Finance: the Present and the Future

The term ‘Finance’ originates from the French word ‘Finer’ which means ‘make an end’ or ‘settle a debt’. Hence, in literal terms, the basic function of finance is to bring an end to a transaction for any underlying purpose it is availed for. It can be paying cash to buy groceries, availing loans to invest in your start-up’s assets, etc. However, let us not mistake finance for the end itself. Finance provides a platform or is a facility to end a problem and move forward. We are constantly dealing with finance, from personal level to a company or institutional level. It would be interesting to understand more about the current state of finance, the past but most importantly, the future.

At the moment, if we think about finance, credit cards, e-wallets like PayTm or GPay, easy access to loans like Flexi Loans, etc. come to our mind. If we carefully observe, these examples show how money is conveniently available to us. A loan, that used to be such a big thing for a household in India in the past, has become so common and normal. You want a car, you get a loan; you want to go for honeymoon, you get a loan; you want to buy a mobile phone, you get a loan; there is credit available for everything you want. Even for businesses or start-ups, availing loans has become much easier. And there’s no problem with that if the loan provided is generating the returns. The question is, is that happening? Are we generating enough returns to repay the loans?

To answer this question, let us have a look at the current global debt-to-GDP ratio. According to IIF, the debt-to-GDP ratio of the first quarter of FY2020-2021 is 331% at $258 trillion. It means that the current amount of debt is 331% of the global GDP. To make it simpler, if the current global GDP (the total value of production of goods and services of a country) is 100, the current debt is 331. And how are we going to pay off the debt? We don’t know! Ideally, a country grows in GDP terms and then pays off the debt. But the growth that high percentage is a slow process and with the pandemic, it is even slower. So growth is out of the question. Second is a revolution like the industrial revolution that disrupts the global market in ways that lead to massive growth. Are we witnessing one? Probably not! The third is that you default, and the possibility of defaulting on loans is quite high especially post the pandemic settles. We know what these moratoriums are going to bring for the Indian economy – lots of restructuring and defaults! Banks have massive amounts of loans under moratorium (for example, IDBI bank has 68% of its loans under the moratorium) and it is going to have a long-lasting impact on the economy as a whole and not just one particular bank or the institution. The last option is to inflate the currencies’ value that will help decrease the value of debt to 0 levels, but that is definitely out of the question because we cannot afford the mass poverty levels and disasters that come along. So basically, there is no plan in which the world can pay off its debt at the macro level.

This is all about the current scenario, the problem we are facing. Going back to where it all started, finance is a means of end and not the end itself. It is obvious that we are moving towards an end in finance if we cannot manage the debt-to-GDP level. Right now, we are left with the option to do the following:

1. Gradually reduce the exposure to investments and loans in the stranded industries that are going to go down soon. For example, coal or later after a decade or two, the oil industry. This will have a tragic impact on the financials of lots and lots of institutions, however, there is a way to compensate it or mitigate the impact.
2. Instead of taking decisions in panic, relax, and alter your loan or investment portfolio from these stranded industries to the newer industries having a bright future. For example, from the coal and oil industry, shift to renewables. Or from companies that just show a top-line (revenue) growth but declining profits or increasing losses, shift to companies conforming to ESG (Environmental, Social, and Governance) norms that are sensitive to climate change and operate aiming at sustainable growth than temporary numerical growth irrespective of the core business performance.

However, the above two changes are quite difficult to implement with immediate effect. It is important to start altering the portfolio one piece at a time and not jump altogether. The bigger banks and funds in the west especially the US and Europe have already started this process and have also started observing the positive impact on their returns. In the end, the true long-term returns will help bring the debt-to-GDP levels at manageable rates.

This was all from a macroeconomic perspective. At the micro-level, how and where can you and I make a difference? The first way is we alter our portfolio no matter how insignificant it may seem. If every individual alters his/her portfolio, the entire world would have shifted to a different story. This shift is going to be slow but worthwhile for the long-term.

The current debt-to-GDP ratio raises concerns regarding another debt bubble that may be forming. Because we cannot see the bubble, does not mean we may not be forming another one. We do not want one more bubble of 2008 or the dot com bubble. To bail out of the 2008-09 crisis we made debts even cheaper – good for the short-term, disastrous for the long-term. Cheap debt is not a problem in itself. The problem arises when the debt given (or the debt-money invested) does not generate returns.

We have seen enough, learned the lessons and it is time to change. However, obscure it sounds, sustainability, and responsible investing seem the way forward to solve the current crisis we are under. Maybe if we change how we invest or give loans, if we change our mindset, our approach, and faith, we may manage to maintain the essence of finance for being an end for a transaction and not the end of finance itself.

Related Reading: Market Performance v/s Economic Performance, Disruption and Resilience – the New Normal