The many fountainheads of India’s economic malaise

An opinion piece written by Dr. Manmohan Singh has justifiably attracted a lot of eyeballs and nods of approval. Written by a ‘student of economics’ as he describes himself, it is a well written essay. He has also zeroed in on some answers. Restore trust and confidence in administration, in the institutions and unleash massive fiscal stimulus.

He is right to call for an elimination of the atmosphere of fear. Some of us had written about it much earlier. See here and here. The government too has recognised the problem. That is why the Finance Minister recently announced a remote system for the issuing of notices and summons. She said that permission from a two-member collegium was necessary to prosecute tax defaults below Rupees 25.0 lakhs. To be sure, Revenue might resist and is resisting the changes. That behavioural issue transcends this government. On its part, the government has recognised the problem. The government-constituted panel has proposed decriminalizing many of the offences under the Company Law. The sooner its recommendations are implemented the better.

More importantly, the reposing of trust in industry was exemplified by the new corporate income tax regime the Finance Minister announced in September. It provided for low tax rates with fewer exemptions and announced a very low rate of 15% for new manufacturing oriented companies commencing production from 2023. Yours truly wrote that the significance of that measure was not the measure itself but the signal it sent. The government was no longer bogged down by the ‘Suit boot ki Sarcar’ jibe. Indeed, that jibe should remind Dr. Manmohan Singh as to the role of the Congress Party in creating an atmosphere of distrust between the government and the industry. That deserves some further explanation.

As a student of economics, Dr. Singh should note that economies and societies rarely settle at an equilibrium and stay there for extended periods. Humans, societies and economies, more often than not, swing between extremes. In that sense, he should reflect on the factors that created the atmosphere of distrust. What role did his government play and the industry play in engendering an atmosphere of distrust?

The Supreme Court took the extreme step of cancelling the coal mining licenses and the telecom spectrum licenses. It was probably too extreme but, perhaps, the Court thought that it was necessary because of the extreme breach of trust, good governance and probity in the award of such licenses. The economy is still hurting from both the action and the reaction.

An excellent article by Aarati Krishnan for BusinessLine documents the failure of many private sector agencies leading to retail and institutional creditors incurring losses on their loans to Dewan Housing Finance Limited (DHFL). After reading the article, I asked another journalist-friend as to whom he would consider responsible for India’s economic slowdown, he said he would place promoters of India Inc., on top of the list.

Abheek Bhattacharya has a review of ‘Bottle of lies’ and calls an Indian pharma company the ‘Theranos before Theranos’. It is useful to reflect on why it had taken 3 years for the acquisition of Essar Steel by the Mittal group. Is it the flaw of the Insolvency and Bankruptcy code or is it the disruptive behaviour code of promoters.

Internationally, in Financial Times today, there is a report on whistleblowers in the ‘Big Four’ audit companies facing a ‘disturbing pattern’ of harassment, bullying and discrimination.

The purpose of pointing out these is not to suggest that one mistake or one wrong justifies another mistake or wrong but to remind ourselves that backlashes inevitably follow egregious behaviour and the longer the original behaviour lasted, the reaction tends to last as long. Nonetheless, it is good to recall that the government is walking back on some of the measures, even if well-intended, that have proven to be inimical to legitimate economic activity.

Dr. Singh does not train his spotlight on the Reserve Bank of India, an institution that he once headed. RBI introduced inflation targeting in 2015, through an agreement with the Government of India. Let us not forget that it was a response to five years of double-digit retail price inflation under the government led by Dr. Singh. Unfortunately, for a better period of the last four+ years since the inflation targeting regime came into existence, the central bank has been more religious rather than pragmatic in its adherence to the inflation targeting regime. It has forgotten that all economics is about context.

Many theories that policymakers from developing countries at the feet of their Gurus in American Universities are abandoned by them before they start implementing them here. Inflation targeting of 2% is open to review there. It might even be replaced with nominal GDP targeting which is nothing but targeting a cumulative inflation rate rather than an annual rate of 2%. Central bank printing money to fund government deficits is now going mainstream. Since negative interest rates are not working to boost economic activity, economists call upon Western governments to splurge borrowing at low interest rates at which markets are willing to lend to fiscally insolvent governments.

In India, whether or not demonetisation of high-denomination notes was a sound or an unsound decision, the textbook response of a central bank to the sudden withdrawal of massive liquidity would be to lower rates. In 2017, RBI cut rates only once and that too in August. Then, in 2018, partly due to international pressure, it raised rates twice and has liberalized external commercial borrowings instead of lowering cost of capital at home.

