The maze of Maitreesh

As I had mentioned in a recent blog post, Maitreesh Ghatak and his coauthors painted a picture of solid economic performance in April 2014 – a month before national elections in India. That passed neither the credibity test nor the acceptance test by voters. In March 2019, he published another piece of research titled, ‘The Mirage of Modinomics’. He did it two months before the vote unlike last time. But, Modi’s margin of victory has increased.

It is ok for him to be biased against Modi and it is ok to present charts that buttress his bias. But, he has to keep in mind his credibility. There, he fails.

What is the theoretical basis of Figures 1 and 7? Global growth and global inflation are not like ‘risk-free rates’ in CAPM to present ‘excess growth’ and ‘excess inflation’. What is the point? That is the classic example of baseless empiricism and data mining.

India’s growth rate in comparison to growth rates in major emerging economies between 2014 and 2018 has been rather good, even if one were to make allowance for the fact that official growth numbers might be overstating economic growth.

Second, Figure 6 shows poor export growth and that explains, partially, Figure 1. India basked under global growth boom between 2003 and 2008 with 40% to 60% export growth rates.

Figures 4 and 5 cannot be read in isolation of the NPA crisis which was made in UPA! The decline in capital formation in recent years is entirely due to overinvestment and malinvestment in earlier years.

That is a bit like fund managers touting returns without disclosing the risks they took or leverage that they deployed.

Indeed, India’s growth performance between 2004 and 2014 came with a banking crisis, a big current account deficit and a rupee crash. The Indian economy is still hurting from the first of the three.

As for agricultural production, NDA 1 and 2 had worse luck with monsoon, intra-monsoon variability than UPA 1 and 2.

As for the tax regime, India is still settling down with GST rates. On direct taxes, the tax buoyancy has been much higher under NDA II than it had been in UPA 1 and UPA 2. Direct tax buoyancy was below 1 for the four years from 2008 to 2012 and barely above it in the next two years. In 2017-18, it reached 1.81 – highest in a decade. See here.

From a press release of the Indian Income Tax Department in October 2018:

The total number of taxpayers (including corporates, firms, HUFs, etc.) showing income of above Rs. 1 crore has also registered sharp increase over the three-year horizon. While 88,649 taxpayers disclosed income above Rs. 1 crore in AY 2014-15, the figure was 1,40,139 for AY 2017-18 (growth of about 60%).

Similarly, the number of individual taxpayers disclosing income above Rs. 1 crore increased during the period under reference from 48,416 to 81,344, which translates into a growth of 68%.

The average tax paid by corporate taxpayers has increased from Rs.32.28 lakh in AY 2014-15 to Rs.49.95 lakh in AY 2017-18 (growth of 55%).

There is also an increase of 26% in the average tax paid by individual taxpayers from Rs.46,377/- in AY 2014-15 to Rs.58,576/- in AY 2017-18.

During the three-year period under reference, the number of salaried taxpayers has increased from 1.70 crore for AY 2014-15 to 2.33 crore for AY 2017-18 (up by 37%). The average income declared by the salaried taxpayers has gone up by 19% from Rs.5.76 lakh to Rs.6.84 lakh.

During the same period, there has also been a growth of 19% in the number of non-salaried individual taxpayers from 1.95 crore to 2.33 crore and the average non-salary income declared has increased by 27% from Rs. 4.11 lakh in AY 2014-15 to Rs. 5.23 lakh in AY 2017-18.

He (and his coauthor) concludes with, what he thought, a killer punch:

So here is what we have after four and a half years: job growth at multi-year lows, a farm crisis, a crippled unorganised sector, currency value at near all-time lows, a soaring current account deficit, high interest rates, a half-frozen banking system, a sputtering tax regime, a struggling corporate sector, sinking exports and a GDP growth rate that, for all the constant revisions and data controversies associated with it, does not stand out compared to the earlier decade.  

Farm crisis? Modi does not make monsoons. Monsoons are not necessarily made in India and global food prices are not determined in India. Soil cards and national e-markets are a start as was crop insurance. But, much more needs to be done.

Currency value at all-time lows? That happened in 2013. Nominal value of 69 or 71 is not how one determines if currencies are near the floor or at the ceiling. Both are undesirable. Inflation performance matters and on that, the contribution of UPA II to the crash in the Indian rupee is a tough act to emulate.

