Six economic policy mistakes – an expanded version

This is an expanded version of my MINT column today. Newspaper columns have to conform to character limit (5500 characters with spaces is the limit that MINT prescribes). Here is the first version of my article:

The slowdown in economic growth (5.7% y/y in the first quarter of fiscal 2017-18), the near-total absence of bank credit growth to industry – small or medium or big, and the lacklustre growth in industrial production, to name a few, have brought many experts out of the woods. There is near-total unanimity on the need for a fiscal stimulus in India. That alone should make the government wary of the recommendation. Second, if the government was the problem, can it also be the solution? Humans’ belief in their ability to find answers to the problems they create vastly overstates their actual record in doing so. It is far easier to spoil than to spruce up. Sometimes, problems do not have solutions. It is not possible to press the UNDO arrow that easily in real life. Discussions of solutions must take into account costs and alternatives considered and discarded. Otherwise, solutions could end up becoming the case of committing a second wrong to right the first wrong.

Until the note-ban happened last November happened, even its worst critics could not really point to egregious economic policy mistakes that this government had committed. But, it had committed a few. We will examine them to see which of them are really reversible.

First, it had not prepared for being in power at all, in terms of using it as an instrument for economic advancement. Manifestos do not count. It inherited the budget projections of the previous government without question. It even copied and pasted text from the interim budget document in the first budget presentation made in July 2014! The mid-term economic appraisal of 2014-15 pointed out that the true fiscal deficit inherited could have been of the order of 1.1% to 1.8% more than the official number of 4.5%. The NDA government thus engaged in a massive fiscal consolidation even as the economy was limping back to normalcy. Had it done its homework and put out a white paper on the economic mess it had inherited in various areas, it would have prepared the ground for a gradual fiscal consolidation. Thus, it could have used the windfall from the oil price crash to recapitalise banks rather than working overtime to legitimise the previous government’s fiscal recklessness and partly-sham fiscal consolidation. In this one aspect, its errors were lack of homework and hence no white paper and mindless pro-cyclical fiscal consolidation. That brings us to the second mistake.

It did not take the emerging banking sector woes seriously enough. It thought that the matter would sort itself out, because of higher growth. If crony capitalism was rampant under the previous regime, it stood to reason that bad financing decisions would have made both for bona and mala fide reasons. The government was again guilty of not confronting the problem but ducking it. Today, the problem has grown bigger and is even yet to peak. Short of drastic reforms to the banking ownership and governance models, the problem of Non-Performing Assets (NPA) is likely to persist and remain a big drag on growth. Nor is it any more a question of recapitalising the banks alone. Governance is a serious issue. Without collusion by bank staff, not all banned notes would have made it into bank accounts. Drastic reforms are made infeasible partly because of resistance from ideologues aligned to the BJP and because of the government’s unwillingness to commit political capital to see it through. Above all, the reluctance to confront the problem stems from the facile assumption that economic growth would wash away the sins that lenders and borrowers committed. That brings us to the third mistake.

It was to believe in the economic growth numbers that the Central Statistical Organisation put out. The CSO put out growth numbers based on its new methodology and new base year that bore no resemblance to reality. That was too apparent because the growth numbers even for the ‘disastrous’ UPA years of 2011 to 2014 were revised higher to appear almost respectable. So, the government felt rather proud that it was able to achieve fiscal consolidation and felt confident that economic growth would turn NPA to PA. Its mistake lies in not being sceptical enough of CSO calculations and asking them to be thorough, transparent and fix the economic growth calculations methodology especially since many competent economists inside the system had expressed reservations on the numbers. The role of bad economic statistics in India’s current economic plight is a story that has to be told. That would put data collection, methodology, accurate and timely reporting an urgent priority for future governments.

The fourth mistake is its implicit and explicit anti-big bias. That was not expected from this government. India’s production structure is fragmented. The sizes of its farms and factories makes them inefficient and primitive. Technology upgradation is infeasible and not viable in their present sizes. The numbers are shocking and beyond belief. I can stick my neck out and state that India cannot ‘make it’ with such extremely nano and micro sized farms and factories. There is no scale in the country in any sector. The solution is not to favour the current big firms (that is cronyism) but to favour potential enterprises becoming big or to encourage firms starting big. There are an estimated 6.34 crore non-agricultural unincorporated enterprises (excl. construction) contributing Gross Value Added (GVA) of Rupees 11.5 trillion only. In contrast, only 189, 468 registered (with the Annual Survey of Industries) factories generate Rupees 11.6 trillion of GVA. More startlingly, just 4.1% of them have 500 or more workers and they contribute 60% of the GVA of the registered factories. The government has to burn the midnight oil on policy reforms that encourage starting big and/or scaling up and growing big. But, the anti-big bias is evident in the fact that the government had stopped (or, been stopped) in its tracks to reform the corporate tax system. Mudra loans without any strings attached will not result in any economic transformation of India but would be a big opportunity cost in a resource-constrained economy.