More recently, it has not unequivocally reassured markets and Non-Banking Finance Corporations with liquidity backstops. It has allowed uncertainty to linger and the problems to fester. Its record in preventing frauds in banks has been spotty at best and sloppy, at worst. Its blanket and indiscriminate adoption of norms for recognition of non-performing loans was struck down by the Supreme Court.

I hope that when future students of economics write the history of India’s economic performance in the second decade of the millennium, they will subject the central bank to far greater scrutiny than current and former students of economics have done.

Dr. Singh has called for a fiscal boost to the economy. He is right. There again, advisors to the government – from within RBI and outside – have made fiscal prudence a cult or a religion. That is why the NDA government of 2014-19 had to undertake a pro-cyclical fiscal tightening when it came to office. It did not demand a longer time frame to set right the fiscal imbalance it inherited from Dr. Singh’s government. Now, when the same advisors turn around and demand fiscal pump-priming, politicians are confused legitimately.

Students of economics should resist and challenge economic theories from becoming creeds if they want governments not to stand in the way of economic activity.

He writes that India is at risk of stagflation. He is partially right. India is at risk of economic stagnation. That said, considering the economic growth rates in many emerging economies, it does not seem to be the only country facing that risk. That is no consolation but it helps to remind ourselves that India’s economic growth troubles are not unique to India. There could be other forces at work. As for inflation risk lurking always in the corner, he may have been prompted by the most recent consumer price inflation rate. However, the core inflation rate is plumbing new lows and monetary dynamics are so poor that the inflation genie might stay in the bottle after popping its head for a few months.

Finally, he says that India has to grasp the opportunity of lower oil prices and a higher domestic political capital. Again, he is partly right. The considerable political capital that the government has accumulated has to be deployed to set the economy on a sustainable and slightly higher growth path than what obtains now. The government is beginning to do the right things but more can be done and faster too. But, will lower oil prices really help? It is not that easy to burn fossil fuels anymore.

The European Investment Bank has announced that it would stop funding fossil fuel companies. That also means that projects that depend on fossil fuels will find it tough to be financed in the years to come. This is a new instalment of ‘kicking the ladder’ that keeps divergence in economic attainments between the developed and developing nations from closing. Be that as it may, it is a growth hurdle that needs to be recognised by policymakers and commentators in India. Climate change and extreme weather events are becoming more frequent in India. That too is not growth-friendly development.

The high growth years of 2004-08 coincided with rising oil prices and were due to global economic boom that boosted India’s export growth. Global demand has languished since then and so has India’s export performance. This is not to deny the abundant scope that exists in India for improving productivity and export competitiveness. Unsustainable capital inflows and malformation of capital were short-term contributors to economic growth in that era. They are now headwinds.

In short, India faces newer growth challenges on top of the ones that have existed. It might have missed the low-hanging growth that was available in the last century.

Finally, Dr. Singh has done a useful service to the nation in reminding us all that economic activity is founded on trust between all participants. Yours truly had written a fortnight ago that restoring trust could be an effective economic stimulus. Hence, I agree with Dr. Singh that trust and confidence are central to economic activity. Further, the weight he has thrown behind fiscal expansion is doubly welcome.

In this essay, he has focused on what the government should do. Given his vast experience, his observations should not be ignored. At the same time, as a keen and perceptive student of economics, he should know that there are other stakeholders in the economic system. If he subjects them to as much scrutiny as he has done the government, the economy would benefit. At a minimum, he should write on the many acts of omission and commission on the part of the central bank in the last five years. Then, he should exhort India’s corporate leaders to reflect on their contribution to India’s economic malaise. That would be a useful service to the country which he has served with distinction in many capacities in the years gone by.

(These are my personal views)

The shrill case for rate cuts with a tasteless header

My young friend Karan Bhasin urged me to wait until I read his full piece in Swarajya when I told him that I was disappointed with the header of his article. He said that the header was not his choice. Fair enough. Then, I have to protest to the editors of the magazine strongly at that tasteless pitch for RBI rate cuts.

In a balance-sheet constrained economy, rate cuts seldom have positive effects and may have effects in areas where we don’t want. Now that the government had cut the corporate taxes aggressively, companies might be willing to borrow and invest for the tax cut might have shifted the sentiment in the commercial sector more decisively.

