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Climbing up the gorge of recession

We have got used to being feted by the international community as a “rising great power”. This suits our exaggerated self-perception and the choreographed diplomatic dance of real Great Powers (US and EU) with China, truly, a risen great power, albeit increasingly not a benign one.

The Covid epidemic has shown up all our warts – too well known to need recounting here. More interestingly, Covid also highlighted, yet again, the source of our economic resilience – generally competent political leadership, stable democratic credentials, a vibrant private sector and the willingness of the bottom 60% of our population- the laboring classes – to bear limitless pain.

It is fortunate that our worker export themselves to earn some decent cash in the Gulf and not in Latin America. Human rights are subservient to wealth and power in the former unlike the latter, where human rights are periodically asserted via violent political upheavals, followed by negotiated settlements, back to the normal of subsidized heaven for the poor and the possibility of incredible wealth for the well-off. The stable Gulf model suits us better.

Like the Gulf, we are a deeply hierarchical society, which could snap, were it tested by violent upheavals at scale. The political passivity of the underdog is crucial for stability, to be unleased briefly, quinquennially via elections. Our cleverly designed constitutional artifice could shatter, as happened in China in 1949, albeit not necessarily with better long-term outcomes.

The government has aligned with this strategic long-term objective very well. The distribution of free cereals and lentils to potentially, 800 million Indians (two thirds of our population) for an extended period, possibly through 2021 is a mindful, contextually relevant tactic. We have a vast embedded food distribution system already and large cereal stocks. Incidentally, it is also good politics because there are major state level elections scheduled for next year.

The Reserve Bank of India – admirably led by Governor Shakti Kantha Das, IAS – has similarly been quick footed to take the technically correct steps – Repo Rate slashed by 1.40 percentage points to 4%; surplus liquidity of around 25% injected into the system to calm the markets and enhanced supervision of banks and financial institutions, albeit yet to show tangible results. Also “The Twist” – sell long duration treasuries to reduce the steep yield curve by pumping the receipts into shorter duration treasuries because exceedingly high future yields on government debt reflect an embarrassing market fear of uncertainty going forward.

The perception of concerned but indifferent government performance stems, not from fundamentals, but the lack of a clearly stated and articulated strategy to (a) deal with the drivers of the economic slow-down, which preceded Covid for eight quarters till Jan-March 2020 and (b) absence of targeted steps to mitigate the mild economic recession sparked by Covid from April 2020, which is likely to persist over six quarters till September 2021.

Medium to long term steps to counter the long term slow-down like labor reform, agriculture reform (essentially to put agriculture on a commercial footing rather than the subsidy-sink, it is today) and industrial reform have been initiated but will show tangible results only five years hence – too long to help a quick, climb back up the economic cliff we fell off in April 2020.

Oddly, one key reform has escaped attention – recapitalizing public sector bank balance sheets coupled with more autonomy for bank boards. Government should retain only a “golden share” to be used rarely. RBIs direct role in administering these banks should be strengthened as ex-Governor RBI Urjit Patel wanted.

During Covid no-one expects governance reform to precede the urgent need for recapitalising these banks. Only recapitalization can allow banks to reduce their lending rates. Presently borrowers pay not just for the cost of money but also the cost of past indiscretions of bank management. Despite the steep fall in repo rates the retail rates facing customers have barely moved. Bank margins remain high (above 3% points on average) because they are recovering the loss from past non-performing loans and provisioning for the new ones arising from the ongoing recession.

The RBI has flooded the market with liquidity but demand for credit has worsened since 2019-20 (Abhijit Mukhopadhyay ORF 2020 forthcoming). Expecting users to borrow when their revenue streams are uncertain, is optimistic. Expecting them to do so at more than 3X the international cost of loans, is turning a Nelsons eye to the core problem.

Bank of America’s 15-year Home Loan, in the US, is at a fixed rate of 2.1% per annum versus 7 to 7.35% floating SBI Home loan in India, notwithstanding the minimal default rate of such loans and the 3% annualized forward US$ exchange rate cost.

The government must budget Rs 4 trillion (2.2% of GDP) to provide against the additional gross stressed assets of around 11% of banks at the end this fiscal (RBI FSA 2020). This is a superior option to splurging on public investment because the benefits would directly accrue to private hands through bank finance at reasonable rates – a non-distortionary, non-discriminatory fiscal stimulus, instead of the “pork” and “leakages” which accompany vast increases in direct public spending.

We need to spend more on infrastructure. But not as a corner stone of the fiscal stimulus. The short-term benefits of government projects are far less than the quick pass-through and wide dispersion possible via cheap bank finance, possibly with higher employment generation and self-selecting restoration of productive “good jobs”.

Ensuring that our trudge up the wall of the gorge we are in, accumulates the least baggage (inflation, incremental debt, low productivity assets) is as important as the time taken to get to the top.

Government has rightly resisted being panicked into flinging money about. Why risk medium-term instability now? Even after reaching the top of the gorge, there remains the next long slog of clawing back our long-term growth rate of 7%. Both China and Bangladesh are watching.

This commentary originally appeared in TOI Blogs

Sanjeev Ahluwalia (ORF)
30 october 2020

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