Here’s how India should prepare for the next global financial crisis

• JP Morgan, an investment bank, has predicted that the next global financial crisis could take place in 2020.
  
• The seeds of India’s bad loan crisis were sowed in the build-up to the 2008 financial crisis, as lending standards were lax and bankers were overconfident.
  
• In order to soften the blow from the next financial crisis, India needs to accelerate the bad loan resolution process, reduce its dependence on foreign funds and encourage a savings culture.
  
  

JP Morgan, an investment bank, has predicted that the next global financial crisis will take place in two years amid a lack of liquidity in the system and the reduced popularity of active investing strategies. While the crisis won’t be on the same scale seen in 2008, it will involve a 20% drop in the value of US equities, a 35% drop in oil prices (which will be a much welcome development for India), a 48% drop in emerging market equities and a 14% decline in emerging market currencies.

This begs the question. Is India ready for the next rout in international markets? It is more integrated the ever into the international economy. The country’s markets have had a volatile year owing to external concerns of a trade war between the US and China, even though some market prognosticators say that this could prove an opportunity for India to up its trade relationship with the US. More importantly, a surge in foreign outflows this past summer - which would take place on a grander scale during the financial crisis - has hurt India’s currency and widened its current account deficit.

A global financial crisis doesn’t leave anyone unspared, but it affects some countries more than others. In addition to reducing its exposure to foreign assets like derivatives and making sure banks implement Basel III regulations by the 2019 deadline, here’s what the Indian government, acting through the RBI and other regulators, needs to do to soften the blow of the next financial crisis.

Bad loans need to be resolved and lending standards need to get stricter

The debt resolution has been sluggish so far. Within the next two years, the RBI’s main priority should be to facilitate the resolution of as many stressed accounts as possible - and should refine the Insolvency and Bankruptcy Code if needed. If the financial crisis hits again, it will batter the balance sheets of India’s banks even further. No one will bid for the assets of bankrupt companies with stressed accounts, which will derail the resolution process. Hence, insolvency proceedings need to be accelerated. A government-backed asset reconstruction company should be established to buy and restructure all large accounts.

While Indian bankers say that the crisis is peaked, to prevent another bad loan crisis from happening again, lending standards need to be incredibly stringent going forth especially at public-sector banks.

Banks cannot act like venture capitalists or investment agencies of the government. All project financing needs to be backed up with extensive due diligence and feasibility evaluations. Between 2006 and 2008, a number of loans were extended to large companies in India, especially in the power, infrastructure and steel sectors. When the financial crisis hit and demand dried up, these companies weren’t able to make good on their payments. All banks should extend credit in anticipation of a similar scenario.

Reducing dependence on foreign fund inflows

Emerging markets haven’t had a very good year so far, and that’s due in part to the fact that foreign investors are ploughing money back into safe havens like the US, which is raising interest rates. In the event of a financial crisis, the pullout will be amplified. This makes India vulnerable since it depends on foreign portfolio investment to prop up its balance of payments deficit and support its equity and debt markets.

On on hand, the government needs to encourage greater domestic investment in stocks and debt instruments - which is highly possible since Indian households are slowly becoming financially literate and diversifying their savings habits. On the other, it should also steer foreign investment into fixed capital, or long-term assets, through its Make in India programme. This will reduce the level of outflows during a financial crisis when compared to a situation when foreign funds are mostly tied up in liquid assets. The government should also put capital controls in place to prevent an outflow of assets from domestic investors during the crisis.

A focus on savings

Granted, two years is not a lot of time, but in addition to the government, Indian households and private companies would do well to prioritise thriftiness and start saving at a higher rate than before. Spending on the national elections should be closely monitored and parties should advocate fiscal prudence. All these will affect growth in the short-term, but they have a long-term payoff.

A financial crisis is characterised by a drastic decline in investment, and in order to get out of one, the Indian government needs to have the resources and funds in place to stimulate the economy. Thankfully, it still has sizeable foreign exchange reserves despite the recent intervention in currency markets. Meanwhile, companies need to keep investing while households keep consuming. Simply put, a higher savings rate in the short term will help keep India’s economy afloat during a dry spell in international markets.