That, in fact, proves the point that rate cut works only when certain pre-conditions are present. It is a limited tool. Its omnipotence is overstated in the West and now, it seems, in India too.

With the benefit of hindsight, RBI was too reluctant to cut rates in 2017. It should have dropped them more as liquidity tightened. It dropped the repo rate only by 25 basis points throughout 2017. It began the year at 6.25% and dropped it to 6.0% in August. 2017. It raised rates twice in 2018 because, by then, the Federal Reserve was raising rates and the rupee was weakening.

Official statistics for real GDP growth in 2016-17 and in 2017-18 is 8.0%. So, may be, was RBI that wrong in maintaining a real repo rate of around 2.0% then?

Karan writes:

This suggests that the RBI believes that the economy overheated in 2017 and 2018 while the exact opposite happened thanks to their policy choices.

8% growth rate (official print) was an overheating economy. One cannot have an official growth print of 8% and then call for aggressive rate cuts. More useful to tell the government to come clean on the actual growth rate.

Growth began to slow in the second half of 2018-19. RBI could have cut rates aggressively then. But, with foreign currency loans repayments (check out the net international investment position data every quarter on dollar amounts falling due for repayment) and an aggressive Federal Reserve (that did a about-face only in December 2018), a central bank has to have its eye on the currency too, even if it is not a policy objective.

Interest rate cuts may help but to suggest that it is guaranteed to work or that it is the only game in town is to let the government off the hook for its acts of omission and commission that contributed to the economic growth slowdown. [To be sure, the Supreme Court and the private sector had big roles too in the slowdown].

Also, it follows the fashion of placing monetary policy at the heart of economic cycles. It is far less potent that it is made out to be and it works only under rather specific conditions. Else, it gives rise to excessive risky lending, asset bubbles and deprives savers of their income.

In India, with banks reluctant to lend and companies still saddled with debt in their balance sheets (check out the interest coverage ratio of Indian non-financial corporations), low rates flow to consumers.

In the last eight years, household debt growth has far outpaced nominal GDP growth:

2016-1839.127
2014-1631.759
2012-1432.736
2010-1227.683
2008-1018.850

The table above depicts percentage growth rates (not annualised) over two-year windows in India’s household debt (nominal and in rupees), based on BIS Quarterly data on non-financial credit.

Further, the compounded annual growth rate of credit card outstanding (one of the categories of personal loans) over the last four and quarter years has been 29.6%. This is available from Table 171 of RBI Handbook of Statistics on the Indian Economy. Data available up to July 2019 at the time of writing this and goes back to April 2007.

This is what happens when the commercial sector is constrained by its own balance sheet from borrowing further. Money flows to the easy but not necessarily the most ideal borrowing segment of the economy. Bankers’ risk aversion to lend to even eligible borrowers must be fixed. That requires not just recapitalising banks but an enabling environment that does not punish them for commercial decisions going wrong. These are in the realm of the government.

The government had been slow to recognise the problem of bad debts and even slower to find answers. This dates back to 2015. To blame the RBI alone for the economic slowdown is way off the mark.

The way the Goods and Services Tax had been implemented (may be, that is what was feasible in a federal and large polity like India) could not have but induced uncertainty among businesses. Insolvency and Bankruptcy code is a good and essential game-changer but it has had short-run consequences for economic growth.

The obsession over tax revenue growth was another major growth dampener. Relative to RBI, the government has been, by far, the biggest contributor to the economic growth slowdown.

Without accounting for these and fixing some that need to be fixed- which are in the realm of government, an uni-dimensional call for RBI to cut rates is not only wrong but also dangerous.

As I had mentioned in my column in Mint today (not my original idea – I am citing someone else), with RBI and the Government asking banks to link their lending rates to external benchmarks while rates on liabilities (deposits) are fixed, banks’ net interest margins will be substantially affected. If aggressive rate cuts are made, this problem will get far worse, making banks chase aggressive and riskier loans (they will carry a higher lending rate) and paving the way for a future cycle of non-performing assets.

Finally, to keep up the shrill attack on the central bank week after week, ignoring its record open market operations (pumping money into the economy) in the last one year which then enabled a record dividend payout from RBI to the government, with strong language (bordering on abuse) is an exercise in losing friends and turning people away.

The magazine too deserves to be reprimanded for its rather tasteless and wrong header.

