Financial Crisis In India - Brief Study

‘The superficiality of (bourgeois – author) Political Economy shows itself in the fact that it looks upon the expansion and contraction of credit, which is a mere symptom of the periodic changes of the industrial cycle, as their cause.’

Marx, Capital, Volume 1

Indian financial system has been going through an intense crisis. The spate of news of huge ‘frauds’ and big defaulting borrowers leaving India in the year foregone just brought this to public attention. However, by the time the year passed the contagion of the crisis also spread from banks to non-banking financial services with big companies like IL&FS and DHFL facing severe liquidity crunch. The resultant conflict on how to resolve the crisis between Modi government and RBI has already claimed the scalp of two RBI Governors. Nearly 12% of all outstanding loans are now officially considered ‘non-performing’, i.e., interest or principal, or both, are not being repaid when due. There are additional bad loans which are termed as ‘restructured’, i.e., fearing default banks have allowed borrowers relaxations and concessions in repayment terms so that, technically, they are not in default. Moreover, a lot of defaulting accounts, including 1.77 lakh crores of stressed power sector loans, continue to be shown not in default by banks. We can, therefore, safely assume that the amount of bad bank loans defaulted on by borrowers are somewhere close to 20% of all outstanding bank loans.

What the Bourgeois Analysts Say

Bourgeois analysts, as expected, have largely restricted their analysis of the causes of this crisis to the usual suspects repeated ad nauseum by them – high interest rates, easy or tight monetary policy, insufficient liquidity, lack of good governance and political-bureaucratic interference especially in government owned Public Sector banks, inadequate credit appraisal skills, mismanagement, corruption, crony capitalism, nepotism, regulatory and audit failures, etc. Their solution is also on expected lines – privatise government owned banks and everything else! However, the NPA contagion has also hit the private banks hard and one after the other, these ‘well-managed’ paragons of lofty, efficient, clean banking are all being found to have hidden massive amounts of bad loans through ‘creative, innovative accounting practices’ like evergreening. Moreover, these banks are also being found to have similar practices of cronyism and corruption, sacking of ICICI Bank CEO Chanda Kochar recently being a glaring instance. 

Facts having forced them off their high pedestal, some of the bourgeois analysts have now started referring to some hard economic facts like huge investments in constant capital by Indian corporate firms through large amounts of bank loans especially after 2008 global financial crisis, decreasing rate of creation of jobs, diminishing profitability of firms making these capital investments, downward pressure on aggregate demand in economy leading to low utilisation of installed capacity created through bank loans. All these resulting in low cash accruals are considered to have impacted the interest and principal servicing capability of firms on their loans leading to present loan default crisis. However, they do this in isolated manner as if all this happened by some accident.

Social Democrats see no crisis!

Even more ridiculous is the position of the social democrats who, in their haste to deflect all talk of a crisis in capitalist production relations, attempt to sit on multiple stools and fall through in so many pieces. Having declared public sector and nationalised banks to be harbingers of ‘socialism’ they are now finding it difficult to theorise the causes of the crisis which initially seemed to have hit only the public-sector banks. Prof Prabhat Patnaik wrote ‘Banks and Non-Performing Assets’ in IDEAs Blogs on 28^th November 2017, on the reasons for the currently mounting NPAs, ‘There are three basic reasons why NPAs arise: one, just mentioned, is that investment projects may not become viable in the manner originally visualized for a host of unforeseen but legitimate reasons. The second is when investment projects are not viable to start with, but banks nonetheless are either cajoled into giving loans by the government, or swept away into doing so by euphoria, rather than careful evaluation of prospects, because of asset price bubbles and such like. When the basic unviability of the project becomes apparent in such cases, the loan becomes a non-performing asset. The third is when the borrower, typically a large financial house, uses its clout and political influence to obtain loans which it has no intention of paying back, at least in full, and which in other words constitute pure “loot”. Needless to say, such “loot” is easier to arrange from public sector banks, because political influence counts in their case, compared to private banks which naturally are more hard-headed in the matter (which incidentally is an argument not for privatizing public sector banks, but for democratic control over their functioning, for example through greater parliament-supervised scrutiny over their lending policy, that frees them from arbitrary government interference).’

Prof Patnaik thinks there is nothing fundamentally wrong with economy. How can either the poor lending bank or the ‘hardworking’ borrowing capitalist know in advance whether the investment will be profitable or go bad! Perhaps they should employ some good astrologers! Then he fully agrees with bourgeois analysts – lack of governance, faulty management practices, inadequate loan appraisal skills, cronyism and corruption in public sector banks have caused the crisis. Oh, but, no, he doesn’t agree with them, he does not agree that privatisation is the solution! He prescribes more ‘democratic’ control through parliamentary scrutiny. But who will exercise this scrutiny on behalf of the parliament? Finance minister Jaitley, or his predecessors like Chidambaram or Pranab Mukherjee!   

