RBI MPC Meeting Minutes – June 2017

Last week, the Reserve Bank of India (RBI) released the Minutes of its Monetary Policy Committee (MPC) Meeting held earlier in June. It made both for interesting and for sad reading. It was interesting because, for the first time, there was one dissent in the meeting. Prof. Ravindra Dholakia dissented. He presented a case for a rate cut for 50 basis points, rather eloquently and cogently. Cannot say the same of others.

Dr. Pami Dua, one has noticed, rather diligently tracks the Economic Cycle Research Institute in the US. One doubts if the U.S. Federal Reserve does that. ECRI’s recession warnings in this cycle have not materialised. In any case, to what extent they matter to India is unclear to me.

The excessive concern of many MPC members with farm loan waivers was disappointing. First, they are being spread over a few years.  Second, they are addressing a distress condition and that is not the same as as unprovoked fiscal give-aways. The latter is fiscal expansion. The former is merely about preventing the economy from sliding further into a slowdown and disinflation. Third and more importantly, as long as the States do not exceed their overall budget deficit, loan waivers cannot be incrementally fiscally expansionary. Dr. Ravindra Dholakia had done well to point that out. There are other reasons to object to loan waivers. But, an inflation risk is not one of them. Not this time. The farm loan waiver that UPA 1 government did in December 2007 deserves to be blamed for that and much more.

He also brought out an important point that if the unexpectedly low inflation rate seen in April was enough for RBI to revise its inflation forecast lower, then it should be good enough to cut rates too. One cannot have it both ways.

Also, it is a truism that one can always wait for more data. But, that is not going to solve the problem. In theory, with every passing month, one has more data. There is a trade-off between waiting for certainty and acting. Certainty will always be elusive in macro economics with uncertain lags. Judgement is inevitable. In the previous three months, actual inflation had undershot the central bank’s expectation.

So, a central bank that moved to a neutral stance in February has had enough time to observe the underlying behaviour of inflation and respond by June. It chose to wait again. That is somewhat inexplicable.

The following observation of the Deputy Governor, Viral Acharya was puzzling:

Accommodation in monetary policy during 2015-16 did not get transmitted to the corporate sector, and private investment remained weak then in spite of the monetary stance. The Treasury gains accruing to banks in this time, while not a direct concern for the monetary policy, only masked the true stress of their balance-sheets.

If the rate cut did not get transmitted in the form of loans but enabled bank balance sheets to get better, that is also a legitimate and justifiable reason for an easing of monetary policy. Banks, under pressure to make more provisions out of profits, were reluctant to do so because it would cause their net profits to decline and make the management look bad. But, if they found some extra gains from their bond holdings, wouldn’t that not make them more willing to recognise bad loans?

I wonder if the Deputy Governor has gotten his logic inside out or may be, I do not know something that he does. That is always possible.

In fact, a good friend pointed out a puzzling comment that the Deputy Governor had made in the February MPC Meeting. As per the Minutes,

The balanced budget, by focusing on fiscal stability and expenditure reorientation to rural and housing, seemed to exonerate the Committee from the burden of skewing rates to bridge the output gap and instead allowed the Committee to focus squarely on the inflation-targeting mandate. [Link]

Probably, he meant to say, ‘expansionary budget’. In that case, it does take the load off RBI of trying to orient monetary policy towards stimulating economic activity. A balanced budget does the opposite and, in fact, requires the central bank to offset fiscal prudence by loosening monetary policy.

In any case, for me, the budget for 2017-18 was pedestrian. Neither prudent nor expansionary nor balanced. It was a nothing budget.

Finally, it is somewhat worrying that the MPC did not discuss the uncertainty caused by government policies – for good or bad reasons. Their note-ban exercise, tax claims and pursuits, real estate regulation bill, benami bill, forthcoming Goods and Services Tax have induced uncertainty over and above the impact of stressed balance sheets.

RBI released the 77th round of Quarterly Industrial Outlook Survey on April 6th. Perhaps, the questionnaire was sent out in February or March. It should have included specific questions about higher or lower uncertainty arising out of note-ban and GST. It did not. I think they missed an opportunity.

I am also struck by the fact that it did not occur to any of the MPC members, if one went by the Minutes of the meeting.

In sum, on reading the Minutes of the June MPC meeting, one get the impression that, barring Dr. Dholakia, others seem to be in need of urgent acquaintance with the art of decision-making under uncertainty.

448 million social media comments and other STCMA – 24 June 2017

The retreat of the Renminbi. Quite. The image of the Global Payment Currency rankings is telling. Danish Krone has a bigger share than Renminbi. Strategically sound advice from Shyam Saran not to assume that Renminbi’s onward international march is dead but factually incorrect. Article behind paywall.

