A 2019 paper co-authored by Arvind Subramanian, former Chief Economic Advisor to the Government of India, and Josh Felman sheds light on the economic challenges India faced at the time. The authors highlighted a “Four Balance Sheet Challenge,” warning that the economy was heading toward an “Intensive Care Unit” due to mounting financial stress.
Subramanian argued that the roots of this issue could be traced back to the “Twin Balance Sheet Problem.”
However, Finance Minister Nirmala Sitharaman has recently stated that India now enjoys a “twin balance sheet advantage,” marking a significant turnaround for the economy.
“The twin balance sheet advantage is evident in both opportunity and confidence that this situation offers us,” Sitharaman said in May this year.
Referring to surveys conducted by the Reserve Bank of India and the government, she added, “From the twin balance sheet problems of 2013-14, we have now moved to a twin balance sheet advantage. Corporate and financial sector balance sheets have not only recovered but are in excellent shape to support growth.”
What Is the ‘Four Balance Sheet Challenge’?
In his paper titled India’s Great Slowdown, Subramanian introduced the “Four Balance Sheet Challenge.” This includes the original two sectors—banks and infrastructure companies—along with two additional ones: Non-Banking Financial Companies (NBFCs) and real estate companies.
The Roots of the Problem: The Twin Balance Sheet Crisis
The origins of the Four Balance Sheet Challenge lie in the Twin Balance Sheet Problem, which was detailed in the Economic Survey 2016-17.
The Twin Balance Sheet Problem emerged during the mid-2000s boom when state-run banks aggressively lent to companies, especially in the infrastructure sector. While this led to robust growth, delays in land and environmental clearances, coupled with rising financing costs, made debt servicing difficult for many companies. This financial strain spilled over to the banks, saddling them with bad loans.
Why Banks and Infra Companies Struggled
Infrastructure companies began accumulating excessive debt while taking on high-risk projects. As approvals for land and environmental clearances slowed and financing costs escalated, these companies struggled to repay their loans. This inability to service debt placed enormous stress on the balance sheets of public sector banks, leading to a cycle of financial distress.
What Caused the ‘Four Balance Sheet Challenge’?
The collapse of IL&FS, a prominent NBFC with a debt burden of ?90,000 crore, exposed systemic issues in the shadow banking sector. NBFCs, which were heavily involved in financing the real estate sector, faced significant challenges when real estate demand declined. Builders were unable to service their loans, leading to increased stress on NBFC balance sheets.
This domino effect extended beyond banks and infrastructure companies to NBFCs and real estate firms, transforming the Twin Balance Sheet Problem into the Four Balance Sheet Challenge.