On 1^st March 2018, 66 economists and public officials led by Profs Prabhat Patnaik, CP Chandrashekhar and Jayati Ghosh wrote, ‘The scale of the recent bank scams and the potential losses faced by banks holding non-performing loans given to some large companies and individuals, has shocked all of us.’ But ‘the basic cause is very clearly the inadequate and faulty regulation and monitoring of the banking sector. This affects all banks, regardless of ownership.’ And, ‘it is worth noting that even a scam as large as the present one has not led to a widespread run on PNB and other banks. At this juncture, it is critical to focus on effective regulation and supervision of all banks, and to make the regulatory process stricter as well as more transparent and accountable.’ Still, nothing fundamentally wrong with the banking or economic system – increase monitoring and regulation, put some wise, honest, skilled people on the job and the issue will go away. But the bigger take away for them is that fundamentals are still strong and even these largescale scams which ‘have shocked’ our professors have not affected the faith of the people and there has been no run on the banks. If there was a run it would have required huge bailout package! Well, 2.60 trillion rupees bank recapitalisation in the current financial year, in addition to those in earlier years, was no bail out, or, was it small, by the standards of our social democratic professors!  In their view there is nothing like a crisis at all, just strict adherence to sound banking rules will revive and recover the patient. Similarly, Prof Jayati Ghosh wrote in The Hindu on 26 Feb 2018, ‘It is now clear that the scams are fundamentally and overwhelmingly a failure of regulation. …. Recovering from this will require stricter adherence to sound banking rules and more transparency and accountability from both public and private players.'
 

But just 3 months after this the shock of these large-scale scams and bad loans having passed with passage of time, again, the position became, what crisis? There is no crisis, and there is no likelihood of any crisis. All is well! Prof Patnaik, the patron saint of the Social democratic economists in India wrote on FRDI Bill in People’s Democracy on 6^th May 2018, ‘Notwithstanding all the hullaballoo over non-performing assets of the banks, these assets are no more than about 12 per cent of total bank assets. Almost 90 per cent of such NPAs belong to the nationalised banks; but given the large share of such banks in total banking business, the weight of the NPAs even in their case is not so large as to be alarming. In addition, the government has just announced a Rs 2.11 lakh crore recapitalisation programme. So, there is no question of such banks being in any critical condition now, or even in the foreseeable future.’

Corruption, Cronyism, Frauds (Some of Which are not really Frauds!)

Nobody can deny the role of corruption, cronyism, frauds, scams, etc in capitalist accumulation. However, these are inseparable part of the profit maximising capitalist system. These have always been and will always be there till capitalist system exists whether an organisation or firm is owned privately or by government. However, despite the presence of these, capitalist system can go through the cycles of booms, prosperity, moderate growth, stagnation, crises, destruction. The reality is that the share of frauds in total bad loans of Indian banks has gone down from a high of 5.3% in 2014-15 to 3.7% in 2017-18. Roshan Kishore notes in Hindustan Times (May 26, 2018), ‘The small share of amount involving fraud in overall NPAs suggests that bulk of India’s bad debt problem is due to cyclical and other economic setbacks to businesses rather than corruption.’ Hence, the frauds and corruption cannot explain the present crisis of bad loans in Indian banks. That requires understanding of how the economic cycle operates and different levels of activity are achieved at different times.  For that we need to study and understand the workings of the basic economic laws of capitalist production process otherwise we shall be just flailing our arms in the dark without reaching any worthwhile conclusion. 

The working capital loans are provided by banks for buying raw materials and paying for buying labour power for starting the production process. Once the commodities are produced and awaiting sale (finished goods inventory) or awaiting payment after sale (book debts or receivables) banks again advance money for restarting the production process for next set of commodities. Often, the seller just presents the Bill to the bank and the banks discounts it and the credit is repaid by discounting the next bill in the cycle. In some cases, banks guarantee payment on behalf of the buyer so that the seller can get credit from their banks. When a commercial capitalist buys a commodity from a producing capitalist he also takes advance from bank for the same. This credit is nominally repaid by selling goods, but in practice it is just a rollover of credit for buying next set of commodities. Hence, in actual market practice these credit transactions are not really separated from each other and what really happens is that one set of credit keeps rolling over and the subsequent credit is used to repay the preceding credit. This cycle of rolling credit continues, and borrower is only required to keep paying interest out of the surplus value generated. However, in many cases the subsequent credit is of sufficiently higher amount to pay off the earlier credit and the interest charged on it as well. Hence borrowers can continue production process without investing much of their own money capital.  This is done by all the interdependent parties in production and circulation sphere. However, when this credit cycle is broken by any one participant for any reason, the whole process collapses like a Ponzi scheme. Then it is usually declared a ‘fraud’ by banks. That is what happened in case of Modi –Choksi affair. Letters from Modi to PNB and from PNB to other banks, that came out in public domain, bear ample testimony for this.

