Interpreting India

Unpacking the Economy with Indira Rajaraman

Episode Summary

Srinath Raghavan and Indira Rajaraman discuss India's 2019-2020 Union Budget, the ongoing U.S.-China trade war, and the slowing global economy.

Episode Notes

Srinath Raghavan and Indira Rajaraman discuss India's 2019-2020 Union Budget, the ongoing U.S.-China trade war, and the slowing global economy.

References:

  1. Union Budget 2019-2020, Ministry of Finance, Government of India
  2. Of Counsel by Arvind Subramanian

Episode Transcription

(Intro) Srinath Raghavan: Hello and welcome to interpreting India. I'm Srinath Raghavan and this is the podcast presented by Carnegie India. Every two weeks we bring to you voices from India and around the world as we unpack the role of technology, the economy and foreign policy in shaping India's relationship with the world. 

Speaking to chief ministers of the states earlier this year, Prime Minister Narendra Modi declared that he wanted India to become a $5 trillion economy by 2024. This vision was also reiterated by the Finance Minister Nirmala Sitharaman when she presented her first budget a couple of months ago. But, the Indian economy is also undergoing a noticeable slowdown. Investment growth remains weak and consumer demand sluggish, with reports of significant job losses in the economy. All this has kicked off a debate among economists about whether the slowdown is cyclical, or structural, or perhaps both, and how the government should respond to the situation. The larger global context isn't particularly supportive either. The U.S.-China trade war has even escalated a notch in the past weeks, and certainly shows no signs of abating. To discuss these issues with us today, I'm delighted to have with me professor Indira Rajaraman. She's a member of the 13th finance commission, whose recommendations covered the years 2010-2015. Earlier, from 1976 to 1994, Indira was on the economics faculty of the Indian Institute of Management, Bangalore and from 1994 until her retirement in 2007, she held the Reserve Bank of India Chair at the National Institute of Public Finance and Policy in Delhi. Indira is also a regular columnist and commentator on economic affairs and she writes regularly in the newspaper the Mint. Indira, welcome to Interpreting India! 
 

Indira Rajaraman: Thank you. 
 

Srinath Raghavan: Let's start with the economic slowdown. Now, if you think of the economy as moving on four wheels, which is public investment, private investment, consumption and net exports, it does seem as though at this point of time, all of these wheels are running slowly and seem to be slowing down. The downward trend in private capital formation continues. Public investment is constrained by the need to keep fiscal deficit in check. Exports have taken a hit, partly because of the global situation and more recently consumption too seems to slowdown. Against the backdrop of this sort of picture, How do you read the state of the Indian economy today?

Indira Rajaraman: I think it's useful to look at the issue of whether the slowdown is structural or cyclical. The surprising thing is that for the last year and a half, capital utilization in the manufacturing sector in India has actually risen and is hovering around 75% which is the long term average when this is the case, one would expect that private investment would rise because it always rises when the long term average is reached. This being an average, it's an average across sectors where it might be 100% and they absolutely have to invest in order to increase capacity and so, but that's not happening. And how do we know it's not happening? I think it's best not to look at the GDP figures which are challenged to a large extent. It's useful to look at domestic production of capital goods and import of capital costs. And surprisingly over the same period over which capital utilization has risen to a sort of stable 75%, both of these have decelerated, imports of capital goods and domestic production of capital goods. And in the last few months the growth has gone into negative territory, which is to say that it has actually declined relative to a year ago. So this is terribly surprising. It does seem to imply that private investment is impeded by lack of confidence in the future.

Srinath Raghavan: So is it just animal spirits? Not rising up as much as they should?

Indira Rajaraman: We don't know what it is, we have to guess. Many people believe that the solution for this is to reduce interest rates, to have more monetary easing. And there are many voices calling for aggressive monetary easing. My voice is not one of those because I see a lot of structural impediments which need to be corrected before we can expect that just to drop in interest rates of let's say, a hundred basis points, we'll actually get investment going.

