The Indian economy was in a fragile state even before the Chinese Virus Pandemic. The GDP was going down, unemployment rising and the Private Consumption and Investment was declining over the last few quarters. This downward trend continued even after the announcement of the Corporate Tax cut by 10 percentage points. The 2 biggest reasons behind this economic downfall were Demonetization and GST. It may be a subject of debate whether Demonetization and GST were economically efficient or not in terms of their cost and impacts on the economy, but something on which most of the subject experts would agree is that both of them brought some significant structural changes in the Economic system of the country which was much needed.

But, the biggest reason according to me for this slowdown is the failure of the financial system in the country. Surprisingly this factor has failed to find its place in most of the public discussions and debates due to certain technical terms involved but it will be given ample space in this article.

The Financial Sector is termed as the Brain of the Economy. It has not been functioning properly for years and this has limited the macroeconomic policy space to respond to any Economic crisis. Let me explain how.

Banks are the pillars of any economy and ensure that the credit flow continues. Moreover, in a recessionary environment, Banks are the institutions towards which people look upon with hope. But what if I say that the Banks in India particularly the Public Sector Banks are broken and are very reluctant towards lending money. This is adversely affecting Credit Growth. In layman’s terms, Yes, the Banks are not lending money, they cannot lend money. And this is the stage where the Monetary Transmission Mechanism breaks, so even if the RBI tries to inject money into the economy by using expansionary monetary policy there is no guarantee that this money will reach the Market as the intermediaries i.e banks are very Risk-averse.

The reason behind this Risk aversion is that the Indian Banking System is currently operating under a lot of stress as the losses from Non-Performing Assets (NPAs) have continuously risen over the last several years. But this is only the 1st half of the story, the 2nd half begins now. On 23rd February 2016, the SC ruled that the employees of Private Banks are also “Public Servants” and can be prosecuted for Corruption and Bribery under the Prevention of Corruption Act (POCA). This decision has reduced the incentive for the Officers in Bank from taking any risks and lending loans. Also, to deal with the problem of NPAs, RBI placed many banks with weak financial metrics in the Prompt Corrective Action (PCA) framework. The PCA framework had stringent norms that place these banks under RBI’s watch list and restricted them from giving loans as it may result in more NPAs. The centre claimed it to be one of the reasons for slow credit growth.

The Modi government’s Insolvency and Bankruptcy Code (IBC) 2016 is a great tool to deal with both the problems of NPAs and Slow Credit Growth. The IBC is a single law and a one-stop solution for dealing with all insolvencies and bankruptcy. This law has worked amazingly so far and has reduced the NPAs. The Gross Non-Performing Assets (GNPAs) has reduced to 8.5% in March 2020 from 9.1% in March 2019, due to the improved recoveries through IBC. Though the long-term solution to improve the financial health of these banks are mergers and privatization which is also taking place at a fast pace.

But wait!! This sounds to be a fairy tale story. Enters Chinese Virus!!

Mass immigration, lockdown of an entire country, collapsing of informal and MSME sector, biggest health crisis, lakhs of deaths, travel restrictions, closure of the institution, economic fallout, and whatnot.

So, where we are heading now?? Well, the Chinese Virus decides, it’s on the driving seat, things not in our control. Then at least let’s find out where we have reached today and what’s next?

In a relief measure, the RBI announced a moratorium that allowed borrowers to defer their EMIs without being classified as NPAs. This moratorium ended on 31st August 2020 but still, the SC ordered that no accounts should be classified as NPAs till further orders. Also, the government has suspended the IBC recovery process for 1 year to help borrowers. So technically, we don’t have any estimates of how much NPAs we are going to have till further orders of the SC and we even don’t have IBC to recover those Bad Loans. The former financial services secretary R Gopalan said “the suspension of both the IBC and recognition of NPAs is a disservice done to the banking sector”. Due to these reasons, the NPAs are expected to see a sharp jump and GNPAs can breach the 14% figure of the total advances.

Now talking about the fiscal deficit, in the last Budget the projected or targeted figure was about 3.5% of the GDP, but it is expected to be double of that somewhere around 8% this year. It is probable that the government amends the Fiscal Responsibility and Budget Management Act (FRBM) for the 2nd consecutive year as the last year too the deficit reached 4.6% against the target of 3.5%. Amending the FRBM Act will allow the government to relax the target for the year ahead. This is enough to show that the government has very little fiscal space left.