Anjana Trivedi of WSJ calls it a ‘The Onion’ Headline. I have to agree.

A very good tweet:

Until China willing allow failures and losses, deleveraging campaign should be taken as seriously as any Democratic congressional campaign [Link]

James Mackintosh tweeted this:

Lovely Deutsche Bank chart of over-optimistic economists’ predictions for 10-year bond yield. Average 12-month forecast error: 60 basis points too high. [Link]

Two great tweets by James Kynge of FT

MSCI’s China A-share choice was between relevance and governance. Like many seduced by China dream, they chose former…. [Link]

…. And will come to regret the lack of the latter [Link]

His articles on the MSCI including China A shares in its index on the China Banking Regulatory Commission asking Chinese banks to reduce their exposure to China’s corporate cowboys (ambitious overseas acquirers) are worth reading. Could be behind paywalls, though.

Chris Balding’s blog post on the both these topics is worth a read too.

It is all about free cashflows in these Chinese corporate cowboys or, more precisely, the lack of it.

Chris Balding tweeted, while commenting on this blog post at PIIE.

“How brutally misleading and worthless a blog post by @PIIE. Look at all the products that aren’t even allowed in so don’t have a tariff rate​” [Link]

I guess we all know where PIIE stands with respect to China.

From the abstract of the forthcoming paper by Gary King of the Harvard University and co-authors:

We estimate that the (Chinese) government fabricates and posts about 448 million social media comments a year. [Link]

After Moody’s, now S&P also threatens a downgrade of China’s sovereign credit rating. Currently, it stands at AA- with a negative outlook.

China’s capital controls put real estate developments in Johor at risk, as most of them bet on the Chinese buyer.

A great article in ‘Australian Financial Review’ on Malcolm Turnbull becoming a China hawk from being a Panda hugger. You must be lucky to catch it. A question that came up in the head is why these leaders have to learn this all by themselves, all over again, when there is so much history and evidence?

The answer, my dear mind, is “They are not stupid. Their incentives are differently aligned and the cost benefit calculus of pursuing those incentives keeps shifting all the time.”

Chinese loans may put Bangladesh in a debt trap.

The economists who wrongly predicted a decline in healthcare costs for American families under Affordable Health Care are still at it, with dire predictions and interpretations of the Republican new Senate Bill. Here is an article from 2013 on how their predictions of declining health care costs turned out.

Avik Roy explains here how the Senate version improves up on the House version of the Health Care bill while keeping health care afforable.

Greg Ip gives the thumbs up to the Trump team banking proposals.

According to Zerohedge,  Israel deployed fighter jets to help prevent a coup in Saudi Arabia on the announcement of succession that replaced the present crown prince with the King’s son. Strange world.

Interesting article on how Jokowi in Indonesia is rebooting his Presidency before the 2019 elections after his ally and ex-Jakarta Governor had been sent to jail for blasphemy against the Koran.

Technology, jobs and societies are my favourite and anxious topics. These two links make me wonder whether we can ever become sensitised to the dangers of what we consider progress and development.

This is a review of Dan Drezner’s book, ‘The Ideas Factory’ by Edward Luce in FT.  These lines explain the problem of jobs and technology linked above:

The optimal talk, particularly for Ted, which serves as an advertising platform for paid speaking, is to focus on what Evgeny Morozov, a critic of Silicon Valley, describes as the “cyber-whig” view of history: the belief that technology is carrying us upwards.

“Find some peculiar global trend — the more arcane, the better,” Drezner quotes Morozov saying. “Draw a straight line connecting it to the world of apps, electric cars and Bay area venture capital . . . Mention robots, Japan and cyber war. Stir well. Serve on multiple platforms.”

Whose standards are poor? – part 2

In response to my post here, a friend responded. Here are select extracts from the email correspondence:

States deficits have indeed increased (excluding UDAY) but are still within the 3% limit that was fixed for them. They have not exceeded the limits, and they do have a binding force that prevents them going above–namely the Finance Ministry which can refuse permission for bond issuance.

There is very low probability of states exceeding 3% (not counting UDAY). In the 10+ years since Fiscal Responsibility and Budget Management (FRBM) was legislated  in states, out of a potential 300 or so violations of the 3% limit, (30 states X 10 years), only about 10 cases (state-years) has it happened till now and in each case it had to be offset by reduction in borrowing the next year. By the way, the 14th Finance Commission recommended a higher Fiscal Deficit limit for states (e.g., Telangana) that meet stringent debt criteria. About 5 states meet them, and they would be within the limits permissible even if they reached 3.5%. This also could skew the average.

