AP: You’re listening to the “Transforming India” podcast, jointly brought to you by the Deepak and Neera Raj Center on Indian Economic Policies at Columbia University and the Times of India. I am Arvind Panagariya, Director of the Raj Center and Professor of Economics at Columbia. My co-host on this podcast is Professor Pravin Krishna. He is a Professor of International Economics and Business at Johns Hopkins University. Welcome, Pravin.
PK: Hi Arvind.x Delighted to join you for the tenth episode of this podcast as we continue to discuss the Indian economy. On the occasion of our tenth episode, I want to take the opportunity to thank our listeners for tuning in each month. We started this podcast last summer and the engagement of our audience has been really heartening. If there is something specific on the Indian economy that you as listeners would like us to discuss on the podcast, please let us know through email at email@example.com. Once again, the email address is firstname.lastname@example.org.
AP: Pravin, since our previous episode, the government has released additional GDP growth estimates. For the third quarter of the fiscal year 2019-20, GDP growth has been pegged at 4.7%. Going by the original estimate of 4.5% for the second quarter of 2019-20, this would represent a much-awaited, even if small turnaround in the quarterly growth rate. But the twist to the tale is that the government has revised the second quarter growth itself upward to 5.1%.
Therefore, the third quarter of 2019-20 now represents the seventh consecutive decline in the quarterly growth rate. On an annual basis, the growth rate now stands at 6.1% in 2018-19 and 5% in 2019-20. Both are sharp declines compared to the average annual growth rate of 7.7% during the first four years of the Modi government. Given this setback to growth and now, in addition, the threat to the economy form the Corona virus turning very real, in today’s episode, let us dissect the slowdown in-depth. I suggest we do this in two stages by first focusing on pre-Corona slowdown and then taking up the threat from Corona and possible response. Let’s start by focusing on the pre-Corona slowdown.
PK: Before we get to the causes, let me first point out that the current slowdown is the third such slowdown in India since the launch of the economic reforms in 1991. From 1992-93 to 1999-2000, India had grown at average annual rate of 6.4% for eight years. This was the first time, actually, that the country had seen above-six-percent growth for such a long period of time. But then the annual average growth rate plummeted to just 4.2% during the next three years. That slowdown was then followed by a robust 8.2% annual average growth for nine years, from 2003-04 to 2011-12.
Then the growth rate fell once again to 5.9% for until 2013-14. After Prime Minister Modi came to power in 2014, India once again averaged 7.4% growth during his first five years. The economy has now fallen into the current third slowdown. This slowdown, the current one during the last two full years, will probably be half a percentage point worse than that during 2012-13 and 2013-14.
AP: I am glad you reminded our listeners of this past history, Pravin. This certainly offers some reason for optimism: twice before, we have come out of slowdowns and so we will do so this time as well. Of course, it is important to understand that the causes of the earlier slowdowns during 2012-13 and 2013-14, and those of the current slowdown are quite different. Therefore, policy responses to the current slowdown have to be different as well. The 2012 to 2014 slowdown was principally due to policy paralysis in the central government, a near standstill in environmental clearances for infrastructure projects, and worsening of the investor sentiment due to a draconian retrospective taxation legislation and a complete lack of reforms during UPA-2 rule. Among the causes cited for the current slowdown are demonetization, GST, weak demand, and breakdown of financial markets.
PK: That’s true, Arvind. The important keys to resuming growth after the earlier slowdown were ending the paralysis, speeding up environmental clearances, ending retrospective taxation and returning to the path of economic reforms.
To overcome the current slowdown, we also need to understand which of the four causes that you’ve mentioned are the most important. And then, we need to ask whether the government needs to take any further actions beyond what it has already done. I would dare say that of the four reasons that you mentioned, GST is the least important one for the slowdown. Some teething pains accompanied it when it was first introduced but it also brought some benefits such as speedy movement of goods along the highways in the wake of a single nationwide tax on each good and the elimination of multiple indirect taxes that had cluttered the supply chains. The most recent data suggest that the GST revenue collections have begun to increase as well, actually, though the government needs to be cautious to be sure that the turnaround is not a reflection of a slowdown in the refund of input taxes that often happens towards the end of a fiscal year.