If I talk about the Monetary Policy, I will start with the man himself, Mr. Shaktikanta Das. First of all, let me remind the readers that Mr. Das is a lateral entrant as he is a 1980 batch retired IAS officer and is a product of bureaucracy. Due to this reason his appointment was also criticized by many intellectuals including the Noble laureate Abhijit Banerjee. After 2 years since Das assumed charge as the RBI Governor, I must say he has faced some very extraordinary problems and so far has been very successful in dealing with them. Of course, he enjoys the support of his political bosses and hence always plays on the front foot. From resolving the Yes Bank crisis within days to synchronizing its action with the government policies on each step Mr. Das never fails to impress through his bold moves. RBI’s action accounts for half of the Rs 20 lakh crore Atmanirbhar package announced by the government. The RBI is currently operating under ultra-loose liquidity policy as the current repo rates are at an all-time low of 4%, and the bank rate stands at 4.25% perhaps the need of the hour. This can be one of the many reasons for the boom in the stock market but is expected to cause a major problem of inflation in the country, which I will talk about in the next paragraph.

One big challenge for the RBI and the Govt. ahead is that the inflation is expected to rise due to the disruption in the supply side mechanism. Also, the businesses want to cover their previous losses due to the lockdown and hence are trying to get the maximum out of customers which again sets the tone for high inflation. The expansionary fiscal and monetary policy again is the need of the hour but is putting upward inflationary pressure. Now the problem with high inflation is that it may hamper the recovery process of the economy. Also, inflation results in the devaluation of the currency, and people tend to shift to other safe-haven assets such as Gold. This explains the high returns offered by Gold over the last few months. Again, high expected inflation is one of the reasons for the rise in demand for digital currencies hence increasing their value as digital currencies are challenging gold and can join the safe-haven club in the future.

In the midst of all this, the economy seems to recover as the GST collection reached an all-time high of Rs 1.15 lakh crore during December 2020. The Power consumption has also risen which suggests a V-shaped recovery.

But, it’s not that easy. Rising Protectionism and an inward-looking policy might apply brakes on the speed of recovery. The custom duties have also risen over the last couple of years and this may not be the right way towards an Atmanirbhar Bharat. The government needs to replace this with a more outward-looking policy and the only way to do this is by Investing in Infrastructure and increasing the ease of doing business. History is witness that an inward-looking policy has failed in many countries and causes high inflation and inefficiencies.

The Minister of Finance, Smt. Nirmala Sitharaman addressing a press conference, in New Delhi on October 14, 2016.

Each year the nation expects a lot from the Budget, but this time it’s very different. There are challenges like never before, situations like never before and opportunities like never before and the budget will have to take everything into account and hence nobody expects a conservative budget. Finance Minister Nirmala Sitharaman said that this Budget will be one like “never before” and this makes it even more exciting. The Vaccination drive is set to start from 16th January and both these developments fill us with hope.

After taking an overview of where we stand, let’s come to the stock markets. The Sensex reached 26,000 dropping 15,000 points and Nifty at 7,600 from 12,000 in March 2020 causing a blood bath. The markets fell so much that investors expected it to be bullish from there. Over 4.9 million new DEMAT accounts were created in FY 2020, which is the maximum in the decade. This suggests that even those who never traded got into trading and increased the demand as they expected markets to rise from this dig. Moreover, the expansionary policies by the RBI and Government, increased investing from Foreign Institutional Investors (FII), ultra-loose liquidity policy, quick recovery, and optimism led to this Bull Run. The stock markets have reached an all-time high and you expect corrections from here, but technically, I don’t see any reason in the coming days for the Bears to celebrate, given that the government doesn’t mess up things for investors in the budget. Even if the market corrects itself to a certain extent, the Bulls can bring it back as they are high on cash due to high liquidity in the economy. Things may not change till the RBI departs from its ultra-loose policies to curb inflation; this can happen anytime soon but will be a smooth departure. But sometimes Markets don’t need reasons to fall they just fall. As there’s this quote by Jim Cramer:-

“Every once in a while, the market does something so stupid it takes your breath away”.

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