A soaring current account deficit? Did he check the numbers? That happened in 2012 and in 2013.

High interest rates? The 10-year government bond yield has declined since 2013 but not by enough.

Half-frozen banking system? Well, it was put in the deep freezer by UPA II and their cronies. Now, it is thawing and half-frozen.

A struggling corporate sector? – over-optimism, overinvestment and mishandling and sub-optimal allocation of national and natural resources.

Sinking GDP growth? Best to have slow and steady growth than stoke unsustainable booms. Statistics needs to be fixed, however. India is not growing at or above 7%, in my view.

The truth, as always, lies between extreme partisan views.

I wrote in my note, ‘Was NDA II an economic failure?’:

There is excessive scrutiny of the government matched by a spectacular underappreciation of the contribution of other institutions and other factors to India’s economic underperformance and uncertainties.

Commentators also fail to appreciate that governments have asymmetric impact. Governments’ ability to damage is far higher their ability to help. We saw that with UPA II. Making good things happen is a lot harder for the government.

Unfortunately, there is no election for commentators and so-called experts.

The biggest failure of this government is not that it hurt the economy (demonetisation did, for sure) but it did not help the economy enough because it did not understand what it was up against – locally and globally. When one is an incumbent and creates high expectations, then the failure to help the economy can be deemed a failure. Difficult to argue against that because NDA II was voted to office to help rescue the economy and the country hurt by UPA II policies.

In trying to paint Modinomics as a mirage, Maitreesh and his co-authors have been trapped in a maze of innuendoes. The risk is that their intellectual credibility is a mirage.

[Postscript: If you wish to read a thoughtful piece of writing by Maitreesh Ghatak, I recommend this.]

Ira Dugal – the arbiter?

Ira Dugal has a piece in Bloomberg Quint titled, ‘Why Few Are Celebrating Low Inflation In India.’

It is a good piece. A nice arbiter between Neelkanth Mishra and Sajjid Chinoy 🙂

Her pertinent paragraphs are these:

The last time India saw a step-change in the inflation scenario was perhaps in the 1990s. Back then, the inflation rate declined from an average of 11 percent during 1990-95, to about 5.3 percent from 1995-96 till the end of the decade. In response to the falling inflation, the bank rate, which at the time was one of the benchmark policy rates, fell from a peak of 12 percent in 1997 to 6 percent  by 2003. In the current period, the extent of fall in inflation has been similar. CPI has fallen from a peak of 11 percent in 2013 to under 3 percent now. Even if one expects that the current bout of low inflation will not last, the MPC will likely ensure that it remains within its flexible target band of 4 (+/-2) percent. Still, the fall in inflation has been substantial. 

In response to this fall in inflation, the benchmark policy rate has fallen from 8.5 percent at the end of 2012 to 6 percent now. To be sure, broader economic conditions then and now are not comparable and neither is the framework that governs monetary policy. Still, the change in the 10-year bond yield then and now drives home the point. 

Between 1999 and 2003, the 10-year yield dropped from 12 percent to 5 percent. Since 2013, the 10-year yield has dropped from 8 percent to 7.2 percent now. No surprise then that few in India are cheering low inflation in India.

One clue might be that between 2013 and 2019, the borrowings of the central government (and central PSUs) have gone up by 60% – about 8.15% CAGR. This does not include State governments’ market borrowings.


If we compare the figures for the period 1995-2003, we might get a clue. I do not have those figures. In an environment of falling household savings and low deposit ratio, the borrowing of the goverment sector kept bond yields from falling. Of course, the conservative central bank monetary policy stance is also a contributing factor.

RBI raised rates in 2018 and cut rates in 2019 by 50 basis points. Effectively, no change in policy in the last eighteen months.

Simply put ,we do have an unwieldy and unproductive Government sector. Therein lies the rub. There is no shor-term fix for that problem.

Asset quality review in NBFC is the need of the hour

My previous blog post dealt with the interview given by Neelkanth Mishra of Credit Suisse to Bloomberg Quint after the elections. This post deals with the interview that Sajjid Chinoy gave prior to the elections.

He dismisses concerns over liquidity and bank lending. Cash in circulation has picked up. Bank lending out of recapitalised banks is accelerating.

