Raghuram Rajan has the last laugh

On Tuesday, in my regular weekly column, I had written that the GDP data for 2016-17 released on May 31 was a wake-up call for the Indian government and for the Reserve Bank of India. The decline in the ratio of of Gross Fixed Capital Formation to GDP to around 25.5% in the fourth quarter of 2016-17 in nominal terms was a shocker to me. This is not the stuff of a big-league economy.

What has gone wrong? There are several culprits and each one must do what they can do instead of arguing that someone else must act first and only then will their actions be meaningful. We do not know in economics with such precision. We act and hope for the best. That is the best that can be said about economic policymaking.

(1) The government: It has consistently underestimated the growth challenge in the Indian economy. It has swallowed its own propaganda of the ‘world’s fastest growing large economy’. It failed to understand and grasp the structural impediments that the economy was trapped under. It agreed to a pro-cyclical massive fiscal tightening in 2014-15 when it took office. The real fiscal deficit it inherited was close to 6.0% and it agreed for a target of 4.1% in 2014-15. That was in the backdrop of a failed monsoon. The collapse in the oil economy prevented its folly from becoming a big blunder.

Subsequently, it had also dilly-dallied on dealing with the non-performing loan (NPA) problem in the banking sector. Majority of the loans are held by banks in which it is the dominant shareholder. The top managements in these banks are its nominees. Its nominees sit on the Board of Directors.

Nothing prevented the government from calling an all-Party Meeting or two and then also knocking heads together with vigilance agencies to allow price discovery of these loans and their resolution from moving forward. Yes, all this takes time. But, I leave it to you to decide for yourself if 36 months was enough time or not.

Third, it has pursued a policy of targeting tax dodgers and other wrongdoers in the business community. Nothing wrong here. I am not even going into the question of whether the government had been selective or unbiased in these pursuits. It has done well to do this for it is never the case of this blogger that India’s private sector is an epitome of business ethics and virtues. Far from it.  India’s economy or capitalism always was in peril and is in peril from India’s capitalists with very few honourable exceptions. So, the pursuit was fine.

But, the government should have realised that it would have an impact on sentiment and on investment by businesses. It must have had a Plan B already. Large-scale privatisations (some trophy but chronic loss-making entities like AIR INDIA) either through strategic sale or though Further Placement Offering in capital markets (FPO) should have been contemplated to shore up sentiment and to create a mood of policy dynamism and progressive thinking, etc., especially in the context of what it did on 8th November 2016. It has done nothing of that sort.

The short-term contractionary impact of ‘note-ban’ decision exercise was not taken into consideration in the preparation of offsetting measures in the budget for 2017-18. The budget was a pedestrian document and it lacked imagination. Post-note-ban, the country needed an offsetting positive excitement. The budget ensured that it did not happen.

So, the government does have a large share of the blame for the current growth malaise in India.

(2) The Central Statistical Organisation: When the history of India’s economic cycles is written for this period, much of the blame must be and will be assigned to this organisation for creating a false perception of ‘all is well’ about the Indian economy. Its ‘no resemblance to reality’ growth prints of 7% or higher had robbed all of the sense of urgency, most of all in the Indian government. Further, it has done nothing to remove the suspicions that still linger over its methodology.

All that we receive, every now and then, from commentators is a reassurance that there is no mala fide in Indian economic growth numbers and that the CSO leadership scores high on integrity. That is not even an issue for discussion.

In fact, it is well known that it makes no sense to attribute malice to something that could be explained by incompetence.

That the Indian economy grew 6.4% in 2013-14 is no laughing matter. But, it is laughable. It is very hard to reconcile with lots of statistics – from mobile phone sales to airline traffic to rail freight traffic to cement production to current account deficit shrinkage, etc.  The growth rate was close to 4.0% then.

Similarly, with credit growth to industries contracting, with private capital formation rates shrinking, with production in infrastructure industries sluggish at best and contracting at worst, with demand for electricity not rising, it is hard to see that the economy is growing at 7.5%.

The CSO might have more data now on the corporate sector, etc., But, how the data are processed also matters. For outsiders, it remains a black box.

The CSO has played a very big role in inducing a perception of ‘all is normal and healthy in the economy’ in the government. Indeed, the biggest contribution that any one can make to any country is to induce a sense of crisis in policymakers. That is what leads to policy reforms and action. Where possible and realistic, patriotic citizens must ensure that the policymakers that have their ears are gripped by a sense of crisis.

The banking crisis, the falling investment rates and the credit off-take were perfect crisis ingredients in India. But, the CSO did a lot to remove the crisis-effect of these on the government. That is a very big disservice it has done to India. I hope historians would take note of it and record it with adequate prominence.

(3) The Reserve Bank of India (RBI):  The Indian central bank gets a free pass from the chattering classes, for the most part, especially from those based in Mumbai. It gets the benefit of doubt from them whereas the government in Delhi does not. Delhi is home to politicians who are not like us. Mumbai is home to the RBI which is led by people like us – elites, educated and thoughtful and therefore, it should be treated with respect and given the benefit of doubt, than not.

