MANAGING CREDIT- PART III-NON-BANK CREDIT IN INDIA

MANAGING CREDIT- PART III

(In Times of Disruption Caused by Covid-19 and Economic Lockdown)

NON-BANK CREDIT IN INDIA

Non-Banks and Credit in India

As noted in first two parts of this series of blogs, credit outstanding to governments, businesses and households at the end of financial year 2020-21 is about Rs. 300 lakh crore or $4 trillion @ Rs. 75 to a dollar. Half of this credit is owned by the banking systems- banks and the central bank put together. The remaining half of the credit is provided by all types of the non-banks, the savers directly and the rest of the world.

Institutional players in this space are non-bank finance companies (NBFCs), housing finance companies (HFCs), retirement savings funds (RSFs) like Employees Provident Fund Organisation (EPFO) and New Pension Scheme (NPS), insurance companies, most prominently the Life Insurance Corporation (LIC) and Mutual Funds (MFs).

Households invests their savings in different forms in many of these institutional players. Almost the entire resources of RSFs and LIC comes from households. Households also provide a significant part of the resources of Mutual Funds. Most of savings is invested in the form of deposits, though not termed as such. Households also provide some resources to NBFCs and HFCs in deposits (in NBFCs-Deposit taking e.g.) and by subscribing to their bonds and in units of debt mutual funds. Households also provide credit directly to government though various small savings schemes.

The rest of the world provides credit to government by investing in the government securities and to businesses directly by buying their bonds and providing loans in the form of external commercial borrowings (ECBs) and indirectly by investing in bonds of and providing ECBs to financial intermediaries like NBFCs, SFCs and MFs.

Bulk of the credit provided by all these lenders/investors is to the government- estimated at about Rs. 100 lakh crores at end March 2020. Estimated credit of about Rs. 30 lakh crores from all these players is to the businesses and remaining Rs. 20 lakh crores to the households.

Covid-19 and economic lockdown has not affected credit to the government. Risk to the credit extended to household is also much lower. It is the business credit portfolio of about Rs. 30 lakh crore which is the most affected. As credit portfolio of NBFCs has concentration of loans provided to businesses, the NBFCs are facing the utmost heat. HFCs, Mutual Funds and LIC provide credit (loans, bonds, commercial paper etc.) to some niche kinds of businesses; these are also impacted to different degrees.

We discuss the impact of covid-19 and economic lockdown in this Part III of the series of blogs of Managing Credit in India.

Funding Credit Requirement of Governments

The non-bank credit providers hold 2/3^rd of government debt- Rs. 100 lakh crores out of total government debt of about Rs. 150 lakh crores.

A little over Rs. 100 lakh crore of government debt is in the form of securities. At end February 2020, the outstanding stock of central government dated securities was Rs. 65 lakh crores, that of state government securities Rs. 30 lakh crore and treasury bills outstanding were of the order of about Rs. 5 lakh crores.

A little less than 50% of the central government securities, more than 67% of state government securities and more than 50% of the treasury bills were held by the investors other than the banks. In all, about Rs. 60 lakh crores of credit in government securities was provided by non-banks.

Most prominent investors were insurance companies which held approximately Rs. 30 lakh crores of the government debt of Rs. 150 lakh crore or about 20%. Retirement Savings Funds look for better secure yields. They held about 1/4^th of the entire stock of state government securities. Their investment in central and state government securities approximates about Rs. 10 lakh crores. Rest Rs. 20 lakh crores credit is held by mutual funds, foreign investors, primary dealers and other non-bank players.

Rest of the central government debt of approximately Rs. 30 lakh crores (Rs. 100 lakh crore- government securities Rs. 65 lakh crore- treasury bills of Rs. 5 lakh crore) comes from non-financial market sources. Approximately Rs. 15 lakh crores in different forms of small savings, about Rs. 6 lakh crores of external loans, over Rs. 2.5 lakh crore of recapitalisation bonds of public sector banks and non-market securities like oil bonds etc. of about Rs. 2.5 lakh crores contribute about Rs. 25 lakh crores. Rest Rs. 5 lakh crore comes from provident funds deposits, public account surplus and numerous other small heads.