He thinks that the economic growth slowdown is transient and that signalling good Non-Banking Financial Corporations from bad ones through a ‘Asset Quality Review’ is the way to get money flowing into good NBFCs.

He cautions against calls to boost bank lending:

The reason credit growth was down was not because the public sector banks have no liquidity. It was because they had serious issues on asset quality on non-performing asset resolution. We have seen in the last couple of years that as a resolution process has started and begun to work its way out, and as those banks have been recapitalised by the government, credit growth has picked up quite meaningfully.

If this continues, there are two to three implications that flow from this. One is that most of the capital to public sector banks is resolution capital and so they will be unable to sustain this rate of growth without more infusion of capital. Second, incremental credit deposit ratios have gone up for these banks and that is hurting monetary transmissions. There are implications for monetary policy as well. For example, if you were to cut interest rates much more and credit growth picks up even further, then that is unlikely to transmit because banks will be more disinclined to cut deposit rates at that time. The third implication is that we need to know very carefully what we want. It’s very well to say that let banks start lending again, especially those banks which graduated from prompt corrective action, but what we don’t want is the repeat of what happened 10 years ago.

Governance structures have to improve commensurately, so that three years down the line, we don’t start with another NPA problem. So I think, we should not be too eager to push up credit growth or M3. It has to be a more organic process.

I like the medium-term focus here.

Overall, good to see consensus between Neelkanth and Sajjid on the absence of fiscal stimulus space. Sajjid is prudent on bank lending too. That is more to my liking too.

Accept lower growth for a while, do reforms in other areas, allow organic recovery in credit disbursement to proceed; lower rates cautiously; set right flow of funds to good NBFC as Sajjid says and do not commit too many policy errors.

Is there room for fiscal stimulus in India?

These are some extracts from the extracts of the Neelkanth Mishra interview with Bloomberg Quint:

This discordant policy is the root cause of the current slowdown and this needs to be addressed by significantly low interest rates. We are just relying on the government to do the needful. We are pushed back in old regime where the government ends up spending too much and the government cannot spend anywhere efficiently as private sector can and therefore cause inflation again. We go back to the old regime. Some of the alternatives which have been discussed in elections are worrying. Because we have distorted the monetary policy so much, we were forcing the political system to go back to regime of high inflation and high fiscal deficit. I don’t think it is desirable. We need now lower rates. [Link]

I am pleased that he concedes that some of the alternatives discussed during the elections are worrying. There may be a theoretical economic case for stimulus but we do not have room. He says that elsewhere too:

Even if the government wants to address the slowdown, it doesn’t have the fiscal space and there is less intent at least in this government to use fiscal tools on the consumption side to accelerate growth.

He is sanguine on the broader markets and I am not. But ,that is me and that is Neelkanth 🙂

Two great lines in the interview:

But we have this tendency of converting our hopes into forecast which we have to resist when we look at markets. It is not the prescriptions that matter but the predictions matter.

Forecasters often make this mistake of conflating what they like to see happen with what is likely to happen. Their job is to do the latter. ‘Prescription’ vs. ‘Prediction’ – nice.

He sets a lot of store by monetary policy actions. He believes that the repo rate can come down by 100 basis poins. I am not sure there is such room and I am sceptical of its efficacy too.

But, I suppose, the public and the market and industrialists want actions and governments have to be seen a doing something. That includes the central bank too. They cannot preach satiation, contentment and acceptance. They have to choose the least harmful option. More often choices come down to that.

In that sense, ‘drastic’ rate cut is less bad than drastic fiscal stimulus.

Was NDA II an economic failure?

What follows below was written on 15th May 2019, eight days before the official declaration of election results in India, to the 17th Lok Sabha and four days before the exit polls. I wrote it for my own clarity. But, it might also turn out to be a response to this long piece by Maitreesh Ghatak and two co-authors. It is a different matter altogether that one must write a separate rebuttal for some of the ‘strange’ figures that the note features. I shall do so separately. This was written and published in March 2019. It did not swing the elections in favour of the Congress or the UPA or whatever else.

One must note, here, that he and two other co-authors tried to pass off, before the May 2014 elections, the UPA II economic record as a good one. That did not swing the elections in favour of UPA and the Congress.

Not only did the Congress Party lose the elections on both occasions, he lost quite a bit of his personal credibility too, in my view.

As you read the file below, pl. remember that it was written on 15th May 2019. You are welcome to quote from it. But, will be grateful for attribution.

