This piece is part of Scroll.in’s Hard Times series, which seeks to simplify the Great Indian Slowdown for readers. You can find the rest of the pieces from the series here.
As Budget Day 2020 approaches, newspapers are full of advice to the government over what measures might get the Indian economy out of the deep trouble it seems to be in. There are suggestions about increasing government expenditure, spurring demand, offering employment and more.
But the biggest challenge facing the government will be handling India’s banks. Even before the Gross Domestic Product growth estimates fell precipitously this financial year, India’s banking system was in trouble.
The financial sector’s woes were a key part of what was described as the Twin Balance Sheet Challenge, involving over-indebted corporates unable to take out more loans and a huge number of non-performing and stressed assets held by public sector banks, hampering their ability to lend.
“The economy seems locked in a downward spiral,” wrote former Chief Economic Adviser Arvind Subramanian and the International Monetary Fund’s Josh Felman in a working paper in December 2019. “Already, this has caused a resurgence in the amount of stressed debt, a second wave of the Balance Sheet Crisis. If this process is left unchecked, the economy will continue to spiral downward, as stress reduces growth, which then intensifies the stress”
How did this banking crisis begin?
We usually think of loans as cash that banks hand out, which then need to be repaid with interest.
But look at it from the banks perspective: Loans are assets that become profitable when they are returned with interest. But when they cannot be repaid, they go bad.
Think of loans as apples. Banks hold on to them, and hope to turn them into something productive. But they can also go rotten. And the rot can easily spread.
Here we try to simplify the complex story of India’s financial system troubles to explain how banks ended up in a crisis.
With inputs from Jayati Ghosh.
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