Likewise, remaining borrowings of about Rs. 20 lakh crores of the state governments are contributed by multiple sources.

Issues Connected with Government Borrowing

There are three major issues connected with the borrowings of the central government- how to fund additional fiscal deficit caused by the economic lockdown imposed and covid-19 shock, streamlining of small savings and dealing with foreign investors in government securities.

Financing additional deficit

In order not to crowd out credit resources to the private sector and to discipline its expenditures, the central government has bound itself with some key binding constraints. Fiscal deficit is to be contained to 3%, total outstanding debt and liabilities are to be brought down to 40% of GDP by 2024-25 and the deficit is not to be monetised.

Extraordinary requirement of 3-5% of GDP on account of pressures on both sides (revenue shortfall may be up to 2.5% of GDP and expenditure requirements might shoot up by another up to 2.5%) cannot be raised from the market without disturbing its equilibrium.

Government has so far opted for backdoor monetisation. Ways and Means Advance limit has been increased from Rs. 75000 crores to Rs. 2 lakh crores. As revenue position is unlikely to improve, sooner or later this WMA would have to be converted into dated securities. Government raised about Rs. 15000 crores in short term treasury bills which were subscribed by RBI indirectly through Primary Dealers. These are now being converted into dated securities through modified twist programme.

Uncertainty in the financial markets about government’s additional borrowing programme and monetisation strategy has made market participants cautious, including banks. RBI reduced the repo and reverse repo rates drastically in last one month, but the yields on central government only moved up. There is a strong likelihood of trading in secondary government securities market sputtering.

It would be better if the government were to inform more clearly about what additional borrowing it expects to make and whether it would monetise the deficit or not. While I find that monetising the additional deficit would be the least bad option in the circumstances, making the borrowing path and strategy clearer, even if it is for non-monetising the deficit would be better than the uncertainty.

Streamlining small savings

Central government and the states together hold stock of about Rs. 15 lakh crore borrowings from small savings out of their total debt stock of about Rs. 1.5 lakh crore. Small savings sourced borrowings now make up only about 10% of total government borrowings. It used to be quite different 20 years ago.

State governments used to have more than 50% of their borrowings from the small-savings based loans provided to them by the central government. Almost all state governments have stopped borrowing from small savings (these borrowings are costlier).

The governments have also dismantled the network of small savings agents which used to source these savings from small savers. Additionally, the banks and non-banks, especially micro-finance institutions, have fanned out in the entire country side. The small savings programme is essentially serving the middle class only and is providing them off-market higher returns. This has created its own distortions.

It is time to wind up the small savings programme.

Foreign investors in government securities

Foreign institutional investors were permitted to invest in debt securities of government of India in 1993. Foreign portfolio investors (FPIs) hold about Rs. 4 lakh crore of central government securities. They have almost no investment in state government securities. The policy relating to their investment has undergone several changes.

Recently, the government and RBI have created a special window ‘fully accessible route’ for investment by FPIs in central government securities. While there are limits on FPIs’ investment in government securities, these specified securities would have no restrictions of FPIs ownership. Theoretically, entire stock of a specified security can be held by FPIs.

Intention behind creating this special structure is to enable India’s participation in global debt indices. Lot of money globally is invested following these indices. If Indian debt securities are part of these indices, the funds which mimic the indices pattern would invest in Indian debt securities to the extent of weight of India in the indices and the additional flows in such indices- based investment vehicles would also be invested in Indian securities in the same ratio.

Last year, the government had made a proposal in the budget to issue foreign currency denominated sovereign bonds. That proposal seems to have been shelved and new ‘fully accessible route’, in some manner, substitutes for such sovereign bonds.

Fully accessible route of encourage foreign debt flows in government securities suffers from all the problems which current system suffers from. It will only accentuate these problems. A good part of the FPI investments in Indian debt is a fair-weather friend. As long as foreigners get good steady dollar return on their investment, such investment stays or even grows. Such times happen to be ones when there is excess capital inflow and RBI is in the market for sucking the excess dollar supply. Rupee tends to appreciate during these times making the returns of FPIs rise. As soon as the tide turns and rupee comes under pressure for any reason (high fiscal deficit, high oil prices etc.), the FPIs start selling debt and taking their money back. In such times, when India needs additional inflows, FPIs’ sales adds to the woes of RBI, government and the market.

