GAME OF TRUST
In the quest for AtmaNirbhar Bharat, Finance Minister announced a package that very smartly combined the fiscal and monetary measures. The package was more focused on infusing liquidity indirectly in the economy then directly and therefore emphasis was on more on supply-side instead of the demand side.
This potentially has two advantages: 1. Businesses will have money to produce goods demanded by consumers and thereby the prices will be in check as goods will be available to meet the demand. 2. Now since the goods have to be produced, labor will be required which will mean the employment is generated, and thereby these employed people(consumers) are again demanding products not building pressure on suppliers to lower the prices because of oversupply of products at their disposal. This way inflationary as well as recessionary pressures are kept in check to continue the demand-supply cycle and keep the economy moving. However, the government surely failed to consider a few important points, 1. Reverse Migration is going to hinder labor availability, 2. Only essentials are demanded by the public in this time of crisis, 3. If businesses keep on borrowing and they don’t have enough resources to pay back loan amounts it can further put a lot of pressure on financial institutions as they deal with NPAs.
Now the even bigger problem here is the problem of moral hazard. As the government continues to announce moratoriums and guarantee-free loan availability, it can lead to bubble creation where we see a great collapse in the banking industry. Right now, businesses are shut and so it makes sense to give them time to pay back on their dues. However, the impact of this lockdown will remain for at least 1 year after the economy opens up. This would mean businesses being unable to earn enough to pay back on their dues. Furthermore, this will mean the situation for financial institutions may actually get worse after the economy opens up. Because this will be the time when we will get to know the actual scenario and the business will be announcing how much hit they have taken.
The situation will be even worse for NBFC-MFIs the reason being till now their business runs on customer touchpoints. They ensure to keep regular contact with customers and EMI collections also happen by way of meeting customers personally or through JLG/SHG meetings. It seems easy for us to say that businesses are going digital, but for MFIs, this is not the case. Some have progressed in terms of cashless disbursements, however; collections still happen in cash.
Rural areas are more hit by COVID then urban areas, not in terms of cases but in terms of economy. The businesses there are also at a halt and more so this was a harvest season and though the crop has been good this time, the demand is lagging and transportation costs have gone up. This has created a bleak situation for those who were looking forward to harvest season to pay back their loans. And if the situation persists for a long time, the MFI business may be hit badly. The operations cost for MFIs is already high and they need to earn on a regular basis in order to function. But if the problem of moral hazard seeps in then it will be really difficult for these institutions to survive. More so, it will more difficult for those remote locations to get financial assistance in times of need. This will mean that the years of sweat in building these institutions would be for nothing. And the situation for such institutions and such borrowers wouldn’t improve for the coming many years. The whole system is now knit with a thin fabric of trust. If the borrowers have enough to pay back these institutions, then, these institutions will have enough motivation to keep serving such financially underserved areas.
Hopefully, the trust will be maintained and borrowers will come around to keep paying back these institutions and ensure survival for both themselves and these institutions.