The fifth big mistake is in continuing with and even strengthening tax terrorism and the obsession with tax revenues. In the process, it has reduced all economic policymaking to one of and only of morality. That is a slippery slope because it is impossible for the politicians to set a personal example and demand reciprocity given how elections are funded. Revenue neutrality is easily achieved in spreadsheets but it happens in reality only when economic activity happens. Note-ban has been seen almost only as an exercise in broadening the tax base and not as a transformative exercise from its pigmy sized farms and factories.

The sixth and final mistake lies in surrounding itself with the kind of advisors who would speak truth to the power. I do not have to add more than what the Tamil poet Thiruvalluvar had said in the 45th chapter of ‘Thirukkural’ which deals with the necessity for a King to surround himself with fearless advisors who are not only loyal but also more intelligent than him. Now, we can decide how many of these mistakes could be possibly reversed by a fiscal stimulus.

5 thoughts on “Six economic policy mistakes – an expanded version

  1. Would you argue that there is a strong case for RBI to be much more aggressive in cutting rates esp post demonetization? When you hit the economy with a liquidity shock of such scale, its only reasonable. When the govt is pushing through major disruptive structural reforms, most of which have an unambiguous deflationary/disinflationary impact, it only makes sense for RBI to balance that with loosening the purse. The key to a rapid recovery probably lies far more with RBI than the govt. Besides, RBI could also play a much better role in cleaning up the NPA mess. The TARP model is not the worst idea and all countries during their early growth stages have a history of such financial reconsolidations. In India’s case, the RBI can extend the duration of the distressed assets and largely bank on revived economic growth to recover its capital (probably quite easily).


    1. No. I would not argue that. I think the efficacy of interest rates is vastly oversated and especially in an environment of constrained balance sheets. In any case, there are surveys across the world that Chief Financial Officers seldom decide investment projects based on prevailing interest rates. Their hurdle rates do not come down when policy rates go down. We will only be boosting consumption demand when it is already rising, eating into household savings formation.


      1. Thanks for the exchange. Don’t you think boosting consumption would lead to effective lowering of the hurdle rates for investment? Starting with the real estate market, I believe there is meaningful evidence that lower rates lead to increased purchase activity, which naturally boosts business investments in the sector. I agree balance sheet constraints are real, that’s why someone needs to press the reset button on npa’s separately.
        Regarding household savings, its debatable if mobilization of savings by pushing them into higher risk assets might be better option than allowing continued investment in ostensibly safe options, which turn out to be anything but (hence all the bank NPA’s).
        Broadly, I think my main argument is that i doubt the political management can do much to reverse the trend, it really needs to come from somewhere else.


  2. Good point. At the very least, worth discussing. But, RBI’s hands were tied considerably in the pre-2008 period with excessive capital inflows with capital controls ruled out for political reasons and reasons of international commitments, etc. Many other things come into play, of course. Post-2010, fiscal dominance made a hash of monetary policy. So, how much RBI’s captive to government fiscal and exchange rate policies must be taken into account in evaluating RBI. But, only when such questions are asked – as you had done – one can understand many cross-currents at work.


  3. This is probably the best analysis of the problems i have read so far. But you leave out one culprit – the RBI. RBI because of its aura of respectability manages to escape blame for many of its mistakes. It was too late in turning the tourniquet in the late 2000’s when inflation was spiking. It bizarrely peddled in ideas of bottleneck driven inflation and disowned responsibility for curbing the money supply. Many NPA’s can be traced back to that era. Once it got burned with 10%+ inflation, like all self-preserving bureaucracies, it has turned into one dimensional bot obsessed with keeping inflation down no matter the cost to rest of economy. The mistakes of the modi govt, esp its moralistic edge in policy making, definitely need some recalibration, but the RBI is as responsible if not a little more.


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