Role of Banks in Capitalist Economy

To understand the real cause of crisis in banking, we first need to understand role of banks in capitalist economic system, their business model and the source of their profit. Marx said ‘with capitalist production an altogether new force comes into play — the credit system, which in its first stages furtively creeps in as the humble assistant of accumulation, drawing into the hands of individual or associated capitalists, by invisible threads, the money resources which lie scattered, over the surface of society, in larger or smaller amounts; but it soon becomes a new and terrible weapon in the battle of competition and is finally transformed into an enormous social mechanism for the centralisation of capitals.’ (Capital, Vol 1)

In the capitalist reproduction process, some capitalists might have money capital surplus to their immediate requirements. On the other hand, there are other capitalists who need capital at various stages of reproduction process, for example when produced commodities have not been sold or sold at credit but raw materials need to be bought and wages need be paid for the reproduction cycle to continue. Hence, the capitalists with surplus money capital lend to capitalists who are short of it. The borrowing capitalist uses this loan capital to produce commodities and extract surplus value. The lending capitalist expects as compensation a share of this extracted surplus value, which is known as interest. The ratio of share of surplus value to loan capital is rate of interest which cannot be higher than the average rate of profit as the borrowing capitalist will not make profit in that case.

This lending and borrowing are usually done through an intermediary who assures and facilitates the payments and guarantees repayment. This intermediary is bank. Bank collects surplus idle capital through deposits by paying interest and lends it onward to functioning capitalists and collects interest from them. Lending rate of interest is higher than deposit rate of interest. The difference between the two is called Net Interest Margin (NIM) which, after subtracting operating expenses, generates the profit of the bank. Hence, the bank profit also comes from the interest which is a share of the surplus value generated by workers in the production process since the bank takes a share of surplus value from the borrowing capitalist and after keeping its NIM passes on the rest to lending capitalist. The rate of profit of the bank on its own capital is also not less than the average rate of profit else the financial capitalists will not run a bank. 

What is described above was the basic operation of the banks as middlemen in capitalist system during its free competition days. As the productive forces developed and manufacturing required more and more concentration of capital, first joint stock companies and then big monopolies in the forms of cartels and trusts emerged. These needed ever higher amount of capital which could not be fulfilled by small middleman banks. This necessitated emergence of monopoly banks through mergers, takeovers and joint stock banking companies with massive amounts of investable money capital. However, the monopoly did not end competition, it rather made it deadlier with manufacturing capitalists requiring ever larger capital funds to concentrate capital and to overcome other manufacturing capitalists. Hence, they needed constant support of the banks for not only loan capital but also in the form of investment by banks into their equity or share capital. Thus emerged alliances of banking and manufacturing capitalists wherein banking capitalists owned shares of manufacturing firms and sat on their board and manufacturing capitalists owned shares in banks and sat on their board, making joint strategy for killing off competition. This alliance or merger of banking and manufacturing capital gave birth to finance capital.    

This finance capital is what we now see dominating Indian economy. In the initial days after independence, along with the development of infrastructure and large primary industry capitalist class assigned the task of accumulation and allocation of scarce capital to state. Accordingly, a state-owned banking sector was created – creation of SBI and its Associate banks, nationalisation of life and general insurance, creation of long-term project finance institutions like IFCI, ICICI, IDBI at national and SIDCs/SFCs at state level and investment institutions like UTI was the first stage, 14 banks nationalisation in 1969 was second and 1980 banks nationalisation was third. In this phase allocation of capital through long term loans by Project Finance institutions, working capital through commercial banks and share capital through LIC, UTI, etc was strictly rationed to those capitalists who had also been allocated manufacturing licences and quotas and the plant & machinery and inventories created out of loan capital was kept as collateral with lenders. This phase was characterised by ‘riskless capitalism’ where equity as well as loan capital was provided by state owned institutions – in most of the Indian corporate firms till 1990s owner/promoter capitalists owned sometimes as little as 2-5% share capital, most of the rest contributed by LIC, UTI, etc and some from other investing capitalists or the coupon clippers.       

However, as the Indian capitalist class grew and became big monopolies, they no longer had need for this restrictive policy and liberalisation started. Now, Indian economy is characterised by manufacturing and banking monopolies giving birth to state and private financial oligarchies. Banking and financial services industry in India is now dominated by 2 public sector groups – SBI & LIC, and two private sector groups – HDFC and ICICI. If we add some second-tier groups to these – PNB, Canara and BoB from public sector and Axis, Kotak Mahindra from the private sector, we will find that almost all large borrowers are financed by one of these or consortia/syndicates led by them. Where ever other smaller banks get to lend to big borrowers it is only through taking a subordinate share through one of these biggies’ led syndicates/consortia. Otherwise, the smaller banks now usually finance the medium and small industries.   

Having described the role of banking in capitalist system and the emergence of finance capital through merger of banking and manufacturing capital, it is clear that crisis in banking – money and credit economy – does not and cannot arise in itself. It only reflects the crisis in the capitalist production process. Once a crisis in production process arises, because the commodities cannot be sold, or it does not generate sufficient surplus value or profit, the capitalists are unable to meet their financial obligations and a crisis in the money market and credit business, i.e., business of banking, starts to manifest. The real crisis in industry and commerce manifests later. Therefore, impression is gained that the crisis is brought about in the sphere of circulation and not in the production process. Therefore, the bourgeois economists look for the causes of a crisis in the sphere of money and credit market and not in production process. We, therefore, need to briefly understand the causes of capitalist crises before examining the causes and impacts of the banking crisis in Indian economy.

