The future of Finance: Will 2021 see spectacular highs or dismal lows like 2020?

It is not effective because, for most firms, particularly MSMEs, it was not a question of shrinking liquidity but that of solvency
What kind of policy needs to be in place? There is very little room from the monetary policy side, so all the action has to be on the fiscal side (Pic: EdexLive)
What kind of policy needs to be in place? There is very little room from the monetary policy side, so all the action has to be on the fiscal side (Pic: EdexLive)
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How will the financial sector shape up in 2021? If there is one lesson that 2020 has taught us, it is that forecasting, even for a short horizon, is a risky business. In general, extrapolating the current indicators, given the understanding that we have developed and theories we have advanced, we can form reasonable expectations about the near future. The COVID-19 shock has shaken it all up. The uncertainty is so high, its nature unknown, that it is difficult to visualise even the near future. Yet, there is some merit in trying to think about the future — it helps us to take stock of the current situation and ponder over the policy options available.

So, let us start with the current situation. The financial sector is in a bit of a mess. And here it is important to remember that some of the issues that we are facing in India precede this pandemic. Banks were reeling under non-performing assets (NPAs) even pre-pandemic. The pandemic is bound to aggravate the situation. Earlier, some large loans accounted for a big share of the NPAs. In 2019, only 12 companies accounted for 25% of NPAs (according to the article 'India's Bad Loan Problems' published in www.epw.in). Now, going ahead in 2021, however, it is more likely that small loans will turn bad as MSMEs face an existential crisis. The policy response before the pandemic was to merge banks, infuse some capital in the PSU banks and keep liquidity high. Post pandemic, again, the most prominent policy response has been to flush the economy with liquidity. This, however, is not only ineffective but will have consequences. 

It is not effective because, for most firms, particularly MSMEs, it was not a question of shrinking liquidity but that of solvency. In fact, as mentioned earlier, the economy had enough liquidity, yet non-food private credit was falling. In many cases, the businesses were endangered because of precipitous fall in demand, which increasing liquidity cannot solve. There are two consequences of this. One, businesses will continue to close and loans will be unpaid — in 2021, we are likely to see an increase in NPAs. The banks are already in a bad shape, so this will stress them further. Two, both because of fall in income and low-interest rates, domestic savings is likely to fall. 

What kind of policy needs to be in place? There is very little room from the monetary policy side, so all the action has to be on the fiscal side. These policies have to be crafted to help efficient firms remains solvent. One such policy can be to use targetted transfers. However, the government has so far been reluctant to do that. It is a bit surprising that the government has not followed a more aggressive expansionary policy, particularly when, given the situation, the risk of crowding out is minimal. In fact, India is running current account surplus, that is Indians (particularly RBI) are investing abroad. This situation is not like any other emerging market crisis we have seen in the past, the government has to realise that the resurrection of the financial sector has to be through the real economy and act accordingly. That is the big hope for 2021.


Dr Partha Chatterjee is the Dean of International Partnerships and Professor and Head of the Economics Department at Shiv Nadar University    

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