Srinath Raghavan: So I want to focus a little bit on the private consumption story, particularly. I know it's a short term, just maybe the last couple of quarters data. But in recent years, private consumption has been the main engine of growth at least over the last four or five years. Here we see there is a decline in public consumption and we see that happening across a range of products from, you know, two wheelers and four wheelers on the one side to fast moving consumer goods on the other. What in your view are the reasons behind this slowdown in consumption? Is it lingering effects of earlier policies like demonetization and, you know, the rollout of the goods and services tax? or is it something else that is sort of affecting consumer demand as an aggregate? 

Indira Rajaraman: Several things contributing. As you know, there is an automobile story which many people say is the result of young people not wanting to buy automobiles anymore and wanting to move to Uber and Ola usage. So they're talking about a structural change in the pattern of usage and purchase of cars. There is a biscuit story as you know, biscuit manufacturers are complaining that rural demand has slowed down substantially. That seems to be a result of the very slow growth of rural wages. So each sector has its own story in terms of why consumer demand has slowed down. But as I said earlier, it's difficult to address this on a sectoral basis. You have to look, as I said earlier, the conjunction of capacity utilization being on an average at its long term average and investment, not rising to the occasion. So we have to be forward looking in this. Why is investment stymied? There are structural impediments as I mentioned, and these absolutely need to be corrected. It's not as though a little push here or there, government lifting the ban on the purchase of new cars is really going to set us going.
 

Srinath Raghavan: Right. And then if you were to identify, say three or four headline things, which are the kinds of issues which need to be tackled in order to get the investment going again, what would those be?

Indira Rajaraman: First and foremost, India suffers acutely from very poorly developed and weak corporate bond market. In the rest of the world it's the corporate bond market which does the heavy lifting in terms of financing long term projects. Banks provide working capital loans and they finance small projects. And just to give you a some comparative figures, just looking at other Asian countries, the stock of corporate bonds as a percentage of GDP is 80% in Korea, it's in the neighbourhood of 40% for Malaysia, Singapore, Hong Kong, it's at 5.5% in India. So it's a huge, huge gap. And unless this is addressed, unless what impedes the development of the corporate bond market is addressed meaningfully. We're just not going to get investment off in the kind of ways we want. And this is what we really want to do if we want to pull the economy out of the doldrums. We have to get large investment projects going, we have to let them multiply, generate the incomes, with which biscuits and automobiles will be bought. So it's really the large infrastructure projects that we have to look at and for that the corporate bond market needs to be pulled out of its present somnolent condition.

Srinath Raghavan: Right. And do you think there's a case to be made for thinking about development banks, more broadly, I mean, these station cases as well as all the 19th century cases like Germany are good examples of a state supported development banks really bank rolling big infrastructure. Whereas at least in the last 15 years in India, we've tried this private public partnership models, right?

Indira Rajaraman: We had development banks. We had ICICI and IDBI and so on, and they failed spectacularly. And that gets me to the second structural impediment in India, which is that because of our history, we have very poor capacity for risk assessment in this country. I remember that until we had the reforms in 1991, we had industrial licensing, and a project which had an industrial license was automatically funded. So the task of due diligence was being done within governments by bureaucrats essentially. And once they approved and gave a license, the project was funded. And even after 1991, unfortunately, we hadn't been able to move away from that. We have a very, very limited pool of qualified professionals who can do risk assessment. And it is this limited pool which has to supply people both to banks for their due diligence departments, as well as to credit rating agencies. And we have had spectacular credit rating failure in this country. There was in the U.S. too in 2008, but that was, you know, newly developed products which weren't understood and so on. But here, standard created credit rating, for instance in the IL&FS failure in November 2018, if you remember, it was the corporate bond market which saw the crash coming and credit rating agencies followed. So they should have been leading. So we have poor risk assessment capability and it is a historical legacy from the time when you know, a risk assessment didn't need to be done. It was done within government by bureaucrats. So to answer your question, I don't think development finance institutions are an answer because they do if you remember crashed very badly. Their NPAs were huge and they were bankrolled by the taxpayer and finally it was decided not to have those institutions.

