What Is Driving Indian Economy’s Growth Worries?

Context

Over the past few weeks, there has been much talk about how the Indian economy is fast coming out of its technical recession.

Key Details

There is an expectation that even if the Indian economy contracts in the current financial year — by, say, 10 per cent — it will perhaps grow by roughly the same percentage in the next financial year — 2021-22.
But it is important to remember that in times of such stark contractions and growth, one should not only focus on the GDP growth rates but also look at the absolute level of GDP. [The GDP or the gross domestic product is the money value of all goods and services produced within the country in a financial year.]
For instance, if an economy’s GDP were to contract by 10 per cent — from 100 to 90 units — in Year 1 and then grow by 10 per cent in year 2 — from 90 to 99, then at the end of the second year, the absolute level of GDP will still be lower than what it was two years ago.
If this economy grows at an average annual rate of just 5 per cent (instead of 8 per cent) from Year 3 onwards, then it will take more than three years to reach the 116.6 units level of GDP.

Report from Oxford Economics

India’s potential growth is likely to average just 4.5 per cent between 2020-2025, as opposed to its pre-virus forecast of 6.5 per cent. It is important to note here that 6.5 per cent is already lower than the average annual growth (6.8 per cent) India achieved since economic liberalisation in 1992.
The main culprit for this fall — from 6.5 to 4.5 per cent — in potential growth rate, according to Oxford Economics, is India’s weak fiscal response, which magnified the structural drags.
In other words, because the Indian government did not spend enough directly to push up the economy, the recovery would be slower.
GDP per capita to be 12 per cent below our pre-virus baseline even in 2025, implying the largest amount of scarring among major economies globally.

Cause of Concern

It’s likely that headwinds already hampering growth prior to 2020 — such as stressed corporate balance sheets, elevated non-performing assets (NPAs) of banks, the fallout in non-bank financial companies (NBFCs), and labour market weakness — will worsen.
The collapse of Lakshmi Vilas Bank and its proposed merger with DBS Bank rattled depositors and stock market investors alike.

The IWG has made several recommendations that are expected to raise the prudential norms in Indian private banks.

These include suggestions such as:

disallowing bank promoters from pledging their shares in such a manner that breaches the prescribed minimum threshold
no longer allowing ADRs/GDRs (negotiable certificates that work as a proxy for shares in foreign markets) issued by banks to be used by any shareholder to indirectly enhance their voting power
raising the minimum initial capital requirement for new banks
tightening the requirement for banks to list in the stock markets
asking banks, which run side businesses, such as insurance and mutual funds, to shield their banking operations by adopting a financial holding company structure.
regulatory norms be harmonised across entities. In other words, if the initial capital requirement for a new bank is raised then all existing banks, too, should comply with the higher standard.
Almost all of these are expected to make private banks function safer.

Some of recommendations that might trigger some debate.

The first one relates to the cap that RBI imposes on a private bank promoter’s stake after a period of 15 years.
The second one relates to allowing large companies and industrial houses to become promoters of banks.

Way Forward

Allowing large corporates to start a bank has always been a tricky issue. Most major economies, except the United States, do not bar them. But India does not allow them to float banks and, on the face of it, for good reason.
For one, many experts believe that corporate governance in India is still not good enough and it is quite possible that such a promoter’s non-financial business and transactions adversely affect such a bank’s functioning.
To be sure, IWG reached out to its set of experts and found that “all the experts except one were of the opinion that large corporate/industrial houses should not be allowed to promote a bank”.
The obvious counter, however, is that if we allow NBFCs by similar corporates then why not banks. After all, banks are more tightly regulated than NBFCs.
The key concern underlying both these proposals is to balance the need for growth and new banking avenues with the prudential norm of having more diversified ownership in private banks lest one dominant owner abuses the system to the detriment of many.

What is driving Indian economy’s growth worries?