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COVID-19 | Liquidity package will ease stress, but hangover is too intense

Given the weak backdrop and a dire future outlook, the severity of the long duration COVID-19 shock raises serious concerns about lasting damage to output and productivity

May 15, 2020 / 10:29 AM IST

On May 13, the government eased liquidity constraints of the micro, small and medium businesses (MSMEs) and shadow banks (the non-banking financial companies or NBFCs), with an aim to help them weather the COVID-19 downturn.

For MSMEs, this is mainly an emergency credit guarantee line of Rs 3 lakh crore for an estimated 45 lakh units, which can avail of fully-guaranteed loans up to 20 percent of credit outstanding (standard assets) for four years with principal repayments of a year’s moratorium. A sum of Rs 20,000 crore of subordinate debt assistance in the form of equity support by banks (Rs 4,000 crore of government credit guarantee) will be given to another 2 lakh stressed units. A ‘Fund of Funds’ with Rs 10,000 crore corpus and 5x leverage will be formed for equity funding for viable MSMEs with growth potential.

These apart, the MSME definition will be changed for scaling-up, i.e. increase in investment limits, adding turnover and removing distinction in manufacturing and services. Market protection or lesser competition was also given by excluding global tenders from public procurement up to Rs 200 crore.

The NBFCs (non-banking financial companies), which are important lending counterparts and fund-starved despite the Reserve Bank of India’s (RBI’s) special credit lines due to banks’ risk-aversion also got liquidity support: a Rs 30,000 crore Special Liquidity Scheme for investing in primary and secondary market transactions in investment grade debt with full government guarantee and Rs 45,000 crore for expanding reach of the December 2019 partial credit guarantee scheme to enable public sector banks for buying high-rated pooled assets from NBFCs with stronger balance sheets — sub-grade debt or AA, unrated papers of lower-rated NBFC borrowers — and increased first loss bearing by the government (20 percent as against 10 percent before).

These credit lines may lessen the risk-disinclination among banks, non-banks and mutual funds. This is long-standing, pre-dates COVID-19 with which it has escalated with sudden closure of six debt funds. It remains to be seen if these measures lessen funding pressures and lower risk premia for the strained and weak shadow banks.


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The liquidity initiatives for the MSMEs should mitigate cash flow pressures on stressed entities. Hopefully, these should also help such production units stay afloat through the prolonged duration of this pandemic. Early signs from March-April data on industrial output and exports are not such a good augur. Seen in conjunction with a longer period, the capacity of the manufacturing MSMEs — these contribute about 45 percent to total manufacturing output and more than 40 percent of India’s exports — to both endure and withstand the savage devastation from the COVID-19 lockdowns is a tentative question.

In March, or pre-lockdown, growth of industrial output collapsed to -16.7 percent, manufacturing output contracted by 21 percent, exports and non-oil and gold imports grew a respective -34 percent and -31 percent. This data, no doubt, represents the production shock that came first from the virus’ disruptions to global supply-chain networks. Data for subsequent months will capture the supply shock’s development into a demand side one caused by the COVID-19 lockdowns of more than one-and-a-half months’ duration.

However, as the chart below shows, there’s a persistent and widespread decline that has depressed industrial output for much longer than this. The dashed vertical lines highlight how feeble and non-lasting were last year’s uplifts; the peaks are well over two years old. It means that balance sheet pressures have existed longer and have now magnified in unimaginable proportions, duration of which is equally uncertain and unknown.

Industrial production 14052020

This trend decline matches the pre-COVID-19 increase in manufacturing slack that, in turn, is connected to exports and global trade. Successive OBICUS surveys (Order Books, Inventories and Capacity Utilisation Survey) of the RBI show that an average 70.4 percent of manufacturing capacities were used in the first three quarters of FY20, a 5 percentage point rise in idleness over three-quarter usage in FY19. There’s even longer evolution of the steady increase in this slack — from 79 percent average use in FY10-12, subsequent sharp drop to the 72-73 percent region until the slight uplift in 2018-19. This trend decline in capacity use synchronises with the post-2012 decline in world trade and Indian export growth, in which the latter’s share in aggregate output fell from its 17.2 percent peak in FY14 to the 12 percent region over FY16-19.

There’s also little doubt that such trend falls make it hard to recover part of the invested capital and assets, which result in permanent loss of output. The severity of the long duration COVID-19 shock in this weak backdrop and a dire future outlook then does raise serious concerns about lasting damage to output and productivity. Businesses already on edge pre-COVID-19 may simply close shop; low turnover and thin-margin units, as quite many MSMEs tend to be even when viable, could question the wisdom of staying alive by borrowing more, no matter the tenor, guarantee and moratorium.

If these entities perceive depressed domestic and global demand extending over one year -- as all forecasts point to -- they are unlikely to believe that repayment capacities will strengthen or significantly improve over time. Those connected to large-scale manufacturing can already see their only buyers operating at significantly lowered capacities than before.

To what extent such considerations play out, in light of the fact that forthcoming times will show more severe and unparalleled output contractions, is to be looked out for. Meanwhile, credit lines help in limiting financial and real sides from damaging each other.

 Renu Kohli is a New Delhi-based macroeconomist. Views are personal.
Renu Kohli
first published: May 15, 2020 10:18 am

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