Srinath Raghavan: Right. So, beyond corporate bond markets what else do you think are the kinds of reforms the government should be looking at this point?

Indira Rajaraman: A major reform which has to originate within government itself is the whole business of delayed payments by government. This has taken the form of a disease. What happened after the fiscal responsibility and budget management act was enacted in 2003 was that fiscal responsibility was reduced to a matter of watching the fiscal deficit. And if the fiscal deficit threatened to go out of control or off target, what would be done is that payments would be delayed and rolled over into the next year. And as you know, once you do that, the next year is going to suffer. And so this problem is never really resolved. They have to delay payments in order to accommodate the delayed payments from the year before. And so this has reached a point where once again, let me refer to the IL&FS crisis, one of the reasons that they plunged into default was because they were not paid by the National Highways Authority for a road that they had constructed. The problem with this is that it is disguised as not a delayed payment but an acquisition that the supplier has not built a proper road, that the work was substandard. And then it's referred to arbitration and it's well known that arbitration awards are, you know, something 50% or less of, of the total at issue. So, I know of infrastructure companies in India which would refuse to have any engagement with government at any level, state governments or central government, simply because of the delayed payments. And this is a disease which has reached right down into local governments. So for instance, after the 14th finance commission, when local governments were given very large grants, some states did not pay local government their full grants, but sequestered an amount, which they owed to power companies and water companies and so on. They were not paying their utility bills. So this is a country where irresponsible government has resulted from unfortunately fiscal discipline acts. It's a way by which you conceal fiscal indiscipline. And unless a correction is set in motion by the centre, which I'm happy to say, the current finance minister has taken cognisance off in her most recent group boosting measures and in her budget speech too,  she mentioned that delayed payments would be addressed and would be taken up at the level of the cabinet secretariat and so on. I have problems with that, which I can go into if you like, but government so far has been part of the problem and if it wants to be the solution, it has to take care of the problem that originates from it.

Srinath Raghavan: Right. And the government has a problem on its hands, right? I mean, there's a lot of clamour from corporate groups, from various other kinds of, you know, constituencies which have a voice, asking for the government to do something to tackle the slowdown in the here and now. And then it is in response to that the finance minister seems to have announced a series of measures which came on the back of budget, including a few which seem to have rolled back some of the initiatives that were announced during the budget, but that's fine. But do you think the government has the wherewithal in terms of fiscal space, in terms of the ability to actually push through the kinds of things that can have an impact on the immediate slowdown that we are facing?

Indira Rajaraman: As I said, where does structural impediment in the economy originates from within government. I would have liked the finance minister to be upfront about it and say that we have been delaying payments. And we are going to stop this. Now, if you're going to stop this, this is going to call for an immediate correction. And I would like to hear a transparent admission that another 1% deficit will arise because of this and we're going to do this once for all corrections. But I don't see this forthcoming in quite the way that I would like it to be. What has been said is that delayed payments will be taken care of the cabinet secretariat level. In the budget speech she had said something more promising. She had said that there would be a payments portal where all payments due would be, would be put up on the portal and once they were paid the date of payment would be on the portal. Now that is the kind of transparency we want. And once that happens, believe me, once infrastructure building firms like IL&FS which is now in the doldrums, but if it were alive and other such firms would go running after government because government is a source of huge contracts for highway construction, port construction and so on. But they're not picking up on that because of delayed payments. So there has to be a recognition that problems originate from within and it's not just a matter of announcing a hundred lakh crore program of infrastructure building, you have to solve this problem before firms will actually execute those projects. 

Srinath Raghavan: That's right. But the problem that the former chief economic advisor, Arvind Subramanian identified as a sort twin balance sheet problem still remains. We've had the insolvency and bankruptcy code coming into play, but at least in the way that the legal process has been playing out, it does not seem like the process has given us time bound results in the way that the act envisaged when it was being passed. And as a result, a lot of the infrastructure players and other companies which are caught up in thinking, particularly in the property markets are bleeding value as this process gets dragged along. And that seems to be a huge drag on the economy.

