The news from financial sector continues to be grim, despite various regulatory initiatives and measures taken to enhance availability of funds. Both risk aversion and demand slowdown, coupled with global uncertainties, have weakened domestic investment activity. All this has contributed to a negative sentiment and the government needs to take immediate steps to correct the situation. To some extent, it has. Government sops have boosted market sentiment in the past few months, but if the Monetary Policy Report (October 2019) of the RBI is an indication, things are still far from comfortable. 

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According to the RBI, overall financial flows to the commercial sector have declined sharply, by a whopping 88% during the first six months of the current financial year amid the slowdown in the economy. The flow of funds from banks and non-banks to the commercial sector has been Rs 90,995 crore in 2019-20 thus far (April to mid-September) as against Rs 7,36,087 crore in the same period last year. With the financial sector going through a turbulent phase, there was a reverse flow of Rs 1,25,600 crore from the commercial sector to non-deposit-taking non-banking financial sector (NBFCs)  and deposit-taking NBFCs, as against a flow of Rs 41,200 crore in the same period last year. Non-food credit flow from banks to the commercial sector also declined, from Rs 1,65,187 crore to a reverse flow of Rs 93,688 crore to the banks. Net issuance of commercial papers (CPs) subscribed by non-banks fell from Rs 2,53,669 crore to Rs 19,118 crore by mid-September 2019. India’s economy has been faltering in the last few quarters. 

The economic growth rate slipped to 5% in the April-June quarter, the lowest in over six years, and the outlook has not appeared too rosy. Last week, the RBI lowered its economic growth rate forecast to 6.1% for this year from 6.9%. International agencies have also revised the projections downwards. There is little doubt that a large part of this distress stems from the shrinkage in one source of funds - NBFCs. For instance, the share of NBFCs in incremental fund flow to the commercial sector dropped to just 1.5% during FY19 from a massive 22.1% in the previous fiscal year. This was symptomatic of the funding crunch NBFCs themselves faced during the second and third quarters of FY19. A SIDBI-TransUnion report explained it well. It said that the slack was picked up by banks partially, as also by the bond market. 

Nevertheless, small enterprises typically dependent on NBFCs, had a tough time as non-bank lenders cater to almost 33% of individual businessmen. Traditionally, banks tend to turn away from such borrowers given the risk and bond investors are unlikely to entertain them because of the low ratings. Clearly then, the government needs to ensure that bringing down funding costs offers an alternative. It will prod lenders to become more open to taking risks. This would ensure the base money created by RBI through printing currency and infusing liquidity flows unhindered as credit to borrowers.