Debt: India's Achilles' heel

Thu, 18 Sep Pre-Open

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The rally in the Indian stock markets has been driven primarily by liquidity. While the economy is reviving slowly, the markets have already discounted the good news and have reached record levels. Money has been available to FIIs thanks to the loose monetary policies of the US fed. Now it appears that China too may be joining the party. China's central bank has decided to pump in US$ 81 bn into the 5 largest banks in the country. This is being done to stave off an economic slowdown. In a world saddled with debt, is more debt the answer? We do not think so. Is India better off compared to China or the US on this front?

It is no secret that India's corporate sector is saddled with a huge debt burden. This is a serious issue regarding the government's finances too. We have seen the negative fallout of this problem on the economy. From the woes of the power sector to the NPA problems in PSU banks; high debt has levels have caused a lot of stress to overleveraged firms, the banks which lent them money and the investors who invested in them. The first priority of these firms will be to pay down the debt on their balance sheet. This will leave less money for investments. As we have seen during the UPA years, if the corporate sector does not invest; growth will take a hit.

There has been new optimism in the economy after the Modi government came to power in May 2014. However, a lot of the problems facing the economy are still with us. A high level of corporate debt is one of them. Thus it makes sense to ask if there has been any improvement in the situation. The answer, sadly, appears to be negative. As an article in the Livemint has stated, the concentration of debt in stressed sectors such as steel, power, and infrastructure remain worryingly high. As per global standards, Indian firms (apart from firms in a few sectors) have very high levels of debt. Thus it would be wrong to conclude that things have really improved on this front.

Even the government's finances is not in a good shape. PSU disinvestment seems to be the strategy being used, to bring down the fiscal deficit. This is not a very comforting sign. On the external front too, things are not very cozy. As per the RBI's FY14 annual report, India's external debt (as a % of GDP) increased from 22% to 23.3% over the previous year. This means that the volatility in the rupee, seen last year, did not prevent corporates from taking on higher amounts of foreign debt. Even worse; 40% of this debt is short term. If un-hedged, this debt can cause problems in the economy.

Overcoming these challenges will not be easy. Bailouts and asset reconstruction companies (ARCs) are not long term solutions. As long as PSU banks remain at the mercy of the government, NPA problems will keep on plaguing the sector. Regulators like RBI and SEBI must get even more proactive when dealing with leveraged firms. Stricter norms for defaulters are a welcome move. However, a lot more needs to be done to ensure corporates do not stretch their balance sheets beyond a point. Healthy corporate balance sheets will ensure that the recovery in the Indian economy remains robust.