AP: That then leaves demonetization, weak demand and the turmoil in financial sector as the three candidates, Pravin. Now many critics of Prime Minister Modi like to pin the slowdown on demonetization. But I must say that there is almost no positive evidence to establish this link. There are many pieces of evidence that point in the opposite direction. First, demonetization took place in November 2016 and the growth rate during 2016-17, which ended on March 31 2017, was an impressive 8.3%. Any major hit to growth should have been captured during this fiscal year. Second, the effect of the massive reduction in money supply should have been felt first in a collapse of prices. But we see almost no break in price data—inflation continued smoothly along its established trajectory in November 2016 and subsequently. Third, even a study by demonetization critics concludes that whatever impact demonetization may have had, dissipated by the end of 2016-17. And finally, critics like to assert that demonetization led to the slowdown by disrupting supply chains of micro, small and medium enterprises. But this is a pure assertion, which has gained currency only through repetition. To-date, the critics have provided no evidence that such disruption actually happened. To my knowledge, there are no surveys of MSMEs before and after demonetization to glean such evidence.
PK: That then leaves us with weak demand and disruption in the financial markets as the two possible explanations, Arvind. The weak-demand argument in particular has found its strongest expression in the calls for assistance by the auto industry for assistance to it. In addition, many commentators have played for a hike in the fiscal deficit to compensate for the weak private consumption demand. As far as policy response is concerned, I feel that we have to take this factor in with some grain of salt. As far as specific industries such as auto are concerned, any action aimed at assisting them I think is a risky proposition. Specific industries may be facing difficulties simply because of their inefficiency. This factor is particularly likely to be at play in the case of the auto industry. Given that despite protection at tariffs reaching as high as a 100% for decades, the auto industry has failed to capture even 1% of the world export market suggests that it suffers from a serious efficiency problem. Indeed, if auto industry was competitive, it could have overcome the problem of weak domestic demand by exploiting more fully the very large 800 Billion dollar export market. But an even bigger problem with rescuing specific industries is that it creates perverse incentives. Industries recognize that any time they run into a problem they can get the government to underwrite their losses. And the end result is that profits end up going to corporations and the losses fall on the taxpayer.
AP: Let me add Pravin that as far as pre-Corona slowdown is concerned, the case for the government to offer additional generalized stimulus through higher fiscal deficit is also quite weak. Indeed, it could prove counterproductive. There are three reasons for this conclusion. First, even with fiscal deficit held at 3.5% in 2020-21, as the government plans to do according to the latest budget, once we add the fiscal deficits of the states and off budget borrowing by public entities, the total public sector borrowing would end up at about 9% of the GDP. The government is thus already providing a heavy dose of stimulus.
Second, fiscal consolidation has been a hard-fought achievement of the government. It has successfully convinced the markets that it is a responsible rather than profligate government. Taking into account the lags in spending plans translating into actual spending and such spending translating into expansionary effect, it is not clear that the benefit of yet higher fiscal deficit outweighs its cost. Finally, any further expansion of borrowing will greatly undermine private investment, which constitutes a highly productive use of savings. Now remember when the government borrows from the market it is leaving less for the private sector, crowding out private investment. In sum, the Prime Minister and the Finance Minister have been wise in holding the line on fiscal consolidation and keeping the deficit at 3.5%.
PK: Arvind, this then brings us to the dislocation in the financial markets as the key factor. Prima facie, the fact that the growth slowdown took place just as the government started cleaning up the massive non-performing assets of the banks, and just as non-bank finance companies, the NBFCs, faced a near-crisis, the disruption in financial markets would seem to me to be the most important explanation.
Even granting that other factors may have played some role, I would argue that the adverse effect of the dislocation in financial markets has been far bigger than all other factors combined. Credit is the lifeblood of all modern economies so that disruptions in financial markets can be devastating to their growth. We can all recall the prolonged disruption that the industrial economies faced after the global financial crisis in 2008.