ECB back at its futile game

My former student alerted me to the European Central Bank going back to monetary easing. Such was the power of its previous spell of sustained monetary easing and ‘whatever it takes’ efforts that, in less than a year, after ending its asset purchases, it had to go back to the tried-tested-and-failed policy. Here is the press release.

ECB’s deposit facility rate has been ‘cut’ further to -0.5%. Now, this announcement says ECB will buy even private sector bonds with yields below the deposit facility rate! Oh, yes, that means that bond purchases have resumed at EUR20.0bn rate per month until such time that interest rates begin to rise. QE Infinity!

Additional monetary easing measures can be found here and here. Banks will not have to pay the deposit facility rate to the European Central Bank for keeping excess reserves with it! How considerate of bank profitability!

In the meantime, the same former student forwarded these remarks by the Vice-President of the European Central Bank in a speech made in Rome in June 2019:

In this context (favourable macro conditions), it is important to recall that the overall effect of our monetary policy on bank profitability has so far been broadly neutral. Nevertheless, the overall effects of negative rates on the banking sector need to be carefully monitored, particularly because the balance of their effects will depend on how long rates remain in negative territory [Link]

Good luck to European banks!

Over-rated and fallible

While monetary policy is a powerful tool that works to support consumer spending, business investment, and public confidence, it cannot provide a settled rule book for international trade. Our challenge now is to do what monetary policy can do to sustain the expansion.

Remarks attributed to Jerome Powell, made at Jackson Hole Central Bank Symposium in August. This is my source. Monetary policy is not a powerful tool that helps any of the above. It is a limited tool that works under very specific circumstances. Experience has taught us that.

After so many years of egging on central banks to go negative, etc., Summers has found religion. He says central bankers are powerless. It is too late and he may well be abandoning a sinking ship. A tweet-storm or tweet thread on this is here (HT: Niranjan Rajadhyaksha). Tweets 18-24 under this thread are the important ones:

In contrast under the secular stagnation view we have outlined – what might be called “new old Keynesian” economics – interest rate cuts, even if feasible, may be at best only weakly effective at stimulating aggregate demand and at worst counterproductive.

There is the further point that reducing interest rates may degrade future economic performance for any of the following reasons.

First, financial instability. The financial crisis had roots in bubbles & excessive leverage caused by efforts to maintain demand after the 2001 recession. Japan’s late 1980s bubble had roots in a low interest rate tight fiscal environment after the 1987 stock market crash.

Second, risks of zombification of firms. Firms that do not face debt service payments are like students who do not have to take tests. They can drift along complacently & ultimately unsuccessfully. And low rates may contribute to increased monopoly power and reduced dynamism.

Third, risks of bank failures. Low rates crowd bank profits and franchise value, making them more vulnerable to adverse shocks at any given level of regulatory capital.

Fourth, risks of further reducing monetary policy effectiveness. To the extent to which rate cuts now “borrow” demand from the future as firms and consumers bring forward investment and durable purchases, low rates now may imply less effective monetary policy in the future.

The right issue for macroeconomists to be focused on is assuring adequate aggregate demand. We believe it is dangerous for central bankers to suggest that they have this challenge under control – or that with their current toolkit they will be able to get it under control.

I hope the last tweet is not the harbinger of more hare-brained approaches. Summers (and his friends in the academia in the United States who still swear by monetary policy effectiveness) would do well to reflect on this speech by Graeme Wheeler, former Governor of the Reserve Bank of New Zealand made in October 2015. It is not secular stagnation in aggregate demand. It is secular stagnation in trend growth. That is the nature of the game. The answer to the question of where inflation is, if trend growth is weak as well is that inflation is driven by wage dynamics. Labour has been stifled and its pricing power emaciated for last four decades. It has not come back. As long as that is the case, conventional inflation rate (CPI index change) is the wrong place to look for deficient or excess aggregate demand. That was the mistake pre-2008 and now post-2008 too.

Summers’ formal piece in ‘Project Syndicate’ is here.

Summers’ ‘revelations’ carry no trace of him having preached something very different all these years. Some acknowledgement of the errors of his past world view would be the intellectually honest thing to do. In fact, as recently as in June, he was urging the Federal Reserve cut rates aggressively.

In the meantime, four Governors of the Federal Reserve wrote a joint op.-ed., urging the American President to respect the independence of the Federal Reserve. Not quite directly but that was the intention. Their effort was undone by an op.ed., by William Dudley (a Goldman Sachs Alumni), former President of the Federal Reserve Bank of New York in which he urged the Federal Reserve not to offset the damage President Trump might be causing the American economy with his ongoing dispute with China and also to tweak policy to thwart his re-election chances! It is unclear as to whom he is batting for. It was clear whom he was batting against.