Causes of Capitalist Crises

The economic crises before capitalism were basically crises of insufficient production or failure of crops. However, economic crises in capitalism are characterised by ‘overproduction’. This ‘overproduction’ is not absolute overproduction, i.e., production over and above the needs of society. This is relative overproduction, i.e., production which is beyond what can be purchased by society. The possibility of crises is latent in commodity production itself. However, till the production was carried on by petty producers under individual ownership, the purpose of production was to sell commodities and purchase other commodities to continue production and to satisfy consumption needs. Hence, sales were followed by purchases. Even if, there were some dislocation between sales and purchases, the resulting crises were of local nature. However, in capitalism, as the productive forces developed, interdependencies in production process became geographically widespread and purpose of production no longer remained satisfaction of consumption needs or purchase of means of production for continuing production process, the sales and purchases got delinked. It is now no longer necessary for a capitalist to use money capital obtained from sales to purchase other commodities. On the other hand, working class consumption needs remain highly unsatisfied but they do not have the purchasing power necessary to purchase the output of industry. Hence, it is always possible that there will be a lag in purchases and some commodities will remain unsold. When this lag becomes considerable and large number of commodities remain unsold, it has a cascading effect and overproduction is the result. As Marx put it: “The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses.” (Capital Vol III)

In the capitalist system the source of crisis lies in the contradiction of the social nature of production and the private nature of appropriation of products. Hence crises are inevitable. How is this basic contradiction manifested in practice? Every capitalist tries to produce highest number of products at the least possible cost. To do this every capitalist keeps on growing organic composition of capital by increasing the proportion of constant capital (machines, technology, etc) to that of the variable capital, that is, quantity of labour power employed in the production process. This results in – one, the unemployment increases (“industrial reserve army”) and purchasing power of the masses decreases; two, while the individual capitalist enterprise functions in organised and well-planned manner, social production is chaotic and anarchic as every individual capitalist increases production for maximum profit with no coordination between total demand (purchasing power) in society and total production. This dislocation and anarchy sooner or later inevitably give rise to over production and crisis. 

A crisis is usually preceded by a boom when all commodities produced are sold at high profits. All capitalists keep on increasing their capital to produce more and more goods. Suddenly stagnation in sales of goods sets in and the produced goods start to pile up unsold. If the commodities cannot be sold, these cannot be converted into money and a money famine or liquidity crisis sets in forcing capitalists to default on their financial obligations. This starts the crisis in money and credit economy as it is first noticed in the sphere of circulation. However, it is the crisis of overproduction. The results of such a crisis are: unsold commodities, closed or partially functioning factories, rising layoffs, retrenchment fuelling high unemployment, massive bankruptcies destroying productive capacity, crisis in credit and banks, paralysis and chaos in economy.

Another feature of capitalist production system leading to crises is the constant tendency to grow the organic composition of capital (rising proportion of constant capital to variable capital) leading to the declining rate of profit on the total capital employed in the production process. The increased deployment of constant capital is funded by loan capital from banks. Banks are to be paid interest on the loan capital. The interest on loan capital is the share of loan capital in the the surplus value generated on the total capital employed in the production process. However, when the production capacity is increased by massive amounts of loan capital and the rate of profit declines the amount of profit, at times, becomes insufficient to service the interest on the borrowed capital leading to defaults by industrial capitalists on their payment obligations to creditors.

We will now proceed to demonstrate that the current crisis of bad loans has also resulted from an underlying crisis of overproduction in parts of Indian capitalist economy combined with high level of organic capital leading to diminishing rate of profit undermining the loan servicing capability of industry.         

First, Economy Booms!

As the Indian capitalist class accumulated capital and their dependence on state reduced, licence-quota based industrialisation along with capital allocation through strict rationing by state owned financial institutions came to an end. This intensified the competition among the capitalists and to overcome the competitors the above described tendency by individual capitalists to grow the organic composition of capital by increasing the proportion of constant capital to variable capital in the production process increased multi-fold. A report in Economic Times (ET), June 08, 2017, notes, ‘Recent Annual Survey of Industries data suggests that the cost of one unit of capital, i.e. interest plus depreciation, has fallen from as high as 16 times the cost of one unit of labour in the early 1980s to less than 0.6 times in FY15. Essentially, this means the cost of capital has become cheaper than that of labour, thus making it remunerative for companies to replace labour with capital (read, use of technology and machinery & equipment). Data suggests employment has grown in India at an average rate of 1.9 per cent per annum over the past 35 years, while capital employed has increased at a CAGR of 14 per cent in the same period. In other words, although the number of employees per factory has fallen from 80 in the early 1980s to about 60 in FY15, total capital employed per factory has increased from less than Rs 50 lakh to more than Rs 10 crore.’ 