AP: In addition to the weakening of banks’ balance sheets, the disruption in the financial sector has also been accompanied by a weakening of corporations’ balance sheets. Bad loans are not just about banks incurring losses through haircuts but also about the balance sheets of corporations going in red. This weakening of the balance sheets of corporations has ended up contributing to weak investment demand. In this sense, even some of the weakness in demand, which was our other factor, has originated in the financial sector.
But the policy question, Pravin, is whether the government needs to take additional actions to strengthen the financial sector. What is your view on that?
PK: I think much of what the government needed to do in the short run, it has already done. It has infused over 2 Trillion rupees in equity into the banks and it need not do more. For the rest, the banks must help themselves by raising capital from the market. Cleanup of Nonperforming Assets is progressing steadily under the Insolvency and Bankruptcy Code. Perhaps the government could do a little more here to speed up the process by appointing more judges to the National Company Law Tribunal, the NCLT. Though cases under IBC are subject to a time-bound process, the NCLT is failing to meet prescribed deadlines. And repeated delays of this kind can lead to the culture of delays becoming accepted. And I really think this needs to be avoided. What do you think?
AP: There is no doubt, Pravin, that the IBC process has greatly improved the resolution of NPAs. Even taking the delays into account, IBC has cut by wide margins the time that asset resolution used to take under older channels such as Lok Adalats, Debt Recovery Tribunals and SARFAESI Act. Recovery rates under IBC have also been significantly higher. But as you say there is considerable room for improving the IBC process both in terms of time taken and recovery rates.
A separate important issue that deserves government attention is that it guard against future accumulation of NPAs. Industry is always asking for forbearance and there is a danger of slipping back into the old practice of letting restructured loans retain their classification as standard loans rather than downgraded to substandard status which is what we call the NPAs.
PK: Is there anything else you would advise the government?
AP: Other measures, Pravin, are of a longer-term nature. There are serious governance issues with respect to Public Sector Banks. The RBI’s powers to regulate them are considerably more limited than its powers over private sector banks. At the same time, Public Sector Banks are subject to regulations by the government that do not apply to private sector banks. They are also subject to potential investigations by vigilance agencies, which makes them super cautious in making decisions on credit and resolution of NPAs. A key reason why the NPA crisis has been prolonged is that CEOs of Public Sector Banks are afraid to make decisions that involve haircuts on NPAs thereby attracting the ire of the vigilance agencies. So, there is a good bit of work to be done in the forthcoming years to get the governance of banks right. This may even involve privatization of Public Sector Banks. What needs to be done is a subject for a separate, future episode.
PK: Let me then turn to the new threat the economy faces: the Coronavirus. In terms of the number of countries impacted and speed of spread, we have no similar experience in modern times. We have dealt with the AIDS pandemic that began in the 1980s, the Hong-Kong flu of 1968, the Asian flu of 1956 and the most dreadful pandemic of the last century, the Spanish Flu of 1918. Among these, only the 1918 pandemic impacted India on a large scale with estimated deaths from it being 17 to 18 million. But the circumstances of that episode were different. Health infrastructure under the British had been non-existent and the global linkages of the Indian economy, which was highly rural and agricultural at the time, were quite limited.
AP: This is a very helpful background to the past episodes of pandemics, Pravin. As you have already hinted, the circumstances India faces are very different today than those during the most horrible episode of 1918. On the positive side, we have substantial health infrastructure in the country and a government that is vigilant and working in national interest. On the negative side, the economy is highly globalized, which means that even under the highly optimistic scenario in which India manages to contain the spread of coronavirus internally, the adverse impact of closing down of the major world markets and near ban on international travel for some time will have a serious negative impact on growth. Under a less optimistic scenario, if Coronavirus ends up taking the course it has taken in Europe and the United States, we may be looking at a very large impact. Given our vast population, spread of the virus to even 1% of the population will overwhelm our medical facilities. This is why preventive measures such as near-complete voluntary lockdown till all existing cases of coronavirus recover and new cases drop to zero is our best hope. Each citizen should behave as though he or she has already caught infection and must therefore remain in seclusion. This is what most of us in the United States are doing currently.
