Why a trial by fire awaits Narendra Modi’s new finance minister, Nirmala Sitharaman

One of the big surprises in the Narendra Modi’s new cabinet on Friday was the appointment of Nirmala Sitharaman as new union finance minister. When it became clear that former finance minister, Arun Jaitley is not in the fray, financial markets and economists were betting for either Piyush Goyal or BJP President, Amit Shah to be given the crucial financial portfolio; Sitharaman’s name was hardly heard on the grapevine. Yet, true to his style of politics, Prime Minister Narendra Modi surprised everyone till the last moment choosing the former defence/commerce minister for finance portfolio. The 60-year old economics postgraduate thus became the first female union finance minister after Indira Gandhi who briefly held this portfolio in the 70s as an additional charge while she was holding the PM’s office.The big political messaging Modi wants to send to his party colleagues with Sitharaman’s appointment could be that performers will be rewarded in this government; Sitharaman was one of the best performing ministers in Modi’s previous term. As defence minister, Sitharaman was the face of Modi government in Parliament confronting Congress’ Rafale attack and defending the government’s deal with evidence.Second, Modi probably didn’t want to take chances on the finance portfolio at a time when the economy is at a crucial juncture. Sitharaman’s background in commerce ministry and her academic credentials in economics would have pushed her name up in the final list. The government probably expects a barrage of attacks from the opposition in the second term on politically critical economic issues such as sliding GDP growth, rural distress, unemployment and a growing trust deficit on official data. It needs a credible and articulate face to confront the opposition.The immediate challenge Sitharaman will face is addressing the liquidity problem in the non-banking industry that has high interlinkages with the broader financial system. Some of the major non-banking finance companies in India, such as DHFL are facing nothing short of a liquidity crisis situation. While IL&FS has already been handed over to an expert panel under Uday Kotak, DHFL urgently needs significant liquidity to stay afloat.[caption id="attachment_5039341" align="alignleft" width="380"]

File image of Nirmala Sitharaman. AFP[/caption]The future remains uncertain post a spate of rating downgrades. The NBFC has already stopped taking fresh deposits and has restricted even premature withdrawals. If the DHFL cash situation worsens, it will have systemic implications. There are as many as 164 schemes across 23 asset management companies with total industry exposure to DHFL alone at around Rs 5,183 crore, as on 30 April 2019, according to data provided by Value Research, Mint reported.There are other NBFCs too which may face liquidity tightness in the coming months. As of March 2019, banks’ exposure to NBFCs stood at Rs 6.4 trillion, which grew from Rs 5.6 trillion a year-ago. In the 12 months ended March, this exposure grew about 30 percent. NBFCs will face a major problem if their funding taps dry and asset quality issues come up. Sitharaman first task is to ensure the NBFC liquidity crisis doesn’t spread across to banking system.The second is sorting out the mess in the public sector banking system. Narendra Modi’s first term saw incremental reforms in the banking sector such as bank account opening drive under Jan Dhan and the creation of Insolvency and Bankruptcy Code. But, the biggest reform—privatisation of loss-making PSUs is pending. The present structure of capital infusion envisaged for state-run banks will prove inadequate when credit demand picks up in the event of an economic revival and also to meet the high provisioning requirement post the large scale NPA-clean up exercise. The government may not be in a position to meet this funding gap without diluting the government stake. Right now, of the 18 PSBs present, 16 have government holding over 70 percent as of end-March, 2019. In at least 12 of them, the government has over 80 percent holding and in six of them, it has over 90 percent stakeholding. Can Sitharaman undertake the difficult task of privatising at least some of the 18 odd PSUs is a question.Third, sooner than later, Sitharaman will have to find ways to push up demand in the economy that has slumped to multi-year lows. The economy is on a slowing path. At the time of filing this copy, the official figures of the government showed GDP in the fourth quarter fell to Q4 GDP at 5.8 percent against expectations of 6.3 percent while the full year GDP figure fell to 6.8 percent as compared with 7.2 percent in the previous fiscal. That’s the lowest growth in five fiscal years. Vehicle sales have been plummeting and FMCG companies have been reporting lower sales on account of demand lull. The economy has been on a sliding path in recent quarters accompanied by rural distress and rising unemployment figures. As finance minister, Sitharaman will have to find ways how to beef up the economic activities by reviving the demand.Fourth, rising unemployment will pose challenges to the new government and as finance minister, this is going to be Sitharaman’s another worry. Unemployment rate rose to 6.1 percent in fiscal year 2018 as per Labour Bureau data, CNBC TV 18 reported quoting the CSO. This is the highest unemployment figure at least in 45-year years. The increasing number of people in the formal workforce not being able to get quality jobs indicates underlying weakness in the economy.Five, Sitharaman will also have to undertake the task of simplifying the GST structure. The multiple slabs and rates have been a big negative for GST’s public acceptance, which was originally conceived as one nation, one tax rate. This structure needs to be simplified to a narrow set of rates so that the economy will benefit from the uniform tax system in the real sense.To sum up, India's new finance minister Sitharaman will have an eventful year ahead. Sitharaman has her tasks clearly cut out. In the next five years of the Modi government, economic challenges will be even greater also due to the worsening global situation. The ongoing trade war between US and China and the uncertainties in Europe, the course of the crude oil prices—all promises a tougher challenge for the new finance minister in office compared with her earlier portfolio; nothing less than a trial by fire.