After years of outperforming its emerging market peers, the Indian economy has been running out of steam. Looking at five consecutive quarters of diminishing economic growth, followed by a very weak Gross Domestic Product ("GDP") print of 4.5 percent for the 2nd quarter of the financial year (FY) 2020, it is safe to say that the India economy is going through one of its most serious crisis. This article will explore some of the reasons behind this slowdown and the steps taken by the Indian Government to deal with the same.
The Economic Slowdown: How Did it Begin?
The Economic Boom of 2000 – The current economic slowdown in India dates back to the year 2000, and to an economic boom triggering a series of events resulting in today's crisis. A major global economic upswing in the year 2000 increased global demand, and India's exports reached an unprecedented high. India's GDP growth surged to 9-10% per annum1. The economic boom triggered an increase in investment, particularly in the infrastructure sector. These infrastructure projects were largely financed by credit from within as well as from outside the country.
The Global Financial Crisis ("GFC") of 2008 – The GFC of 2008 adversely impacted India's exports due to a slowdown in global trade growth. India's export growth rate fell from more than 15% before the GFC to 5% post the GFC2. The GFC also triggered an increase in credit interest rates and depreciation of the Indian rupee. This, coupled with the general downturn of the market rendered companies' financial projections made during the economic boom, inaccurate. Various companies found it difficult to profit from ambitious investment projects entered into during the boom, which resulted in them being unable to service their debts. The depreciation of the Indian rupee also adversely affected companies that had made borrowings from outside the country.
The Twin Balance Sheet Crisis(Banks and infrastructure companies) -By the year 2015, stressed firms accounted for 40% of corporate debt3. The rise in corporate debt meant a corresponding increase in the Non-Performing Assets (NPAs) of banks, leading to a 'twin balance sheet' problem with 'NPAs or bad loans on one hand, and heavily indebted corporates on the other'4. The gross NPAs of banks increased from 2.3% of total loans in 2008, reaching a peak of 11.5% in FY 2017/18, to 9.3% as of September, 20195.
Attempt to Resolve the Twin Balance Sheet Crisis– The Indian Central Government attempted to solve the twin balance sheet crisis by injecting capital amounting to over Rs. 2.8 lakh crore as of FY 2018/19 into public sector banks6. Public sector banks account for 70% of bank loans, and for 90% of total NPAs in India7. These capital injections enabled banks to write off Rs. 7.2 lakh crore of their NPA burden, and to reduce their NPA to loan ratios by 2 points, from 11.5% in FY 2017/18, to 9.3% as of September, 20198.
Why did the Indian Economy Continue to Grow? -The demonetization initiative and the introduction of the Goods and Services Tax (GST) regime have been understood to have dragged growth down by "still-unknown extents over still-to-be-defined periods." In the long run, however, these negative shocks were offset by stimulus such as the post-GFC oil price decline9. At the beginning the year 2014, international oil prices began to fall, and were at one-third of their earlier levels. This provided the Indian economy, with India being an importer of (crude) oil, a windfall, boosting GDP growth by 1.0 to 1.5% during the period of 2015-201710. This, coupled with an increase in world demand in 2017 and 2018, resulting in non-oil export growth, greatly benefitted India's economy.These events made it appear as though India's GDP was steadily climbing, and concealed the negative effects of demonetization, the introduction of GST, and the twin balance sheet crisis. Another massive stimulus in this regard was the Non-Banking Finance Company ("NBFC") lending boom, which is discussed in the next section.
The NBFC Lending Boom and its Aftermath – The demonetization of high-value currency notes by the Indian Government in 2016 resulted in large amounts of cash being deposited with banks and mutual funds. A large amount of these funds were then on-lent to NBFCs, which subsequently lent them out, mostly to the real estate sector. Infrastructure Leasing & Financial Services ("ILFS"), an NBFC, accumulated a debt of Rs. 90,000 crore and defaulted on repayment of several of its obligations to its creditors. This jeopardized a large number of real estate and infrastructure projects, banks, mutual funds and other investors associated with IFLS11. NBFCs' massive lending to the real estate and infrastructure sector, and subsequent debt accumulation was also affected by the fact that the ambitious projects of the post-2000 economic boom were difficult to complete post-GFC. Most NBFCs were caught in a funding squeeze forcing them to scale back their credit to the real economy.Provision of loans to small businesses, as well as to consumers for durable goods such as automobiles by NBFCs slowed, thus affecting investment in these sectors12. The NBFC crisis also affected the lending capacity of public sector banks, some of whose lending to NBFCs amounted to 10% to 14% of loans they extended13.