VAN_Was the NDA II government an economic failure_15052019

Ideas for India

Pulak Ghosh and Soumya Kanti Ghosh (both are well known to me and I respect them a lot for the integrity of their work) have written an op.-ed., in ‘Business Standard’ on the above header.

The text of their piece with my comments are below. My comments are in italics in purple.


Ideas for India: A lot on the plate for NDA government

Soumya Kanti Ghosh & Pulak Ghosh 

Last Updated at May 26, 2019 23:00 IST

With the NDA government set to assume office, there is a lot of chatter about the reform agenda. While some of that is purely repetitive, we first need to understand that in last few years we have been held hostage to economic ideas that are governed purely by rhetoric and less by data based evidence. This will also help us identify the immediate priorities of the government.

First, the idea that high real rate of interest is a strong enabling factor for savings is a misconstrued fallacy in the Indian context and it has done enough harm. It may be noted that such a debate was first initiated by former Reserve Bank of India governor Raghuram Rajan and has been emphasised repeatedly. Interestingly, in a recent RBI paper it has been conclusively argued that income is the primary determinant of savings in India. 

Even the empirical evidence in the Indian context strongly supports the contention that savings is insignificantly small related to real interest. – This sentence has to be rewritten for greater clarity

In fact, the actual coefficients are significantly small and insignificant in most of the cases, suggesting a large change of as much as 3 per cent to 10 per cent in real deposit rates will be needed to change savings rate by 1 per cent and small changes will hardly make any difference, if any. This is perhaps the primary reason why real interest rates in India are so high for the wrong reasons thus hurting investments even as inflation has been materially overshooting. (I think they meant to write that inflation has been materially undershooting)

A singleminded focus on moving towards a 4 per cent inflation may have also resulted in keeping real interest rates at a high level.

[Whether real rates are high or low depend on the inflation proxy. If CPI-IW were used, real rates are negative still. Or, if one used household’s measure of current inflation, real rates are more negative. If savings are not influenced by the level of real interest rates in India, it is important to figure out if real productive capital formation are influenced by the level of real interest rates, in an environment of balance sheet stress. How do we account for low deposit growth and the search for yield in non-banking financial entities, if not for the fact that real interest rates are perceived to be too low?]

So, the first thing, the government and the RBI needs to do is to have an honest debate about the sanctity of the 4 per cent inflation target. In 1980s and 1990s, monetary policy in India was subordinated to fiscal policy, but now monetary policy clearly dominates fiscal policy, instead of complementing it. 

[Regardless of the above comments I had made on computing real interest rates and their impact on savings and investment, I agree with the need for debate on India’s inflation targeting regime]

We need to have lower rates, coupled with adequate liquidity and an instruction from RBI to banks for transmission by linking repo rates to an external benchmark like CASA.

[I am at best agnostic on this recommendation and, at worst, opposed to the idea that for all ailments in India, low interest rates are the answer]

Second, the clamour for a faster fiscal consolidation. While the idea for fiscal consolidation in the Indian context is always welcome, the problem is that such consolidation often becomes a constraint (as is currently in the quest for government to push growth).

With global debt, currently at close to $250 trillion, there have been a couple of insightful commentaries on the role of debt and fiscal policy recently. Most recently, noted economist Olivier Blanchard in his presidential address to AEA reemphasised that high public debt is not catastrophic, if it justified by clear tangible benefits in the form of public investment. Blanchard also added that aggressive contingent fiscal rules are more important than the level of debt as a percentage of GDP itself and even steady fiscal austerity.

[We must remember that whatever is said about high public debt, high deficit, etc., by these economists are in the context of countries issuing hard currencies. It is in their context.  Not in our context. We have a general government deficit, including that of central publc sector enterprises and state governments, of 8 to 8.5% of GDP. Much as there is a cyclical case for fiscal stimulus, the room for it is simply not there. We can consolidate more slowly than before. The glide path can be longer. But, I doubt if there is room for incremental fiscal stimulus. The opportunity to have engaged in gradual fiscal consolidation was available in 2014 and it was not utilised by the then new NDA II government]

Even Paul Krugman has repeatedly emphasised that governments should be spending money on infrastructure and on health care and education that have huge long-run payoffs. 

