India’s Covid-19 Fallout Collides With A Shaky Economy

The bromance between Donald Trump and Narendra Modi features the kind of rivalry no world leader wants: the title of fastest-growing Covid-19 epidemic anywhere.

Advantage, Indian Prime Minister Modi. With 4.2 million confirmed cases under his belt, U.S. President Trump’s nation is far ahead in an absolute sense. But India’s 20% jump in infections over the last week to 1.4 million puts Modi’s nation on top in terms of velocity.

And that’s the last thing Asia’s third-biggest economy needs as 2020 unravels before our eyes.

As the year began, India was seen growing at least 5%. Now, it’s seen contracting by roughly that amount–at best. Worse, perhaps, that could turn out to be overly optimistic considering the dire state of global demand and the pre-existing conditions that New Delhi brought into this pandemic.

The biggest is a dysfunctional economy that Modi was slow to address in the 68 months before India confirmed its first Covid-19 case. The most dangerous ailment being a banking system burdened with bad loans and a government looking the other way as symptoms of credit dislocations intensified.

Don’t take my word for it. New books from two top former central bank officials paint a troubling picture of the gulf between what Modi promised in terms of modernizing a chaotic financial sector and bold action. The amount of actual heavy lifting to reduce the magnitude of bad loans has been underwhelming at best.

One book by former Reserve Bank of India Governor Urjit Patel, titled Overdraft, highlights how far Modi’s government went to dilute new bankruptcy laws aimed at forcing banks to address bad loans. “Instead of buttressing and future-proofing the gains thus far, an atmosphere to go easy on the pedal ensued,” Patel wrote. “Until then, for the most part, the finance minister and I were on the same page, with frequent conversations on enhancing the landmark legislation’s operational efficiency.”

Such episodes belie Modi’s efforts to project an image of bold financial change. Patel lasted just over two years in the job, after having replaced the widely respected Raghuram Rajan in September 2016. Rajan, too, had experienced a sudden exit from the RBI.

Patel’s replacement, Shaktikanta Das, acted quickly to relax pressure on lenders, arguably all carrot and no stick. Governor Das lifted a deadline to force defaulters into bankruptcy. Lenders were given 30 days to examine delinquent accounts and another 180 days to devise restructuring plans, a significant easing of previous timelines.

Months after Patel’s unsettling departure, his deputy, Viral Acharya, was gone. His own forthcoming book will reportedly explore the government’s failure to rise to the bad loan challenge. In Acharya’s telling, there had been a strategy to clean up bank balance sheets and recapitalize the industry. Yet “in about 10 months to follow, not only did progress stall but also several policies regressed,” he explains.

It’s a Modinomics pattern. Governor Rajan took the helm at the RBI in 2013, several months before Modi assumed the premiership. The former International Monetary Fund bigwig cut a huge profile in global circles. And his deft policy making amid the “taper tantrum” in emerging markets was credited for New Delhi escaping a threatened downgrade to junk status.

Rajan wasn’t liberal enough with monetary easing, though. Modi opted for a replacement he thought would be more compliant. And yet Patel, too, turned out to be his policy spoiler, unwilling to go far enough to help the government make the bad-loan problem look less dire. But as with other ailments festering below the surface, the coronavirus crisis is reminding the globe why India Inc. isn’t ready for global primetime.

In March, regulators allowed lenders to cease collecting payments from borrowers for 90 days. Then, regulators added another three months to payment delays. The trouble for lenders, however, is that investors are keen to see where things stood in June when they report quarterly earnings. Bottom line, it’s becoming harder than ever to gauge the health of India Inc.

Gavekal Research warns of a “debt time bomb.” The RBI reckons the non-performing loan ratio will rise to 12.5% by March 2021—or 14.7% if there is “very severe stress.” This scenario now seems less of a risk than a certainty.

All this speaks to the huge gap between the epochal reforms he promised in 2014 and where India actually is in 2020. Modi surely did open sectors like aviation, defense and insurance. He oversaw passage of a national goods and services tax. Yet he’s largely punted on the truly big reforms—labor, land, tax rates and opening the retail industry much more assertively.

If Modi had used the first five-year term to remake India—he was reelected in 2019—the economy might be faring better amid Covid-19 fallout. Its banking system might not be faltering. And its fiscal and monetary shock absorbers might have greater latitude to stabilize growth as coronavirus cases surge.

“Any hope of a V-shaped recovery in India has died,” argue Gavekal Research analysts Tom Miller and Udith Sikand in a new report. “With recorded infections surging towards 1.5 million and a high number of localized lockdowns hampering the economic restart, a slower U-shaped recovery is the best India can hope for. And with its long-suffering banks preparing to absorb yet another round of bad debts, a prolonged L-shaped recession is not out of the question.”

In absolute Covid-19 cases, India is trailing only the U.S. and Brazil. Indian states with the fastest-increasing cases include Maharashtra, Tamil Nadu, Andhra Pradesh and Karnataka. The second-most populous nation has its work cut out to deal with a surge in domestic infections and global turmoil. These challenges are made worse by cracks in India’s underlying financial system one would’ve hoped Modi had tackled by now.