In today’s newsletter, we look at another paper by the former chief economic advisor, Arvind Subramanian and see if we can provide a simplified guide and condense about 13,000 words in the process.

Note: We will refer to Arvind Subramanian simply as AS in the story


The Story

So the paper begins with a bold assertion — The Great slowdown is here and it is unlike anything we have ever seen. In fact, AS compares the current scenario to the 1991 crisis when the government effectively ran out of money and had to be bailed out by the World Bank. The comparison is made based on important economic indicators (Industrial Production, Imports, Electricity) that seem to have a lot in common with their 1991 counterparts.

But he does not dwell on this much and moves to the all-important question. Why did economic prospects suddenly sour when in fact India seemed to have been on the growth path only a few years ago? More importantly, is the current economic predicament a short term blip (cyclical) or a structural slowdown that’s going to persist for a long time?

He then compares arguments on both sides but tackles the structural camp first. He starts off by analysing a very popular theory- that our slowdown could be attributed to long-standing problems in the Indian economy (Things like labour laws and land restrictions). In response, AS convincingly argues that this explanation is incomplete for it does not take into account the fact that India’s GDP (total economic activity) grew in the double digits only a decade back. So it can’t be that these restrictions have suddenly come back to haunt us.

Then he tackles another hypothesis — that our slowdown could be attributed to income inequality. The story goes like this — India’s economic growth in the past 20 odd years was largely driven by a small group of people who benefited from the IT boom. They made money. They spent money. In effect, they were the only drivers of the country’s consumption engine and since their growth has now plateaued, India’s growth engine is sputtering with it. But AS immediately argues that India’s growth in the past decade was primarily driven by the Investment/Export boom. And therefore he suggests that it is inaccurate to pin the problems on consumption alone.

He then tackles the ‘cyclical’ ists — those who argue that India’s problems are temporary and primarily a result of the ebbs and flows that characterise all economic growth. Now, since most of these people pin the blame on GST, Demonetisation and other recent events AS simply dismisses the argument by pointing out that key economic indicators were still doing fine despite these troubles. And at this point, he provides his own prognosis i.e. the current downturn is both cyclical and structural in nature. So everybody can stop bickering.

Now, since we have about 400 words worth of real estate left, we have to summarise roughly 10,000 words in that space. So you have to bear with us because things are going to get bumpy here.

Anyway, AS then draws out his grand theory to explain the great Indian slowdown. He calls it the Four Balance Sheet Challenge — the Old Twin Balance sheet problem+The New Twin Balance Sheet Problem=The Four Balance Sheet problem. Get it?

First, the old Twin Balance Sheet problem. Back in 2008, we witnessed first hand the Global Financial crisis. At this point in time, most Indian corporates (especially the Infrastructure companies) had stretched themselves thin by betting big on the future. They made huge investments in the hope that India’s growth would continue unabated and when such growth did not materialise they were saddled with large amounts of debt that they simply could not wash away. So that’s one balance sheet down.

Then, the banks that had loaned generous amounts of money to these folks found out that they were in a spot of bother as well. First, the repayments stopped. The banks tried to cover it up by extending new loans to crippled corporates and help them pay out the old ones. This plugged the holes for a while until (in 2015) the RBI forced them to come clean and soon enough, the skeletons tumbled. With corporates now running out of funds, the defaults picked up and unpaid loans took centre stage. And so, the banks took a massive hit and with it, the second balance sheet crumbles.

At this point, it's important to remember there was some respite thanks to low oil prices (that helped us spend less on foreign oil and as a consequence, more on domestic goods&services) and a very generous government that was willing to spend money and prop up the economy.

But problems were still festering. Most notably in the real estate sector. These good folks had invested large sums of money in exorbitant projects that simply did not have enough buyers, to begin with. Its sort of like trying to sell a 2 Cr. project to some chap who’s barely making 10 lakhs per annum. That scheme won’t work and inevitably unsold homes started piling up everywhere.

Now I know what you are thinking. Why not simply reduce prices?

Well, because they couldn't since most developers were borrowing large sums of money by pledging these unsold homes as collateral. If they reduced prices elsewhere, the value of their collateral would drop simultaneously. Do you think the banks would be happy with that? Of course not. So the prices stayed put. And the homes, vacant. Only problem — Demonetisation, GST and the black money act broke the backs of many real estate developers and their debt burden also began to spiral out of control and so the third balance sheet is now in dire straits.

Finally, we have the Non-Banking Financial Corporations. As banks started reeling from the bad loan problem, NBFCs started to take over in a massive way. They bridged the funding gap and helped steady the ship. Unfortunately, most of them loaned out large sums of money to the Real Estate Sector. So there were big problems under the hood. But the music did not stop until the IL&FS crisis  (in 2018)— when one of the largest NBFC in the country defaulted on its payments. Since the banking business is primarily built on trust, this new development sapped confidence in the entire NBFC ecosystem. And so, the final balance sheet tumbles.

Now AS does in fact go on to prescribe remedial measures. But that’s a story for another day.

For now, we have already said too much. And so we must bid adieu. Until next time.

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