Indira Rajaraman: First of all, all credit goes to the present government for having actually enacted something which should have been done 25 years ago at the time of reform or soon after reform when it was clear that once you dropped industrial licensing and facilitated industrial entry, you had to at the same time facilitate industrial exit. Otherwise you were not going to have rational resource allocation in the economy. So, for some reason, once again, I hope a historian will look into this, why this didn't happen. Incidentally, there are political scientists looking into why the corporate bond market is not developing in India and the equity market has spectacularly. So, these are all political economy issues which need to be looked at. But anyway, finally, the IBC was enacted, but when it was enacted, once again, there was a capacity constraint. There weren't the kind of professionals, the resolution professionals that you needed. There is a huge insufficiency of that. And as part of Skilling India, this huge queue, there is a problem, there is a plumbing problem with IBC. There are cases lined up. They're not able to get any attention until the cases in process of resolution are pushed through.

Srinath Raghavan: Oh, that's right. In fact, my understanding is that a lot of insolvency resolution professionals being appointed by the government are chartered accountants, and they are being now asked to sort of reconfigure these industries which have, so conglomerates effectively.

Indira Rajaraman: These are a very highly priced even in the developed world because they are few and far between to find. But you really needed to hire one or two crap professionals to solve this prom plumbing issue. You know, when you're bringing in the IBC which is overdue by 25 years, you have to recognize that there's going to be a huge queue.

Srinath Raghavan: You referred earlier to monetary policy and you said that there is this demand for a more aggressive path towards cutting down rates, and the RBI has already embarked on the path, we don't know how far down the road they are. I think there's certainly been a course correction from the earlier monetary policy committee  take that inflation targeting had to be done in a somewhat much more aggressive way. I think they've stepped back from that and said that there are the things to watch out for especially in terms of value creation in the economy. But where do you think the problem is? I mean there is a lot of discussion amongst economists about whether the headline rate cuts by the RBI are actually transmitting into rate cuts as far as a consequence on, we know very well that our banking system is heavily dominated by consumer deposits rather than any other of lending. So where do you think the sort of problem lies, which is to say that despite such lowering of rates, we don't seem to be translating into new lending a new borrowing by corporate players. 

Indira Rajaraman:  Yeah. Once again, you know, this keeps coming back to the same structural impediments in the Indian economy. Monetary transmission is impeded by the fact that there is a high, on top of the repo rate which is an overnight rate, there are two margins, which are added on, before the final lender is actually given his loan and knows what interest he'll be paying. One is the terms premium, because the repo rate is an overnight rates so you have to add on the term premium. And there's also a credit premium which is a function of the banking systems assessment of the credit worthiness of the borrower. Once again, this comes down to very poor risk assessment capability within banks. What happens is that banks are so ill positioned in their ability to distinguish between borrowers in a nuanced way that they tend to set the credit premium very high, building in essentially a risk premium against default. You know, you're not able to distinguish very carefully between borrowers, so they will just slap on a huge credit premium. He who can pay that high interest base, he who falls by the wayside defaults. And, the person who's paid is that what is earned from him is used to set off the losses from the defaults. So there are structural problems in the financial sector in its ability to intermediate between the ultimate borrower and the ultimate lender. And for some reason this problem has never been fully recognized for the problem that it is. And what has been attempted over the years has been to get very good finance professionals, like for instance, Viral Acharya into his post as Deputy Governor of the Reserve Bank or now the Chief Economic Advisor, he's again a very good finance professional. But you don't need just those people at the top, you need to have a whole training program in order to equip banks in that task of risk assessment. Now this is obviously going to take a long time. So that's one of the reasons why people looking at this problem say, just reduce the repo rate by let's say a hundred or 150, really crash it so that even after you have added on this overstated credit margin, lending rates will still come down. And borrowers and the margin of whether to go in for a small project or not, we'll still do so. But remember, we're still left with the task of having to take care of banks were lending for large infrastructure projects, which will have a life of 25 or 30 years. And so banks are still being asked to do maturity transformation. So we have to get to the task of really repairing the corporate bond market with immediate attention, and the first thing that has to be done is to improve secondary liquidity in the market, so that people don't have, once they bought a bond, they don't have to hold it to maturity. They can sell it if they want, if they need liquidity. Unless you address secondary liquidity in the corporate bond market, it's not going to take off. Unless you do that you're not going to get monetary transmission because it's corporate. It's the corporate bond market that has to do the heavy lifting in terms of getting infrastructure off. And unless you get infrastructure off, you're not going to get the kind of aggregate demand that you need in the economy that will do it through the multiplier effect.