This new route of making foreigners’ investment in Indian debt without any limits and restrictions does not seem to be in larger interest of the country.

Credit to Businesses and Non-Bank Finance Companies (NBFCs)

Outstanding credit to businesses from all the non-banks is around Rs. 30 lakh crores, less than half of the credit provided to businesses by the banks.

Amongst the Non-Banks, NBFCs are major providers of credit to businesses in India. Gross outstanding credit by NBFCs as on 30^th September 2019 to businesses was of the order of Rs. 18.79 lakh crore. Approximately, 2/3^rd of non-banks credit to businesses comes from NBFCs. The rest of credit flows from Housing Finance Companies (to real estate companies/ builders), Life Insurance Corporation (loans to some companies and investment in their corporate bonds), Mutual Funds (loans against shares etc.) and investment by retirement savings organisations (RSOs), FPIs and savers directly in the corporate bonds.

HFCs provide loans to households primarily with some accommodation to the real estate businesses. As per NHB’s Report total loans and advances of HFCs were Rs. 10.38 lakh crores as on 31^st March, 2018. Of that Rs. 7.53 lakh crore were for housing loans and Rs. 2.86 lakh crore to others- essentially to builders and real-estate companies.

The insurance companies, mostly LIC, find much more comfort in routing their credit to public sector entities and authorities like NHAI, HUDCO and others.

NBFCs credit to businesses was growing at a much faster rate than banks prior to blow-out of IL&FS. NBFCs were able to leverage cheaper resources from mutual funds. NBFCs are also able to reach to businesses which the mainstream banks find difficult or costlier to reach. NBFCs are also not restrained in providing credit to certain sectors like real estate which the banks are literally prohibited to do so. NBFCs are also digitally nimble and have much lower cost of doing business.

Impact of covid-19 and Economic Lockdown on NBFCs

NBFCs do not have access to steady resource of deposits from households. They do raise some borrowings in the form of long-term debentures. However, bulk of their resources comes from credit provided by banks and other players in the financial landscape like Mutual Funds. The NBFCs had seen their access to such funds becoming costlier (spreads had risen sharply) and in some cases totally denied in the wake of ILFS blow-up. The NBFCs are facing a kind of ILFS replay in the wake of covid-19 crisis.

NBFCs are also dependent upon constant reflows from their existing portfolio of loan assets. If the reflows get affected, their ability to service their resource providers and to provider fresh loans suffer. The moratorium granted by RBI on the servicing of loans given by NBFCs has created a lot of problems, more particularly on account of the fact that there is no clarity on the applicability of moratorium on loans which NBFCs have to service.

NBFCs’ loan to businesses suffer precisely from the same problems, only in a more accentuated form, what banks’ portfolio of loans is going to suffer from the impact of covid-19 and economic lockdown. NBFCs’ loan portfolio has smaller proportion of gross non-performing loans- in the range of 5-6% as against 10-20% in case of banks. The portfolio of NBFC business loans is riskier both on business risk and credit risk. It is likely to see a sharp uptick.

The NBFCs are facing a double whammy. Their loans to businesses are likely to turn bad in greater proportion but they would have to give moratorium to all these businesses and they would not be able to enforce their security or approach IBC courts. On the other hand, the NBFCs will have to service their loans to banks, pay regularly on debentures issued and likely to see funding cut from mutual funds.

The NBFCs in India are in existential crisis.

Credit to Households

Banks have credit outstanding towards households of about Rs. 25 lakh crores. Non-Banks have another Rs. 20 lakh crore of credit outstanding to the households.

The largest share of credit to households comes from Housing Finance Companies. Mortgage loans by HFCs to households are about Rs. 10 lakh crores. NBFCs outstanding credit of about Rs. 5 lakh crores is primarily for household loans for vehicles and other consumer durable assets. The remaining credit comes from other non-bank sources.

