03 Jul 2019 19:30 IST

Time to tackle the liquidity crunch

The NBFC crisis has aggravated the cash shortage in the economy and impacted growth

India’s GDP is at five-year low, growing at less than 6 per cent. To counter this, the central bank has softened its stance and the Reserve Bank of India cut the repo rate by 25 basis points, to infuse more liquidity in the market but considering that the stock market fell after the announcement, the rate cut was obviously inadequate.

The fallout of the non-banking finance companies (NBFCs) defaulting on payments has hit the economy hard, as NBFCs are significant providers of credit, especially for unorganised players in the economy. Credibility in the sector has been affected significantly and one outcome could be that this will increase real demand for money as people would rather keep the money with themselves instead of investing it. This crisis along with various other factors has led to liquidity crunch.

As NBFCs borrow cash from banks and if the sector continues to be insolvent, this would generate more NPAs. Banks, as a result, have become more cautious in lending to NBFCs which, in turn, could escalate the unemployment rate in the SME sector.

Blow to manufacturing sector

Banks are already burdened with enormous amount of accumulated NPAs and if NBFCs account also becomes NPAs, it will lead to higher lending rates. India has one of the highest real interest rates on lending across the world. As lending rates are high, fewer manufacturers are willing to take loans and invest. This liquidity crunch has hit the manufacturing sector, one of the major contributors to the GDP, contributing 18-19 per cent.

The RBI has proposed introducing a Liquidity Coverage Ratio (LCR) for large NBFCs to help tackle liquidity issues in the manufacturing sector. After the collapse of Infrastructure Leasing and Financial Services last year, the RBI doesn’t want similar issues to crop up and become a systemic risk.

Stricter IBC

Due to the repo rate cut, a few commercial banks have cut interest rates on various kind of loans to attract more customers. The SBI, for example, has introduced cheaper home loan rates. The government has implemented the Insolvency and Bankruptcy Code (IBC) to counter threats from such NPAs and targeted top 12 defaulters, which contribute to about ₹2.5 lakh crore out of total ₹7.5 lakh crore. There has been some amount of success with government recovering about ₹80,000 crore directly through IBC and about ₹3 lakh crore through indirect payments made by firms.

But the IBC should be stricter in the implementation process, as the resolution time it took under the law to recover the amount is much more than the targeted 270 days. One has to understand that it is not possible to recover complete amounts as, in most cases, auction of these redundant property and plant would fetch less value. The government has to take more steps and make the IBC more robust to instil fear among defaulters.

The market is expecting a lot of stringent measures to tackle the liquidity crunch and the upcoming Budget needs to bring in the necessary measures. The government should consider taking suggestions from credit agencies such as Crisil in lending funds to institution and firms.

(The writer is a student at Great Lakes Institute of Management, Chennai.)