If there is a boom in 2010-11, it cannot happen without the financial sector’s participation.
One inevitable consequence of a rapidly expanding economy is the rising demand for funds. Businesses want capital for expansions as well as to fund working capital expenses; consumers want more credit; infrastructure project financing is required. The chain of cause-consequence can also run in the opposite direction. If money is cheap, demand stimulation can trigger economic growth.
Through most of 2009, policy makers attempted to spark revival by offering liquidity. This appears to have been successful in India, at least to some extent. Corporate growth in the First Half of 2009-10 showed improvement over the Second Half of 2008-09. Projections suggest second half of 2009-10 will show further acceleration. Third Quarter results may provide confirmatory data.
If the rebound continues into 2010-11, as one hopes, demands on the financial sector will rise substantially in the next fiscal. Businesses will resurrect shelved expansion plans and financial closure will be sought for many new infrastructure projects with vast outlays. At the same time, retail demand in the form of housing mortgages and auto hire-purchases will also expand.
The structure of instruments required to feed renewed demands may vary. But ultimately all that money has to be found, one way or another. Unfortunately, inflation has climbed. That means rates are likely to rise and the RBI is unlikely to be happy about easy liquidity.
Overseas liquidity via FDI and ECBs has improved but it's certainly not as forthcoming as it was in 2007-08 or the first half of 2008-09. Private equity completely dried up in late 2008-09 and is only now making a small comeback.
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Somehow the financial sector will have to juggle with higher rates and still find ways to generate and disburse more funding to sustain a revival. If this is going to happen, commercial credit must expand considerably and there needs to be a lot of IPO activity as well. The primary market does seem in reasonable shape though the last few issues have been aggressively priced and left little on the table for investors.
In the infrastructure finance market, there could be a quantum jump in activity as well as sophistication. Project finance is often doled out at high debt:equity ratios and projects are usually handled via special purpose vehicles with complex equity structures and lock-in norms peculiar to specific sectors. Since there's a huge market there and it's growing, the finance sector cannot stay away from it.
However, risk-mitigation systems need to improve sharply to handle infrastructure financing effectively. Any infra project is capital-intensive and long-gestation. Risks are difficult to quantify since political risk plays a big role. Asset-liability mismatches tend to be especially tricky due to long tenures. Most banks and commercial financial institutions lack the skills to evaluate infrastructure projections as well as any access to the kind of long-term funds required.
There aren't even easy exit routes for debt investors since the secondary debt market for non-government securities doesn't really exist. To top it all, a tardy legal system makes NPA recovery inside meaningful time-frames impossible.
Structuring projects and correctly evaluating the risks involved could be make-or-break. Parcelling out those risks, perhaps via take-out or mezzanine finance schemes that allow the participation of short-tenure funding, will be crucial.
The financial sector will have to find ways to create instruments that can help lay off risk and also try and create liquidity by encouraging development of a secondary debt market. Obviously the RBI, Sebi, Ministry of Finance, FIPB, et al, will have to play their parts as well.
If all this comes to pass, along with hoped-for expansions in retail credit, the next fiscal will be considerably better for the finance sector. In fact, you could say that growth in the real economy is likely to be reflected in exaggerated topline expansions for financial entities. Assuming they get it right, it will also mean better bottomlines in the future. If they get it wrong, there will be seriously messed up balance sheets.
That makes the financial sector a big bet for 2010. This includes banks, specialised institutions like IDFC and PFC, and NBFCs operating across the retail space. Exposure here are high-risk since growth must come in the face of higher rates, which is normally difficult to envisage. But if there is a boom in 2010-11, it simply cannot occur without the financial sector's enthusiastic participation. So you may as well bet on it happening.