Best response to William Dudley came from Michael Lebowitz:

Dudley really has some nerve. The Fed, with Dudley’s help for ten years, lays tons of economic tinder for economic troubles and then he places blame on the potential spark (Trump). [Link]

STCMA on August 1, 2019

Pakistan rolls back the increase in cooking gas tariffs for roadside roti/naan outlets. [Link]

Ruchir Sharma’s piece in Times of India on July 31 echoes what I wrote for Mint on July 26:

Japan showed that central banks can print all the money they want, but can’t dictate where it will go.

Authorities in the Chinese capital have ordered halal restaurants and food stalls to remove Arabic script and symbols associated with Islam from their signs, part of an expanding national effort to “Sinicize” its Muslim population. [Link]

OF course, none of these seem to matter for Stephen Roach who sees nothing ‘red’ in China.

His tally of assets at a broader universe of Chinese lenders in “distress” is 9.2 trillion yuan, or about 4% of the commercial banking system and nearly 10% of gross domestic product. [Link]

The UBS analyst, cited above, is being careful, to sound positive (if you read the full story) so that he avoids the fate that befell his economist-colleague

I think what Raghuram Rajan is saying here is that central bankers have become the fall guys because they set themselves up to be supermen and women. It is time for a confession.

Business Today carried an useful article on tech. applications that are considerate to our privacy concerns [Link]

A friend had flagged this. It is indeed nuts. See Ruchir’s piece above too.

The analysis by S&P Global Market Intelligence found unrated entities in China, the U.K. and the technology sector in Asia Pacific are among the most at risk of a sudden spike in defaults. [Link]

Jeffrey Frankel is not sure whether inflation targeting really works because we still do not know, after all these years, how inflation expectations are formed. At least, one interesting link to a paper in his piece. [Link]

Finally, Google gets rid of another employee who is a conservative Republican.

Which inflation to fight?

The lesson, to me, is crystal clear. Deflation is a threat posed by a critical breakdown of the financial system. Slow growth and recurrent recessions without systemic financial disturbances, even the big recessions of 1975 and 1982, have not posed such a risk. The real danger comes from encouraging or inadvertently tolerating rising inflation and its close cousin of extreme speculation and risk-taking, in effect standing by while bubbles and excesses threaten financial markets. Ironically, the “easy money,” striving for a “little inflation” as a means of forestalling deflation, could, in the end, be what brings it about. That is the basic lesson for monetary policy. It demands emphasis on price stability and prudent oversight of the financial system. Both of those requirements inexorably lead to the responsibilities of a central bank.

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 227). Public Affairs. Kindle Edition.

This is the lesson that central banks in several advanced nations have ignored repeatedly in the last decade and are preparing to ignore again, in 2019

Volcker-William Sharpe conversation

I found myself sitting in the audience next to William Sharpe, a 1990 Nobel laureate in economics whose “Sharpe ratio” has become a widely accepted measure of risk-adjusted returns for fund managers. I nudged him and asked how much this new financial engineering contributed to economic growth, measured by GNP. “Nothing,” he whispered back to me. It was not the answer I anticipated. “So what does it do?” was my response. “It just moves around the [economic] rents* in the financial system. Besides it’s a lot of fun.” (Later, at dinner, he suggested the possibility of small ways in which economic welfare could be advanced, but I felt I had already gotten the gist of his thinking.) 

Source: Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 206). Public Affairs. Kindle Edition.

Here we are, a decade after the crisis, and the scurrying lobbyist chipmunks are nibbling away in the name of efficiency and simplification (good, in itself), but with the ultimate aim of weakening the new safeguards.

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 209). Public Affairs. Kindle Edition.

I am sure Tim Geithner and Larry Summers would have been content if I disappeared. The potential for conflict in policy approaches was real.

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 212). Public Affairs. Kindle Edition.

In my view, ‘Keeping at it’ was a good book but not a great book. He is a master of understatement. Mr. Volcker’s transparent sincerity, simplicity, impeccable integrity came through. But, he was not going to make scathing statements or judgements on any one. That is a testimony to the man’s character but that also makes the book somewhat duller. One has to pierce through his statements to understand what he left it for readers to figure out. One example is the comment on Geithner-Summers above.