Steps Taken by the Indian Government
Introduction of the Insolvency and Bankruptcy Code, 2016 – The Insolvency and Bankruptcy Code, 2016 (the "Code") was introduced in December, 2016. The Code aims to complete the insolvency resolution process in a time bound and efficient manner14. An important aspect of the Code is the way in which it deals with the issue of NPAs. The Code enables all classes of creditors15to file an application for initiation of the corporate insolvency resolution process16. The creditors may apply to the relevant authority under Code for the appointment of a resolution professional17, who will take over the management of a defaulting debtor.The Code provides for an Insolvency Resolution Plan ("Resolution Plan"), and procedure for application thereof, as an alternative to liquidation of the debtor concern/company. The Resolution Plan is to be approved by a creditor committee with a 75% majority18.The time period for completion of the Corporate Insolvency Resolution Process ("CIRP") is specified under the Code as 180 days, which can be extended by the relevant Adjudicating Authority by a maximum of 90 days19. The time limit is an attempt to ensure, inter alia, that NPAs are recovered in a time-bound manner so as to reduce stress on banks and other financial institutions. The gross NPA to loan ratio of the banking sector is estimated to have declined from 11% in the second quarter of 2018-201920, to 9.3% as of September, 201921, a drop which has be attributed, in some part to the CIRP under the Code22.
Taxation Reforms – The Taxation Laws (Amendment) Act, 2019 (the "Amendment Act") amending the Income Tax Act, 1961 (the "Act") and the Finance Act, 2019 (the "Finance Act') came into force on September 20, 2019. The Amendment Act has introduced certain measures for the benefit of companies.
Domestic companies will have the option to pay tax at a rate of 25.17%23, as opposed to the 30% rate prior to the Amendment Act.24 Such companies will also be exempt from minimum alternate tax.25 Domestic companies incorporated on or after 1st October, 2019 making a fresh investment in manufacturing have an option to pay income-tax at the rate of 15%26. This tax rate is contingent upon such companies commencing their production on or before 31st March, 2023. This provision has been put in place in order to boost the 'Make in India' initiative, and to attract fresh investment in manufacturing.
Companies which continue to avail exemptions or concessions under the Act shall continue to pay tax at the pre-amended rate of 30%27. However, such companies are allowed to opt for the aforementioned concessional tax regime after the expiry of their tax exemption/holiday period.The Amendment Act has also reduced the rate of Minimum Alternate Tax to 15% from the pre-amended rate of 18.5%28.
The Amendment Act provides that the enhanced surcharge under the Finance Act29 shall not apply on capital gains arising on sale of any security including derivatives in the hands of Foreign Portfolio Investors30, or on the sale of equity share(s) in a company, unit of an equity oriented fund, unit of a business trust liable for securities transaction tax, in the hands of an individual, HUF, AOP, BOI and AJP31. This provision has been introduced with the intention of stabilizing the flow of funds into the capital market32. The Amendment Act also provides that tax will not be charged on the buy-back of shares in case of companies which have already made a public announcement of such buy-back before July 5, 201933.
Environmental Impact Assessment Waived for Oil and Gas Exploratory Drilling – The Ministry of Environment, Forests and Climate Change vide a notification dated January 18, 2020 ("Notification")34, has waived the requirement of environmental clearance for oil and gas firms conducting exploratory drilling35. Promoters of exploratory projects prior to the Notification had to mandatorily prepare an Environment Impact Assessment plan, scrutinized by a committee of experts appointed by the Centre. The Notification was issued in response to a request made by companies wanting to explore for hydrocarbons in the Cauvery delta.