RBI adopted the inflation targeting regime when the rest of the world was having second thoughts on it. It is not a disaster, per se, even though much thought and discussion should have preceded it. That did not happen.

Even I was guilty of not being critical of its adoption because all of us were stung by the experience of five years of continuous annual double-digit inflation under the previous government from 2009 to 2014.

Further, its fiscal policy also undermined the independence of the central bank. Therefore, it is doubly unfortunate that the fiscal dominance of monetary policy and sustained annual double digit inflation for five years raised sympathies for an inflation targeting regime in India too.

But, in a social science subject like economics and policy framework based on a social science like economics, rules are guideposts and not millstones. It is what policymakers make of them. Creative interpretations have been made even in inflation targeting regimes. They can change the weights; they can creatively assume different lags (after all, they are long or short, variable or fixed as we like them).

For a creative reinterpretation of its mandate, ECB is enough example despite a Treaty-defined mandate only for inflation targeting. Not that I endorse what they do.

Yes, a framework does bind and can be an inconvenient one. Also, if someone stretched it once in one direction, on another occasion, another central banker can stretch it in another direction. But, that is an ever-present risk with all regimes.

The risk comes from the framework and from those who interpret and implement them.

A NPA situation bordering on 10% of GDP and a capital formation rate of 25% of GDP are outside the normal deviations that a creative interpretation of the inflation targeting regime was warranted, in my view, in the RBI policy meeting that concluded yesterday.

Hence, the central bank is guilty of being bookish.

Why should Raghuram Rajan have the last laugh? The title of the blog post is a reaction to the stories here and here. This government did an utterly foolish thing and made a spectacle of itself by the manner in which it had him leave office last year. There were far better ways of doing so. That was very bad karma and it is coming home to roost now.

Its current predicament and frustration with the current leadership of RBI are therefore well earned and well deserved.

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22 thoughts on “Raghuram Rajan has the last laugh

  1. I am not an economist but do understand a view point so lucid and rational in its explanation.
    RR ‘s dismissal came as a shocker and was anguished.
    Read your analysis with great interest.

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  2. Very well written article. Also I think GST will be a deflator to the GDP and not booster as everyone is claiming due to the complex GST which is being implemented. We are set for very interesting and tragic times. Govt with a majority is unable to push economic reforms and is happy about 7% growth which is the new normal growth rate given the productive age of our country. Any Govt now would also have achieved this growth.
    Your articles are very thorough and insightful, do continue writing.

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  3. Dear AN- Apologies for the post. Guess, I am used to trolling/being trolled that it was an influx reaction. I can guarantee that it was a Mr..:) Now 2-3 points A) YV Reddy has said he supports the decision to not increase the CRR B) Where did you draw the figures of NPA= 10% of GDP??

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    1. I do not quite understand your comment (a). I do not know the context in which you are saying that. CRR increases are usually tightening measures used by a central bank. On (b), currently, the total stressed assets are estimated at USD180bn. See this article, for example. The dollar GDP is about USD2.2trn. That brings us to 8 .1% of GDP. Then, recently, RBI has warned of telecom sector debt. RCom debt has become dodgy and that is why I wrote, ‘bordering 10% of GDP’. I did not say we were at 10% of GDP. Apollo Global Management, a PE firm, puts the number at USD300.0bn, in fact. That is well in excess of 10%.

      On the other hand, RBI numbers will give us an estimate of around 7% for Gross Stressed Advances to GDP ratio. The March 2017 GDP estimate is 151.8 trillion Rupees. Bank Credit to the Commercial Sector is 85.2 trillion rupees, also as of end-March 2017. That is 56% of GDP. According to the RBI Financial Stability Report of December 2016, the ratio of stressed advances was 12.3% (Chart 2.2). That gives us about 6.9%. But, the 12.3% estimate was from December. After that, RBI had informed us that some banks – including private sector banks – had under-reported their stressed assets. Further, it has warned on emerging risks in the telecom sector.

      Finally, one of the fundamental principles of accounting is conservatism. If we over-estimate bad news and it turns out to be a lot less bad, then we would only be pleased. It is best to assume the worst, prepare for it and be pleasantly surprised than the other way around.

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  4. I read your post for the first time and found it thought provoking. I get little time for reading economic articles like yours due to heavy resource crunch and my penchant for doing quality work.
    I felt that my time well spent.
    Somehow, I was not convinced at current euphoria on Sensex and being considered as representation of India’s economic health.
    I have been looking for some fundamental factors to support the euphoria.
    I read all the comments and I believe readers should not post derogatory and demeaning comments. One can seek the reasons behind any view for professional discussion.

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  5. In the long run it will be proved that no one was indispensable.On being asked to relinquish a post he may left red herrings for government to pick up and fail.
    But course correction is a possibility.The play of numbers is just hogwash to hoodwink the lay man.

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    1. Pl. read the blog post again carefully. It made no mention of anyone being indispensable. OF course, that applies to elected politicians as much as they apply to unelected central bank governors. But, that is beside the point. The post drew attention to the manner in which he was made to leave. That was wrong. That is all.