PK: That’s excellent advice, Arvind. In case our listeners have any doubts about how we are trying to deal with the situation in the United States, let me mention that even as we record this episode, Arvind Panagariya and I are each in our respective homes, as are our producer Atisha Kumar, and our editor Rebecca McGilveray. We are all communicating using a digital platform. Turning to policy responses to Coronavirus-induced slowdown, possible actions can be divided into two categories. In the first category, we have measures that aim at alleviating Coronavirus-induced economic distress among the vulnerable. As consumers cut back their purchases of non-essential items, many self-employed workers stand to lose their incomes partially or wholly. Those working on daily wages may face similar hardship. Some targeted action is required to help these individuals. Here it is important to remember that the vast majority of this population is likely to be urban. Therefore, what the government should do is to affect cash transfers and enhanced distribution of subsidized grains to urban poor who qualify for assistance under the Food Security Act. If signs of Coronavirus induced economic distress emerge in rural areas as well, the transfers should be extended to rural areas. As a precautionary measure, the government may further consider converting NREGA wages temporarily into cash transfers.
The second category of policy measures has to be aimed at minimizing the disruption of economic activity. This is a more difficult area and greater caution is required when intervening. Possible instruments of relief are delays in tax collection and loan repayments but if deployed they should eventually be withdrawn once the economic activity returns to normal levels.
AP: Pravin, let me add that there is perhaps also room for the RBI to make a contribution here. With no threat of demand-induced acceleration in inflation, the RBI should consider cutting the repo rate aggressively. This is exactly the course that the Fed Reserve has taken in the United States.
A final point I wish to comment on concerns the overall fiscal stimulus on which debates in India often concentrate. The spread of Coronavirus has coincided with a sharp decline in oil price. Being a large oil importer, India benefits greatly from this decline. Available estimates suggest that for every $10 per barrel decline in oil price, India gains approximately $15 billion. Last year, oil price had average approximately $65 per barrel and is likely to average $30 per barrels this year. This would mean an overall gain of more than $50 billion. The government has wisely raised excise tax on oil to convert a significant part of this gain into revenues. These revenues provide the government sufficient funds to finance policy actions in response to Coronavirus. Nevertheless, a violation of the current fiscal deficit target may still happen due to a fall in revenues that is likely in view of reduced economic activity.
PK: Arvind, that is the last word since our time is up. As usual, let me wrap up the episode with a quick summary. We have discussed today four potential causes of pre-Coronavirus slowdown in growth: GST, demonetization, weak demand and disruption in financial markets. Our view is that of these four factors, disruption in financial markets is by far the most important one. Here the government has taken a number of important actions, which are enough for now. But, for the future, it should guard against, returning to the old ways whereby restructured loans were allowed to be classified as standard assets. The global best practice here instead is to downgrade restructured loans to substandard status or to that of a Nonperforming Asset. On Coronavirus-induced slowdown, at this stage, there is far too much uncertainty. Minimally, even if India manages to contain the spread of the virus internally, the damage from a near-complete lockdown of the world economy and the ban on travel will lead to a significant adverse economic impact. Among policy measures, we have suggested ramping up transfers to those already vulnerable and those likely to be adversely impacted by the virus, principally in urban areas. As for measures to keep the economy going, the government may consider delays in tax collection and loan repayment without penalty. But these measures should be temporary and withdrawn once the economy returns to a normal level economic activity.
With that, we end today’s episode. Signing off, this is Pravin Krishna.
AP: And this is Arvind Panagariya, on the “Transforming India” podcast, produced by Atisha Kumar, Research Scholar at Columbia University and edited by Rebecca McGilveray at INCITE at Columbia University. Thank you for listening.
DISCLAIMER : Views expressed above are the author’s own.