As may be deduced from the above, the economic slowdown was caused by a melee of factors over a number of years and cannot be attributed to a single major event that triggered the downturn. However, the Indian Government seems to have realized the downward slope towards which the economy was heading and has taken several significant steps to seize and reverse such downturn and the effect of the Government's efforts remain
4 The Hindu (Online), 'Resolution of Twin Balance Sheet Problem to Take Upto Nine Months,' April, 2018, Available at: https://www.thehindu.com/business/Economy/resolution-of-twin-balance-sheet-problem-to-take-upto-nine-months/article23546804.ece
5 Livemint (Online), 'Worst not Over Yet, RBI Forecasts NPAs will Rise,' December, 2019, Available at: https://www.livemint.com/industry/banking/worst-not-over-yet-rbi-forecasts-npas-will-rise-11577467735537.html
6 Livemint (Online), 'Worst not Over Yet, RBI Forecasts NPAs will Rise,' December, 2019, Available at: https://www.livemint.com/industry/banking/worst-not-over-yet-rbi-forecasts-npas-will-rise-11577467735537.html
7 Ideas for India, 'How Banking Crisis is Impeding India's Economy,' October, 2019 Available at: https://www.ideasforindia.in/topics/poverty-inequality/how-banking-crisis-is-impeding-india-s-economy.html
8Livemint (Online), 'Worst not Over Yet, RBI Forecasts NPAs will Rise,' December, 2019, Available at: https://www.livemint.com/industry/banking/worst-not-over-yet-rbi-forecasts-npas-will-rise-11577467735537.html
9Investopedia, 'The 2008 Financial Crisis and Its Effects on Gas and Oil,' November, 2018, Available at: https://www.investopedia.com/ask/answers/052715/how-did-financial-crisis-affect-oil-and-gas-sector.asp
11 The Economic Times, 'IL&FS: The Crisis that Has India in Panic Mode,' October, 2018, Available at: https://economictimes.indiatimes.com/industry/banking/finance/banking/everything-about-the-ilfs-crisis-that-has-india-in-panic-mode/articleshow/66026024.cms
14 The Insolvency and Bankruptcy Code, 2016
15 Section 3(10) of the Code defines a 'Creditor' as "any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decree holder"
16 Section 7, The Insolvency and Bankruptcy Code, 2016
17 Section 16(2), The Insolvency and Bankruptcy Code, 2016
18Section 111, The Insolvency and Bankruptcy Code, 2016
19 Section 12(3), The Insolvency and Bankruptcy Code, 2016
20Supra note 1 at 22
21 Livemint (Online), 'Worst not Over Yet, RBI Forecasts NPAs will Rise,' December, 2019, Available at: https://www.livemint.com/industry/banking/worst-not-over-yet-rbi-forecasts-npas-will-rise-11577467735537.html [Accessed: 20th January, 2020
22 The Hindu Business Line, 'IBC Boosts NPA Recovery,' December, 2019, Available at: https://www.thehindubusinessline.com/money-and-banking/ibc-boosts-the-recovery-of-stressed-assets/article30390240.ece
23 This percentage refers to the effective tax rate, inclusive of surcharge and cess
24 Section 115BAA, The Income Tax Act, 1961
25 Section 115BAA, The Income Tax Act, 1961
26 Section 115BAB(2), The Income Tax Act, 1961
27 Section 115BA, The Income Tax Act, 1961
28 Section 115JB(1), The Income Tax Act, 1961
29 Part II, The First Schedule of the Finance Act, 2019
30 Part II, The First Schedule of the Finance Act, 2019
31 Part II, The First Schedule of the Finance Act, 2019
32Supra note 31
33 Section 36, The Finance Act, 2019; Section 115QA, The Income Tax Act, 1961
34 Ministry of Environment, Forest and Climate Change Notification: S.O. 236(E) dt. 16th January, 2020 Available at: https://cdn.thewire.in/wp-content/uploads/2020/01/19150836/Amendment-Notification-Hydrocarbon-exploration-exemption-2020.pdf
35 The Hindu, 'Centre Waives Green Clearance for Onshore and Offshore Oil and Gas Exploration,' January, 2020, Available at: https://www.thehindu.com/sci-tech/energy-and-environment/centre-waives-green-clearance-for-onshore-and-offshore-oil-and-gas-exploration/article30595276.ece
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