This process created a sort of boom and prosperity in the capitalist economy – commodity and other asset prices were high, profits soared, investment was high, stock markets went through the roof, real estate was booming.  Capitalism appeared to be on high. Then came the global financial crisis endangering the whole edifice. Collapse seemed around the corner. Indian capitalist class, influenced by the bourgeois theories of crisis – ‘under-consumption’ and the Keynesian solution for it – high expenditure, welfare, investment in infrastructure – nudged public sector banks to open their purse strings and expand credit freely helping capitalists to invest more in constant capital - construct factories, power plants and buildings, expand capacities, build roads, open mines, construct large number of homes. Roshan Kishore writes in Hindustan Times on May 02, 2018, ‘the previous economic boom in India was characterised by a sharp spike in share of investment in GDP. It is from these investments that the majority of India’s bad loans was created. By the end of 2014, capital intensive sectors — mining, iron and steel, infrastructure and aviation — accounted for 44 per cent of the total stressed assets in India’s banking system. Infrastructure alone accounted for 30 per cent of total stressed advances of scheduled commercial banks.’

An EPW paper by Rohit Azad, and others, shows that there was a significant spike in infrastructure spending during the 11th and 12th Five-Year Plan periods in India. Numbers from the erstwhile Planning Commission show that the percentage share of infrastructure investment in GDP increased from 5 per cent between 2002-03 and 2006-07 to projected levels of 8.2% during 2012-13 to 2016-17. A large part of this increase was driven by a rise in private sector spending which was projected to almost match public sector spending in the sector in the 12th Five-Year Plan period. Most of this private sector spending on infrastructure came from Public Sector Bank (PSB) loans. Government intervention to channelise credit towards specific sectors via PSB lending is not unprecedented in the Indian economy. Just a few PSBs lending aggressively to infrastructure would have been enough to force similar actions by others due to fears of losing business. Infrastructure push was an important element of growth strategy during this period. This strategy created India’s best ever economic boom. The EPW paper cited above says, “Such PSB credit finance investments, particularly in the infrastructure sector, played a crucial role in generating elevated levels of economic activity in the aftermath of global economic crisis in 2008-09…Such a growth trajectory, however proved to be unsustainable when the expansionary phase came to an end in 2011-12 and bad loans began piling up in the banking system”.

Then it Boomerangs!

For some time, this strategy seemed to work, appeared to be successful in staving off the inevitable crisis and instead created a boom. But this resulted in further problems -  increased investment in constant capital further reduced creation of employment, demand expansion was constrained, capacity became excess to the demand created leading to lower capacity utilisation, per unit costs increased, rate of profit on capital employed started to go down, industry generated lower operating cash, working capital requirements went up, interest costs became very high and the cash generation was not sufficient to service interest on bank loans what to say of repaying the principal. Crisis of bad loans was staring in the face. Again, the government and banking regulator tried to hide that by the device knows as ‘restructuring’ whereby the repayment term were relaxed giving immediate breathing time to industry. However, the projections did not materialise as bad loans started piling up towards the end of this period. What caused the crisis?

Diminishing Rate of Profit, Rising Interest Costs

We discussed above that with the growth of concentration and centralisation of capital, the organic composition of capital invariably grows, that is, the proportion of the variable capital to the constant capital decreases. But the higher organic composition of capital tends to lower the rate of profit and the lower the rate of profit the lower the capacity of the capitalist to meet its financial obligations. The problem started to become visible in 2013-14 itself as ET reported on 1^st February 2014, ‘After hitting a peak of 10.7% in 2007-08, the share of corporate profits in GDP has declined to an estimated 7.5% in 2012-13. Net profit margins of companies slumped to their lowest level in a decade in the quarter ending September 2013. Net profit margins, which stood at 12.7% in 2007-08, slumped to 7.8% in 2012-13. Interest costs as a percentage of sales has surged to all-time highs and was over 15% of sales at the end of September 2013. Interest expenses have increased steadily for companies and have more than doubled in the past four years.’

This does not mean that absolute profits declined, only that rate of profit on total capital employed was showing a downward trend. The same report adds, ‘Despite losing share in GDP, corporate profits are still up 6% on a compound annual basis since 2008 as nominal GDP has grown in every single year, averaging 15% in the five years from 2008-2009.’ One year later the situation worsened. ET reported again on June 29, 2015, ‘Corporate profit, pulled down by higher interest payment and depreciation, is failing to keep pace with GDP. India Inc’s profit-to-GDP ratio fell for the fifth consecutive year, slipping to 4.1 per cent in the year ended March 31, against the 10-year average of 5.3 per cent. Operating profit margins of BSE 500 companies (excluding financials and oil PSUs) fell to 18.18 per cent in FY15 —the lowest in a decade — against the 10-year average of 21 per cent. In the last 10 financial years, interest expenses of the companies increased 28 per cent annually; as percentage of operating profit, they increased 2.5 times to 21.33 per cent from 8.19 per cent in FY07. Although total debt of the companies fell marginally in FY15, the average interest rate paid on debt increased to 7.35 per cent, higher than the 10-year average of 5.81 per cent.’ 