Srinath Raghavan: And I suppose a prerequisite for rebuilding of this or to get the corporate bond markets really off the ground is to get banks, particularly public sector banks out of the infrastructure lending business where the asset liability mismatches are of very long term nature and it's very difficult for them to operate in that domain. Right, so the one consistent theme that seems to be coming out of what you've been seeing is focus on structural bottlenecks and focus on improving human capacity within the system at various points to take care of these choke points and to be able to get investment flowing again. All right, let's move on to the RBI itself. Just a couple of days ago, and we are recording this on the 29th of August, the RBI has announced that in accordance with the recommendations of the Jalan Committee it is going to transfer 1.7 6 trillion rupees to the government. Now, how do you see this move? Will it give the government more headroom to jumpstart some degree of public investment, especially in the infrastructure space?

Indira Rajaraman: Yes, as far as the routine transfer of surplus is concerned, as you know that some of 1.76, it's a sum of two components. There is a 1.23 trillion which comes from surplus transfer of this year, and there's a 0.53 trillion which is a surplus from, which is a vast stock which has been transferred. So there are these two components, 1.23 and 0.53 which adds up to 1.76. Now, out of the 1.23, .28 had already been paid as an interim dividend. So that left 95,000 crores, which is due this year, and since 90,000 crores had already been budgeted, clearly the government had some advanced intimation that this, this big sum was going to come. They've never had this big dividend before. It's always been capped at around 60,000 or so crores. This is already a big bonanza, this transfer of the current surplus. And then of course, over and above that was the 0.53 trillion, which is coming from the transfer of the stock of reserves. Your question was should they use this to jumpstart investment? Yes, but there has to be a cognizance by government that if they start infrastructure projects, they're going to pay for it. You know, they're not going to use this for some other politically convenient expenditure. And when those infrastructure companies build their roads face the whole problem again of saying, you know, we can't pay you, your work is substandard. So there has to be an upfront recognition by the government of errors made in the past, that those errors will not be repeated, that this sum has essentially been escrowed. If they were to say this has been sequestered and this is going to be paid to you if you do good work, that would, that I think it's just the promise of this going into infrastructure would not be sufficient. It may be necessary, but you also have to have sufficiency.  You have to have a promise that government will mend its ways.

Srinath Raghavan: So I want to shift from the focus on the Indian economy to looking a little bit at the global picture and how it bears down upon our India situation today. So one of the things that I think this government has had a reasonably easy time with is lowering prices, which is help them keep inflation down and build their fiscal deficit position. But we've also seen that over the last couple of years, the trade war between U.S. and China has been escalating. And there are premonitions now  of a global economic slowdown coming perhaps later in this year. Now, how do you think all of this is likely to effect India's own economic position? Particularly on the trade front where we have seen a slump in exports for a duration. But at the same time is the trade war and opportunity for India? We have economists who say that, listen, if global manufacturers are looking to get their supply chains out of China, then countries like India should be positioned well to be able to step into those shoes. But at the same time, empirical data shows that countries like Bangladesh and Vietnam seem to be doing much better than us are when it comes to some of these things. So how do you see the trade war really impacting on India? What, if anything, should we do to take this opportunity for getting into the space of Asian manufacturing supply chains?