The delinquency in household credit portfolio is quite small. The credit portfolio, except for the Micro Finance Institutions (MFI)- NBFCs, is relatively concentrated in households with steady incomes, only marginally affected during the covid-19 induced crisis.

CONCLUSION

Credit outstanding to governments, businesses and households at the end of financial year 2020-21 is about Rs. 300 lakh crore or $4 trillion @ Rs. 75 to a dollar. Half of this credit is owned by the banking systems- banks and the central bank put together. The remaining half of the credit i.e. Rs. 150 lakh crores have been provided by all types of the non-banks, the savers directly and the rest of the world.

The bulk of the credit provided by all these lenders/investors is to the governments- at about Rs. 100 lakh crores at end March 2020. Estimated credit of about Rs. 30 lakh crores have been provided by all these players to the businesses and remaining Rs. 20 lakh crores to the households.

Covid-19 and economic lockdown cannot affect quality of credit to the governments, though there is likely to be some pressure on state governments’ borrowings. Risk to the credit extended to the households is also much lower. It is the business credit portfolio of about Rs. 30 lakh crore which is the most affected. As credit portfolio of NBFCs is majorly concentrated on loans to businesses, the NBFCs are facing the utmost heat.

There are three major issues connected with the borrowings of the central government- how to fund additional fiscal deficit caused by the economic lockdown and covid-19 shock, desirability of continuance of small savings programme and investment of the foreign investors in government securities.

Extraordinary deficit financing requirement of 3-5% of GDP seems to have arisen on account of pressures on both sides (likely revenue shortfall of up to 2.5% of GDP and expenditure requirements shooting up to 2.5%). This cannot be raised from the market without disturbing its equilibrium.

Uncertainty in the financial markets about government’s additional borrowing programme and monetisation strategy has made market participants, including banks, cautious. RBI reduced the repo and reverse repo rates drastically in last one month, but the yields on central government only moved up. There is a strong likelihood of trading in secondary government securities market sputtering.

It would be better if the government were to inform more clearly about what additional borrowing it expects to make and whether it would monetise the deficit or not. While monetising the additional deficit would be the least bad option in the circumstances, making the borrowing path and strategy clearer, even if the choice is not to monetise deficit, would be better than continuing with the uncertainty.

New fully accessible route for permitting foreign debt flows in government securities has been created on 31^st March, 2020. It suffers from all the problems of existing framework. A good part of the FPI investments in Indian debt is a fair-weather friend. As long as foreigners get good steady dollar return on their debt investment, such investment stays or even grows. Such times happen to be ones when there is excess capital inflows and RBI has to go to the market for sucking the excess dollar supply. Rupee tends to appreciate during these times making the returns of FPIs rise. As soon as the tide turns and rupee comes under pressure for any reason (high fiscal deficit, high oil prices etc.), the FPIs start selling debt and taking their money back. In such times, when India needs additional inflows, FPIs’ debt sales adds to the woes of RBI, government and the market.

This new route of making foreigners’ investment in Indian debt without any limits and restrictions does not seem to be in larger interest of the country.

The governments have dismantled the network of small savings agents which used to source these savings from small savers. The banks and non-banks, especially micro-finance institutions, have fanned out in the entire country side. The small savings programme is essentially serving the middle class and is providing them off-market higher returns. This has created its own distortions. It is time to wind up the small savings programme.

The NBFCs, which provide 2/3d of non-bank credit to businesses, are facing a double whammy. Their loans to businesses are likely to turn bad in greater proportion than banks but they would have to give moratorium to all these businesses. They would not be able to enforce their security or approach IBC courts as well. On the other hand, the NBFCs will have to service their loans to banks, pay regularly on debentures issued and likely to see funding cut from mutual funds. The NBFCs have to be dealt with fairly and to be provided a level playing field.

The delinquency in household credit portfolio is quite small. The credit portfolio, except for the Micro Finance Institutions (MFI)- NBFCs, is relatively concentrated in households with steady incomes, only marginally affected during the covid-19 induced crisis.

SUBHASH CHANDRA GARG

APRIL 24, 2020