ET noted again on May 15, 2017, ‘Despite an impressive run of the Indian stock market, the corporate profitability-to-GDP ratio in India has dropped to a decade-low of 4.1%. This is because the market has faltered on one count: the earnings growth of the benchmark index Nifty, which accounts for nearly a quarter of the total market capitalisation, has averaged only 4.2% between 2012 and 2016, according to news agency Bloomberg. There are a couple of reasons why earnings growth hasn’t picked up. Firstly, return on equity of Nifty companies has been falling consistently, indicating companies have been losing pricing power due to rising competition, and their average realisation per unit is faltering. Also, the fixed cost per unit of companies swelled as many firms expanded their capacities, while volume growth remained muted. The Nifty’s Return on Equity dropped to 12.11% in April this year, against 23.3% in 2007. …. most companies expanded their capacities using debt. The rate of growth of debt has been higher than the operating profit. The average interest paid on debt increased to 7.35%, compared with the previous 10 years’ average of 5.81%. The interest coverage ratio of companies, particularly in metals, cyclicals and the commodity sector have continuously deteriorated as the recovery in commodity prices has been weaker than expected.’ And the Economic Survey presented to parliament in January 2018 confirmed that the profitability is now at its lowest for a long time, ‘India’s corporate earnings to gross domestic product (GDP) ratio has fallen to 3.5%.’

Producer Commodity Prices Went Down

Average monthly Wholesale Price Index, which, to a considerable extent, reflects prices received by producers, was 111.1 in 2013 (base 2012=100). It went up to 114.8 in 2014. Then it came down to 110.3 in 2015 and remained at the same level in 2016. It’s clear that producer prices were rising fast in 2013, the rate of increase in prices came down quite a bit in 2014 and then the prices started going down in 2015 and then persisted at same levels during the next year. However, more pertinent fact is that reduction in Price Index was driven by Metals, Steel, Minerals, Fuel & Power, Construction material, Cement, etc for which the prices went down quite sharply compared to consumer goods for which demand elasticity is lower. Here, the question may arise as to why the corresponding retail prices didn’t go down. Though retail inflation rate has also gone down the absolute prices have not reduced for two reasons. First, the consumer goods industry reduced the production levels to great extent to avoid the glut of produced goods resulting in lower levels of capacity utilisation and laying off workers; second, the monopolies in trade distribution are able to prevent prices from going down and retail consumer does not have the pricing power force reduction in prices since these items are the last ones for which buying can be deferred. Decrease in producer prices is evidence of the overproduction in these sectors of industry.

Low Capacity Utilisation

As the capitalists find their commodities to be lying unsold, they must fully or partially close down their factories. This is reflected in the lower installed capacity utilisation of industry. While the industry and government has been asking for lower interest rates and easy liquidity to resolve the economic slowdown, Reserve Bank of India (RBI) in its monetary policy statements has consistently argued that manipulation of the monetary policy cannot resolve the crisis of inadequate aggregate demand reflected in the historically low capacity utilisation which has gone down up to 68% in some months and has been at the level of 70-72% compared to the peak of 92% in 2007. RBI has also mentioned that in some months coal and power production has been surplus and the many of the power plants have been facing problems as no buyers were to be found for installed power capacity. ET reported on June 29, 2015, ‘many manufacturing lines lie idle as average capacity utilisation continues to dip. According to RBI data, average manufacturing capacity utilisation of Indian companies dropped to 72 per cent in Q3FY15 from 83 per cent in FY11.’ ET reported again on May 15, 2017 that, ‘According to analysts’ estimates, capacity utilisation of Indian companies was 72% on average in 2016, compared with 92% in 2007.’

Crisis Unfolds

Let us have a look on how the crisis unfolded. Himanshu, from JNU, told Scroll in an interview published on 14^th September 2017, ‘Some of these problems started in 2013-2014. Wages had started turning negative in real terms since 2013. The problem of non-performing assets had appeared by then. The global recession was visible. These factors were well-known. The one big trigger that happened around the time the present government took over was in August 2014, when primary commodity prices collapsed following a fall in oil prices. This hit farmer incomes hard. … In 2014, agriculture GDP contracted and in 2015, it was almost flat. These factors severely dented agricultural incomes. Since wages were anyway going down, rural demand collapsed by 2015. Obviously, jobs were not being created and wages were turning negative in real terms – growing slower than the rate of inflation. …The impact on the construction sector became visible with construction GDP turning negative in the last quarter and manufacturing starting to decline. Credit declined, and private investment went down. This happened over two years. Construction is key to employment creation. It has been the bulwark of employment in the non-agricultural sector in the past 10 years. But the government was in denial till the second volume of the Economic Survey came out and the chief economic advisor, for the first time, accepted the possibility of demand deflation in the economy. …. Instead, in a normal monsoon year in 2016 after two consecutive droughts, when the situation was improving, demonetisation broke the back of the informal economy.’

Amit Kapoor, Chairman, Institute of Competitiveness wrote in the same vein in ET on 11^th August 2017, ‘The twin balance sheet problem of high corporate debts and rising non-performing assets (NPAs) with banks has been impeding fresh corporate investments. Both borrowing and lending activities have been affected due to this long-standing problem. As of March 2017, India's corporate debt-to-GDP ratio stood at 55 per cent of the GDP, which is one of the highest among the emerging economies. Moreover, a recent IMF report points out that nearly a fifth of the corporate debt is held by companies that are not making profit.  … Another reason for corporates to avoid making fresh borrowings is their level of capacity utilisation … the level of capacity utilisation for Indian corporates is at historically low levels of 70-72 per cent.’