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  6. Sir , your article is great . It brings many malices in the system . More than that I am impressed the way you handled the anonymous comments . Indeed thats what intellectualism and humanism is ! I would try to be even more calm than before .

    I’m from Punjab

    Like

    1. Thank you for your comments. Yes, we do not need to make everything personal. We can disagree honestly. The mirrors through which we view reality can be different. Important to remember that our views themselves are constantly evolving.

      Like

  7. Talking of note ban and traders, well I as a salaried person -who has to pay the entire tax upfront – would definitely love them being cornered for their share. However looking at the bigger picture, there were two categories amongst the Black Money guys. Those who earned big time in corruption and found enough ways to legalise this tax free income through investment vehicles and real estate deals. The others were these traders that earned through hard work but did not pay tax. The ban mostly impacted the latter and while the former had already converted their cash. Hence the GDP drop without a significant trade off from unearthing black money. In fact the need of the hour is to encourage enterprenuership thru reduction in compliances at early stages. That is what will lead to self employment and job creation outside the established organizations​.

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  8. Agree on the criticism of government who haven’t done enough on the reforms front.
    However, the following section does seem like criticism with hindsight.
    “Even I was guilty of not being critical of its adoption because all of us were stung by the experience of five years of continuous annual double-digit inflation under the previous government from 2009 to 2014.

    Further, its fiscal policy also undermined the independence of the central bank. Therefore, it is doubly unfortunate that the fiscal dominance of monetary policy and sustained annual double digit inflation for five years raised sympathies for an inflation targeting regime in India too.

    But, in a social science subject like economics and policy framework based on a social science like economics, rules are guideposts and not millstones. It is what policymakers make of them. Creative interpretations have been made even in inflation targeting regimes. They can change the weights; they can creatively assume different lags (after all, they are long or short, variable or fixed as we like them).

    For a creative reinterpretation of its mandate, ECB is enough example despite a Treaty-defined mandate only for inflation targeting. Not that I endorse what they do.

    Yes, a framework does bind and can be an inconvenient one. Also, if someone stretched it once in one direction, on another occasion, another central banker can stretch it in another direction. But, that is an ever-present risk with all regimes.”
    Also, how will Basel iii norms impact banking sector in India with 2019 deadline looming?

    Like

    1. Thanks for the comment. If you read my MINT column on Tuesday (linked in the post), you would not think it was criticism in hindsight. To me, the capital formation rate was the clincher. I had written very clearly that if I were in the MPC, I would go for a rate cut of 50 bp. Second, when I quasi-endorsed the inflation targeting regime when it was unwrapped sometime three or four years ago (the Urjit Patel Committee report), I wrote in MINT that I was doing so because the Committee did acknowledge the need to monitor secondary parameters like credit growth, etc. Once I locate the relevant article of mine and the exact wording from the Urjit Patel Committee report, I intend to do another post. The point is that there is plenty of leeway to policymakers because the time-frame to hit the inflation target is never precise (medium term) and the effect of policy actions could be unpredictable both in terms of impact and timing. So, the weights that one attaches to many variables must change with the context.

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  9. When did your love for RR start, before 2014 or after.
    Hope you also comeback and revisit this post without your biases.

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    1. dear Mr. Anonymous,

      Pl. read the post carefully. The post was critical of the manner in which he was asked to leave. Nothing more. Nothing less. All of us have biases. If I conform to your priors, I am unbiased. Otherwise not. Coming back checking my biases and coming back to read insulting language hurled at a stranger, when there was nothing personal stake involved, are two different things. In any case, again, you are talking about ‘love for RR’. Pl. read all the posts from the past and my MINT columns to know where I stood or stand in these matters. Your language is unacceptable.

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  10. Don’t let your love for RR cloud your judgement.
    I hope you get out of your Tamil love and come back to see through your biases

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    1. Very poor way of attacking a thinker based on prejudice rather than hard facts. Just what Taliban would be doing in their respective countries.

      Like

  11. First, the govt. must set higher fiscal deficits, like 10%. Absurd comment as to how dare the govt. aim so low, it must have aimed at 5.9%. Second, the CSO must induce fear in govt.s?? Like how, Sir?? That we are decelerating towards 3% GDP?? Another thoughtless observation. Third, he claims NPA’s are about 10% of $2 trillion GDP = $200 Billion. Where did this pooh land from?? All I can advise you is “Get out of here”. I wouldn’t hire you as a peon in the CSO.

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    1. Dear Mr. Anonymous,

      Thank you for those erudite comments eloquently expressed. I am going to let your comment stay. I hope that you live long enough to come back and see this comment and feel embarrassed about it. The assumption being that you would be not just older but a bit wiser too, by then. Seeing the way you express yourself here, I am sure that there are many other things that you had said and written to be embarrassed about, at leisure. Where did you learn to attack, instead of arguing?

      Liked by 1 person

      1. How did u conclude Anonymous was a Mr ? Bhaskar…chennai..we met at Dikshatar Program . Am following your articles..as always erudite

        Like

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