A 2019 paper co-authored by Arvind Subramanian, former chief economic adviser to the Indian government, 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 towards an ‘Intensive Care Unit’ due to increasing financial stress.
Subramanian argued that the roots of this problem could be traced back to the ‘Twin Balance Sheet Problem’.
However, Finance Minister Nirmala Sitharaman recently stated that India now enjoys a “double balance sheet advantage” which represents a significant turnaround for the economy.
“The double balance sheet advantage is reflected in both the opportunities and the confidence this situation offers us,” Sitharaman said in May this year.
Referring to studies conducted by the Reserve Bank of India and the government, she added: “From the dual balance sheet problems of 2013-14, we have now moved to a dual balance sheet benefit. Corporate and financial sector balance sheets have not only recovered, but are also in excellent shape to support growth.”
What is the ‘four balance challenge’?
In his article 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 sectors: non-banking financial companies (NBFCs) and real estate companies.
The roots of the problem: the double 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-owned banks aggressively loaned 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 it difficult for many companies to service debt. This financial pressure spilled over to the banks and saddled them with bad loans.
Why banks and infrastructure companies were struggling
Infrastructure companies began accumulating excessive debt while taking on risky 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 put enormous pressure on the balance sheets of public sector banks, leading to a cycle of financial problems.
What caused the ‘four balance challenge’?
The collapse of IL&FS, a prominent NBFC with a debt burden of Rs 90,000 crore, exposed systemic problems in the shadow banking sector. NBFCs, which were deeply involved in financing the real estate sector, faced significant challenges as demand for real estate declined. Builders defaulted on their loans, leading to more pressure on NBFC balance sheets.
This domino effect extended from banks and infrastructure companies to NBFCs and real estate companies, transforming the Twin Balance Sheet Problem into the Four Balance Sheet Challenge.