[We cannot guarantee, in India, that the fiscal stimulus would be sequestered and spent on the specific cause. IN any case, Paul Krugman has not much credibility left as an economist.]

Back home, a recent RBI paper on emerging market economies using the structural balance approach to fiscal deficit found that in the post-Lehman years (2008-10), the impact of fiscal stimulus turned out to be positive and statistically significant. The study concludes that the observed slump in growth in the post-crisis period would have been much sharper in the absence of stimulus, implying that fiscal activism pursued by these emerging market economies, including India, was largely successful in arresting the growth downslide.

[It may be true and it may well have been necessary to do a fiscal stimulus post-2008. But, we know that in India, it stayed at high levels for too long and that is why we had a big current account deficit, high inflation (because quite a bit of it was monetised) and hence a crash in the Rupee. Indeed, that epitomised the economic mismanagement of UPA II. Now, we should not be, inadvertently, whitewashing it!]

Here is our contention: How far and how fast we can go below current 3.4 per cent as far as the centre’s fiscal deficit is concerned against the current demand slowdown? Do we stay put at 3.4 per cent (assuming it is met) for the first two years of the current government and then move down aggressively, as growth comes back to the system? We propose a radical shift in thinking as far as fiscal is concerned. The alternative to targeting fiscal deficit is that like most advanced economies and several emerging market economies India should target a structural deficit, which serves as an automatic counter-cyclical stabiliser.

The FRBM targets that have been set from the outset as a fixed percentage of GDP do just the opposite. The deficit shrinks when growth dips and balloons when growth rises. This pro-cyclical target setting has forced successive finance ministers to look for creative ways of getting around such FRBM straitjacket (off balance sheet financing for example).

[This is worth a discussion, indeed. Agree]

Even IMF comes up with the structural fiscal balance for every country. Based on such, projected balance for India as per IMF comes to an average of – 6.3 per cent for the 2018-23 period. Clearly, it looks even the IMF finds it difficult for consolidated deficit to decline meaningfully below 6 per cent in the next couple of years. The question is therefore, do we keep it at current level of 6-6.5 per cent, or go down the FRBM glide path to 5 per cent?

[This too – the Central and States’ combined fiscal deficit and its glide path to 5% –  is worth a discussion. Agree.]

The ideal fiscal rule we must debate is that India sets its own fiscal benchmarks (and not as defined by Maastricht treaty at 3 per cent) but then enact fiscal rules to ensure strict compliance. The policy makers in India thus have two options — to continue to deviate from FRBM-mandated targets or enact country-mandated credible, transparent and achievable fiscal rules.

[Framed as G&G have done, the choice is clear – we need credible, transparent and achieveable fiscal rules and we must stick to them, once we have defined our own rules and convinced credit rating agencies and bond investors of the same.]

Apart from these basic initiatives, the government should now find a way to address the issues in the NBFC sector. Does the government issue long tenure bonds to infuse liquidity to take advantage of the current low spreads at long end? These are some of the issues that can be debated.

The other reforms that the government could do is related to the rural sector, banking sector and a comprehensive set of legal, administrative, judicial and police reforms. 

[It is hard to quarrel with these two paragraphs. Interesting that they discuss the government issuing long-tenor bonds. Implications?]

The government must create a repository of all existing central and state laws, rules and regulations and address the backlog of pending cases.

[This is important and it is unfortunate that this has gone off the radar. Important to continue this. As someone said, not enough to remove old and outdated laws but laws that are superfluous even in the present]

Clearly, a lot on the plate for the second term of the NDA government.
[Indeed]

________________________________

Soumya Kanti Ghosh is group chief economic advisor, State Bank of India; Pulak Ghosh is professor, IIM Bangalore. Views are personal

Non-linearity and Asymmetry

In our Q&A, Lacy and Bill discussed how linear economic models are just not working and nonlinear  analysis is so critical. A lot of practical people are turned off by this, thinking it shouldn’t be so complex. But, these same people would never tell a physicist to avoid nonlinear concepts. [Link]

This is unsurprising to yours truly. I had written copiously on non-linearities and asymmetries in economics because human responses are anything but symmetric. Loss aversion is a classic example of asymmetry. The values we attach to what we already possess and what we crave for are asymmetric.

Relationships between economic variables are non-linear because economic agents (i.e., ordinary people) are asymmetric. It is as simple as that.