Investment Goes Down

As the capitalists find that the increased output cannot be sold and there are forced to run their factories partially or close them down, new investment stalls. ET reports on May 07, 2018 based on Economic Survey presented to Parliament in January, ‘The investment to gross domestic product (GDP) ratio (a measure of what part of the overall economy does investment form) peaked in 2007 at 35.6 per cent. It has been falling ever since and in 2017, it had stood at 26.4 per cent. No other country in the world has gone through such a huge investment bust, during the same period, the Survey suggests. Private sector companies have been facing issues of excess capacity in recent times. The asset turnover ratio of private sector companies fell to 1 in the financial year ending in March 2016 (FY16), noted a Mint story. The asset turnover is a ratio which looks at net sales divided by average total assets. The decline in recent years suggests that companies are not able to squeeze sales out of existing assets. This is also because they had added assets faster than growth in their sales in previous years. This excess capacity is one of the reasons that the private sector has been unwilling to be at the forefront of a capital expenditure drive.

Unemployment goes up

As the shrinking purchasing power constrains demand and the capitalist are forced to close factories, they stop hiring more labour and start to lay off workers. Reports ET on May 07, 2018, ‘A fall in the investment to GDP ratio also suggests that enough jobs and employment opportunities are not being created. A recent estimate made by the Centre for Monitoring Indian Economy suggests that in 2017, two million jobs were created for 11.5 million Indians who joined the labour force during the year. With sufficient jobs and employment opportunities not going around, it has impacted the earning capacity of many Indians. 

Ultimately, enough jobs and employment opportunities not being created has translated itself into lack of growth on the consumer demand front. This can be seen in capacity utilisation of manufacturing firms, which has varied between 70-72 per cent for a while now. This lack of consumer demand has finally translated into falling corporate profits, over the last decade. A falling investment rate leads to fewer jobs and employment opportunities, in turn leading to lower consumer demand and lower corporate profits. Lower consumer demand obviously has a negative impact on the investment rate, which again has an impact on jobs, employment opportunities and corporate profits. And so the cycle works.’ Recent CMIE reports of destruction of 1.10 crore jobs in 2018 and government suppression of NSSO survey findings of unemployment rate being at 45 year high confirm the crisis of job creation.

Wages Go Downward

As the size of industrial reserve army of unemployed workers increases, the law of demand and supply works to reduce market price of labour power. The wages go down. Livemint reported on 11 May 2016, ‘Real wages of rural labourers, probably the poorest of the poor, have been shrinking in the past two years. In December 2015, average real rural wages (wages adjusted for inflation) were down 1% from a year ago. What’s more, in December 2014 too, they were lower by almost 1% from a year ago …. real rural wages grew rapidly in 2011 and rose substantially in 2012. The deceleration started in 2013, when inflation shot through the roof, but the reversal started in the second half of 2014, when growth in real rural wages slipped into a negative territory. They continued to fall till February 2015 after which they moved up a little. Since September 2015, however, growth in real rural wages has been negative.’

According to the ASI data the labour-capital ratio in 2014, i.e., the number of employees per rupee invested was one tenth of the ratio in 1982 in major manufacturing industries. Same survey also tells while labour productivity has increased 8 times since 1983, labour wages have only increased by barely 50%. The contract workers are paid only half or even less of what the regular workers are paid. This combines with the fact that the proportion of contract workers has steadily risen across industries. Between 1999 and 2010, the share of contract workers in total organised employment rose from 10.5% to 25.6%. But the share of directly employed workers fell from 68.3% to 52.4% in the same period. This indicates that the share of wages and labour benefits in gross value generated has gone down from 35% to 10% – more surplus value is being appropriated by capital owners. 

Stagnant Credit

With an economic downturn, demand also didn’t take off leading to surplus capacity in many industries, thus impairing debt servicing capacity. Despite a slew of schemes launched by the Reserve Bank of India (RBI), this growing pile of toxic debt continues to elude resolution. The root of the problem—and this will lead to an increase in bad debt—is the falling debt servicing ability of Indian firms. They are also highly leveraged, especially in industries such as power and steel. According to Credit Suisse estimates, about 40% of debt lies with companies with an interest coverage ratio of less than 1. The result of the NPA problem is a slowdown in credit growth. Capital-starved banks can’t expand their balance sheets quickly enough. There is fear of lending to corporates. Retail loan growth is the key reason why system credit growth is holding up close to 5% levels. Mahesh Vyas of CMIE writes on 8^th May 2018, ‘As a result of this slowdown in the growth of credit offtake, its share in GDP has declined in the last four years - from 53.4 per cent in 2013-14 to 51.6 per cent in 2017-18. The only time when the credit squeeze was more intense than this was in the early 1990s when India faced a payments crisis. While that was a deliberate credit squeeze dictated by the government in response to a crisis, the current shrinking is largely because of lack of demand.’

