The Reasons for Present Indian Economic Slowdown

First, is this a slow down and what are the indicators and signs?

1. GDP has fallen sharply to 5% (against normal 7-8% and ambitious growth rate of 10%+)
2. Automobile sales have sharply dropped
3. Unemployment rate has increased
4. GST collections growth rate (@6.5%) is declining and in some months of de-growth (decline) is seen against expected 10% growth rate.
5. Private sector wages are not increasing
6. Lot of negative news about banking and financial companies
7. Bank credit growth low for long and slowing down below long-term average

Ok, there are enough signs but what are the reasons?

Actually these signs are reasons for one another; i.e., they are interdependent.

Ironically all these bad things started because of good things. I mean the root cause of these bad things are actually the good things that were done few recent years ago.

Good policies and actions by RBI and government that disrupted the "business as usual", sown the seeds of slow down.

Business was as usual with banks evergreening the loans, banks lending to businesses that did not have sound balance sheets, cronies seizing the business opportunities, real estate assets being created, bought & sold without any traces in the formal economy, lot of cash transactions by people and businesses outside the banking system, businesses generating enough cash revenues  to employ people and vendors and paying them informally.

But then RBI started tightening the screws on banks about Non Performing Assets (NPA's or  bad loans or even simply, the loans which are not being repaid to the banks by the borrower) and evergreening (close the existing bank loan account as though it's paid back and open fresh loan account, just to make loan look like new and performing asset) of loans. As a result banks started to (forced to) clean up their balance sheets, recognize the bad loans correctly. They had to acknowledge many  loans marked earlier as "standard" to be bad loans or NPA's and make provisions for them. Banks profitability was impacted and their lending power (to give new loans) came down. Many banks under Prompt Corrective Action (PCA) framework of RBI were almost stopped from issuing new loans (barring few small loans to consumers). Even the banks that were not under PCA framework became cautious and conservative and significantly reduced lending to risky borrowers and corporate borrowers including NBFC's (Non Bank Finance Companies; which lend like banks though they are not banks, ex: Housing Finance Companies like DHFL, LICHFL and Gold Pawn Finance Companies like Muthoot, Manappuram or Consumer Finance Companies like Bajaj Finance etc or Automobile Finance Companies like Shriram Transport Finance etc). NBFC's were / are heavily dependent on banks for their source of money for their lending. As it was difficult to get long term loans from banks they started to look at other sources of money  from mutual funds and other similar portfolio investment institutions.

Simultaneously one more thing was happening - people in want of higher returns and increased awareness and better tax treatment have started investing money in mutual funds than in bank deposits. Deposit base of banks was shrinking while Mutual fund assets under management was growing. This also had an impact on bank's lending capacity. Though NBFC's and corporates were eager to get money from mutual funds, the objective and working method of mutual funds is different from that of banks. NBFC's and corporates however had lesser choices and mutual funds had more money. So Mutual Funds gave money... More money than they usually,  to NBFC's and corporates. That has created Asset-Liability Mismatch (ALM) problem. That means the NBFC's and corporates which earlier used to borrow long term money from banks and use it for long term lending or capital investment, started using short term money from mutual funds and other portfolio investment institutions. That's what is asset liability mismatch. For understanding assume you are a banker. You borrow from a person for one year and you lend that money to someone else for 5 years. Of course, you lend at higher rate of interest than you have borrowed at; but that's not the point here. Because you have to pay back your lender after one year,  by when your borrower would not have paid back to you yet, you have to look for another lender to lend you money so that you can pay back the original lender. As you can understand this is risky if you can't get a new lender you will be forced to default. So, that's what happened. That's why big financial firms like IL & FS and DHFL succumbed.

Further, the loans extended by NBFC's are typically riskier than the ones by the banks. Because bank won't give loan for such risky profile, borrower would go to NBFC, willing to pay for higher interest rates. For example SBI or ICICI Bank won't give home loan if property you want to buy is of sub standard (ex: property / project not approved by local authority or the one built with some deviations to the approved plan). But DHFL would have given you the loan for the same at for higher rate of interest than SBI or HDFC Bank.

Majority of the commercial vehicles and capital goods of SME's are funded by NBFC's because borrowers are of risky profile (Self Employed, Small businessmen etc). Same is the case for home loans by self employed individuals.

So, the loans given by NBFC's run higher risk of default or becoming non performing assets. When economy slows down, the revenues & profits of the small businesses and self employed people gets heavily impacted. They defer their loan repayment or default on EMI's. For example a builder who has taken loan from DHFL is unable to sell the apartments he has built as the demand has dried up. This person's loan has become NPA for DHFL and it was not receiving periodic repayments from this person. More number of such instances cause concerns among the  people and institutions who had given deposits or investments to DHFL. If these institutions lending money to DHFL happen to be mutual funds, unlike banks, they flee from risk on the first sign.  They try to get back their money and stop giving further the money. Problem gets spiralled and compounded and brings down the whole company.

As these NBFC's were having cash crunch they were not giving any fresh loans in a significant manner. Whichever loans they gave, they were giving to safer profiled people like salaried persons.
Commercial vehicle financing is done majorly by NBFC's and the loan takers are are self employed or business owners. Commercial vehicle financing has come to almost a standstill. Most commercial vehicle sales happen with Finance. In the absence of finance there was no commercial vehicle sales. Commercial vehicle manufacturers like Tata motors, Ashok Leyland, Mahindra etc got hit. Even the passenger vehicle sales portion, that was contributed by self employed and SME's should have got hit because of non-availability of finance for such people.

Meanwhile, retail passenger car buyer behavior was also undergoing change during this period. Birth and growth of Uber and Ola and several other car rental services started serving the need and purpose of owning a car and hence natural demand also started coming down. The increase in the sales contributed by taxi hailing service companies and car rental companies did not match the decrease caused by themselves, as one taxi can serve many individuals. So, owning a car has again become a luxury or at least super-convenience than need. However, for the reason that wages  of private sector work force, have not increased meaningfully in recent years to at least cover the increase the cost of living and taxes, such luxury spend will take back seat.

On top of that, government's ambitious visions and policies about emission norms and electric vehicles kept car buyers postponing their purchases.

Cumulative effect of all above was sledgehammer impact on auto sales and automobile companies and their ancillaries. Though I gave example of passenger car in the above explanation most of it holds good for two-wheelers also; impact however is little smaller.

Auto industry is the backbone of manufacturing sector. Auto companies started cutting production and doing shutdowns at the time of festive season of the year, during which otherwise usually they produce 24/7. The problem percolated down the value chain and SME's that are vendors of these auto companies had to lay-off employees.

And big financial policy disruptions like demonetization and GST have indeed disrupted usual business in the overall economy. These actions forced businesses and businessman to move from informal to formal practices or the business itself moved from informal to formal organisations, resulting in to increased unemployment. It has largely checked "fearless" disproportionate (with respect to the tax profile of individuals) purchase and spends on high value products and services including cars, homes and properties. That means demad and consumption has reduced.

Reforms in banking and financial services, technological innovation in consumer services, tax reforms, stricter scrutiny of tax evasion, progressive policy visions for cleaner and better environment, etc have caused all the bad things about today's economic situation.

Now, you may feel astonished how these good reasons have caused the bad results. What do you think about all this now? If feel bad, how bad?

Well, you may also ask, how all this going to change to better? And when?

The answer is is like all these good things that have sown the seeds of all the bad effects we are seeing today, all these bad results are sowing the seeds of good things to come in near future. I am hopeful that like all these things that started 4-5 years ago have caused the worst situation now, over a period of time, same way, next 4-5 years you are going to see things turning from worst to best.