Indira Rajaraman: Well, what you said is absolutely correct in the sense that this was an opportunity for India to step in where China had been pushed out. But I'm afraid we've already lost that race because Vietnam and Bangladesh, the countries you mentioned have pushed ahead of us. So the issue is why did they push ahead what it is that held us back? I think India has traditionally been very wooden in its approach to building into global value chains. It has to be remembered that that is not easy to get into global value chains because there are product liability issues. There are the large value chain, which is incorporating you as a small element has to be completely sure that in terms of quality and dated delivery, you're going to be there where you're expected to be. And I'm afraid India has not established a very good reputation in this regard. Indian exports have largely done well outside global value chains. We have not integrated into global value chains very effectively. And there I would blame, you know, foreign trade establishment. We have a network of trade attaches in the major development country markets like no other. I know that Bangladesh and Vietnam for sure don't have a network like we do, but those trade attaches don't seem to be clued in to the needs of the Indian export sector. And here, I think the problem is turf warfare within the government of India. This is another big problem that we have within government. One I mentioned was delayed payments. The other is warfare between departments of government. So the trade attaches are typically reporting to a vertical in the Ministry of External Affairs, and they're not linked to the Ministry of Commerce which is where export and export promotion is being done. And whatever happens in file passage between these ministries, somehow, this network is not clued into the kind of nimble and agile movement that you need in order to position India and move very quickly to get India into a value chain, which is losing a critical China component. Vietnam and Bangladesh, are smaller countries, there's probably less turf warfare within their governments. And so they've been able to run faster than we have. I'm afraid we've lost out and GST also, in its initial phases because of the huge lapses between the entitlement refunds and the actual payment of those refunds by GST. That also pushed back exports at a time when the global slowdown was happening. So I'm afraid we shot ourselves in the foot at the time when GST was introduced.

Srinath Raghavan: But is it an irredeemable situation? Because I mean, the reason I ask this question is because, um, you know, one way to think about exports is that it has got to be an important part of the story of India emerging as a significant manufacturing player in the world, which is important from a domestic Indian perspective because that's where quality jobs are going to be created. And as we know, jobs have been all in the news. That's is one of the prime requirements of a young labor force, which is coming on stream now. So is it a story that is gone behind? Some people say we have prematurely deindustrialized, is that true?

Indira Rajaraman: I don't think it's an irredeemable story because for instance, the GST refund stories of unreceived refunds and the delayed refunds, i'm glad to say, is in the past, it's history. Now refunds are being paid more promptly. But one of the reasons why  it's good to take time to step back into the race is because in exports reputations matter. It becomes an infection, it becomes contagious. If one export firm in India fails, then India is written off and they look elsewhere. So there has to be a very close watch on what is holding exports back, what is holding us back. It's not irredeemable. It's certainly, I mean time t equals zero today, we can certainly build ourselves into a big export source. But it's going to take a lot of concerted, very quick action, in cooperation between the Ministry of Commerce and External Affairs to get this thing rolling.

Srinath Raghavan: Finally, is there any book that you've read lately, which you would recommend to our listeners as they try and figure the workings of the Indian economy and where things are going for themselves?

Indira Rajarman: Well, there's a recent book by Arvind Subramaniam titled Of Counsel. It's a collection of his speeches and writings when he was here. But it covers a number of important, at least two important events that occurred during his tenure. One was demonetization and the other was the introduction of the GST. I had a lot of criticisms about the initial structure of the GST. And I'm happy to say that after the first three months there were corrections set in, although the corrections happened in a slow dribble and that in itself was a problem. But, I think it is useful to see the writings and words of a very informed and intelligent official from within the system as it was happening, and to get some understanding of why it is that even if you have a very well intentioned, very intelligent person in the machinery of government, somehow things don't work out the way we would like them to.

Srinath Raghavan: Indira Rajaraman, thanks so much for joining us today and sharing your insights. Thank you.         

(Outro) Thank you for listening to this episode of interpreting India. A podcast presented every two weeks by Carnegie India. I'm Srinath Raghavan. For more information about the podcast and the production team, you can follow us on social media and visit our webpage.