Forced Concentration & Centralisation of Capital

This has further speeded up the concentration of capital in Indian economy. While the crisis was already unfolding, government administered the double shocks of demonetisation and GST to force the pace of concentration of capital already going on in the economy by increasing the compliance, tax and transaction costs for small industry in enforced formalisation of informal economy. ET reported on Oct 24^th, 2017, ‘"The entire process started on November 8, 2016 when demonetisation was announced and precipitated with GST. Business has systematically moved from smaller firms to bigger, more organized players. After demonetisation a big chunk of the market moved to organized players and this drift started last year. Every rupee that has increased for larger companies has come at the cost of a smaller micro or small enterprise." says Rajiv Chawla, President, Faridabad Small Industries Association.’

Same phenomenon was reported by Scroll on August 24^th, 2017 based on an RBI report, ‘Now, a report released by the Reserve Bank of India suggests that the ban of Rs 500 and Rs 1,000 notes in November hit some sectors harder than the government (or anyone else) expected. And smaller firms with an annual revenue of less than Rs 500 million were the worst affected. These companies saw a sharp slump in their earnings even as sales for industry grew at a decent 7.2% on the back of a good performance by a few large firms, which somewhat neutralised the negative impact of demonetisation on the economy. …companies earning between Rs 250 million and Rs 500 million a year saw the deepest sink in their sales year-on-year as the growth rate decelerated to a negative 53.6% in 2016-2017 from a negative 19.3% in 2015-2016. The trend remained the same for firms with annual revenues of up to Rs 10,000 million as they saw their sales contract at a faster pace in 2016-2017 compared to the financial year before that. However, the opposite trend was true for bigger companies as they saw their sales rise 9.5% year-on-year from 3.2% in the preceding period.’

Corporates Unable to Repay Debt

Constantly diminishing rate of return on capital employed and the lower capacity utilisation owing to overproduction in certain sectors of economy combined led to impaired debt servicing capability of large number of firms resulting in massive increase in bad debt losses of the banks. In an August 2015 report, India Ratings had predicted that even in the best-case scenario, stressed companies would not be able to service about 25% of their debt, leading to at least Rs1 trillion worth haircut for the lenders. Livemint (13^th October 2016) reported, ‘About one out of every three rupees lent to industry over the past five years would have been classified as unsustainable under the central bank’s sustainable structuring of stressed assets, or S4A norms, according to a Mint analysis. Under S4A, banks are allowed to split a stressed firm’s debt into the two parts—sustainable and unsustainable. Sustainable debt is defined as that portion of debt that can be serviced by the company’s immediate cash flows. In other words, if a company had only this portion of debt, its interest coverage ratio (ICR) would be one, or its earnings from core operations would equal interest payments. Anything above this level of debt is unsustainable. For firms, whose median ICR is less than one in the five fiscal years to 2015-16, the increase in debt has been Rs2.85 trillion—that is 37% of the Rs7.65 trillion rise in bank credit to industry. Note that all these firms had an ICR below one in fiscal 2016 too.’

Bankruptcies Loom

It could all end in only possible scenario - destruction of massive amounts of productive capacity by bankrupting many of the firms unable to pay off their debt or to get more debt to keep the default hidden. The scale of bankruptcies increased to such a level that the existing legal structure could not cope with it and the government had to bring a new law, Indian Bankruptcy Code and involve new set of courts National Company Law Tribunal and National Company Law Appellate Tribunal to manage the burial rites in the graveyard of industry. ET reported on 11^th October 2017, ‘Bankers say some of the past resolution efforts under bankruptcy courts show that asset values are a fraction of what’s on their books. For instance, builder VNR Infrastructure, with a loan of Rs 1,000 crore, was valued at just Rs 80 crore. And Innoventive Industries, which defaulted on Rs 1,500 crore of loans, was valued at Rs 140 crore.’ It’s the same story in case of more than 2000 firms referred to bankruptcy procedure till now.

And here is what Rajnish Kumar, SBI Chairman, had to say. If bidders or the indebted firm “cannot service even 5 percent or 7 percent of outstanding credit obligations, then I don’t see any reason for reviving each and every enterprise.” The result is that even the bankruptcy code has not helped much and there have been few resolutions through the process till now.

Data shows that between 2015-17, the average recovery ratio of Indian banks was 26.4 per cent. Private sector banks performed much better than their state-run peers with a recovery ratio of 41 per cent and 25 percent respectively. During this period, the average amount recovered through all existing legal channels including Sarfaesi, DRT and Lok Adalats was a paltry 10.8 per cent of the total amount involved. In the last eight years, recovery of bad loans has declined to 20.8 per cent by March 2017 from 61.8 per cent in 2009.

Thus, we find that the current crisis in financial system is the result of the crisis of capitalist production relations which are now in the firm grip of overproduction and downward spiral of rate of profit and making a large swath of industry unable to generate enough cash flows to meet their obligations to banks. The only way out of this within the capitalist system is huge destruction of existing productive capacities through bankruptcy and liquidation of large number of firms leading to further centralisation and concentration of capital. However, that is bound to result in further crises down the line. 

February 2019