanishing of funding. And this could be even more deadly than the previous two blows, as finance is the life blood which sustains their life force, could result in large scale closure.

On top of the smaller and tiny units, one sector which is facing a crunch right away is reportedly the housing and construction activities. Their problem is that a large stock of housing stock is near completion or even completed. The last bit of funding could see their eventual completion and sale. That would mean return flow of funds from the buyers into the construction and housing companies and resuscitation and recovery of dues. This would make these projects, and there are many now, would become viable. Failing final completion and their handover, any delay resulting from lack of funds would in fact make these companies unviable and their loans into bad debts. It is this prospect that is weighing on the economy.

Market reports are that a good number of the best known names among housing and some large NBFCs can fall victim to the last mile shortage phenomenon and create another round of chain effect. So far, on the basis of technical analysis RBI has stated that there is adequate liquidity in the system and no need for fresh infusion of funds. RBI has even stated that it will take steps if there are crises and will step in with funds to mitigate any large scale defaults.

That is not what the approach should be. RBI may not even have to infuse large funds just yet. All it has to do is to create a window for funding NBCs and categorically state that funds would be available for sustaining present level of activity. Reassuring words from the RBI is enough to restore confidence in the financial markets rather than the central bank saying there is no problem at all.

The RBI has a stabilising role to play and restoring the market confidence in the Indian rupee. In the midst of the current global situation, the Foreign Institutional Investors (FIIs) are reshuffling their emerging market portfolio. With talk of the US interest rates going up and the US equity markets giving handsome returns, the FIIs are indeed keeping their options open. They are holding cash rather than remain invested in the emerging market economies.

A link has long operated between the FII moves and the foreign exchange markets. As they liquidate their positions in the equity market and takeout funds, the exchange rate comes under pressure. An additional source of trouble is the adverse current account situation. Oil price is also going up in spurts and worsening an already bad situation. We need to show a little bit of strength.

There were talks of raising some resources from overseas such as NRI bonds as we had done before. That could of course mean conceding to NRIs somewhat attractive returns. The Indian public sector banks meanwhile had spoken of raising some bonds – running up to around $30 billion — from abroad. This can however be done only with RBI blessings. Apparently, talks were on between RBI and some of the bigger PS banks for such an issue which RBI has opposed. There is reason to believe that RBI could be a little more pro-active and give its assent.