Further, the states cannot, on their own, violate the ceiling –because it is fixed in advance in absolute rupee terms at 3% of the estimated Gross State Domestic Product (GSDP) calculated by the Centre. Permission to issue bonds is controlled by RBI at this absolute level for a given fiscal year. Bonds are issued through the RBI’s debt office. What can happen is that, ex post, the Central Statistical Organisation (CSO)’s calculation of GSDP may be different from the earlier estimate. IF the denominator moves adversely, what was 3% (same numerator) may become 3.2% because of a smaller denominator.

However, the reality does not appear so straightforward. My friend is not necessarily wrong but it would be difficult to explain away the ex-post deficit ratios of many States over the years as marginal overshoots. More below.

In the month of May, ‘The Economist’ wrote a Leader and an accompanying article on the finances of Indian states. You can see them here and here (may be, behind paywalls).

In the ‘Leader’, there is a sentence:

Indian states are meant to keep their budget deficits below 3% of GDP. But this rule is often trumped by political expediency.

There is another sentence:

It is time to signal that they bear responsibility for their own borrowing, and to end the perverse incentives that encourage them to dig themselves ever deeper into debt.

Both these comments are partially true. Evidence points to the opposite for non-special category states but evidence conforms to the above statement for special category states. I had painstakingly manually entered the actual GFD/GSDP ratios for 28/29 states from 2008 to 2015 – that is seven financial years, from the RBI Annual Study of State Budgets. Violations of the 3% deficit rule are not sporadic.

That special category states are seen to have violated the ‘Fiscal Responsibility’ in hindsight is a bit disappointing because they get additional grants from the Union government. To understand what ‘Special Category’ status means, see here.

It points to many forces at work. Either they underestimate their spending or overestimate revenues or growth wilfully, gaming the system, or there is no competence or expertise to do them correctly. Or, it is that the denominator,  GSDP, is so badly overestimated ex-ante that the final numbers push up the GFD/GSDP ratio.

May be, ex-ante, the Union government never allows a deficit more than 3% except under very special circumstances. But, ex-post, what is the penalty for doing so? To be sure, non-special category status States are not serial violators of the deficit rule. That is, if the GFD/GSDP were above 3.0% in one year, it would be much below in the following year.  That is mostly true for the 17 or 18 non-special category States. But, there are exceptions even there. Until 2014-15, for which actual data are available, West Bengal, Kerala and Punjab have been somewhat persistent in their violations of the deficit rule.

In fact, the XII Finance Commission provided for special grants to West Bengal, Punjab and a bit to Kerala, to bring down its revenue deficit. See Table 10-12 of the Twelfth Finance Commission Report for the full details of the various special ‘Grants-in-aid’ allotted Special and Non-Special Category states.  Yet, these three States – West Bengal, Kerala and Punjab – have been offenders on the deficit ratio.

With the exception of Jharkhand, most of the other States signed up to Fiscal Responsibility Legislation (FRL) between 2005 and 2006.  See Table 2 of the RBI’s Study of the State Budgets 2008-09.

The article has a following sentence:

a 3% annual deficit cap is waived as often as it is enforced.

Even though FRL exists, it is not clear what penalties does the Union government impose for violations of FRL. It would be difficult for it to do so given its own ‘fair weather’ record on fiscal probity and prudence.

It is true, though, on a consolidated basis, the States’ GFD ratio had not exceeded 3% since 2004-05. See page 42.

Indian Public Finance Statistics for 2015-16 are available here.

May be, it will all be more consistent and credible with the Fourteenth Finance Commission.

This article in ‘Indian Express’ (from 2016) does a far better reporting job:

There will be year-to-year flexibility for relaxing fiscal deficit to states subject to fulfillment of conditions as specified in the FFC recommendations. States should have had no revenue deficit this year and in the preceding year. The states will be eligible for flexibility of 0.25 per cent over and above the fiscal deficit limit of 3 per cent of GSDP if their debt-GSDP ratio is less than or equal to 25 per cent in the preceding year….

… States will be further eligible for an additional borrowing limit of 0.25 per cent of GSDP this year if the interest payments are less than or equal to 10 per cent of the revenue receipts in the preceding year….

If a state is not able to fully utilise its sanctioned fiscal deficit of 3 per cent of GSDP in any particular year during the 2016-17 to 2018-19, it will have the option of availing this unutilised fiscal deficit amount only in the following year but within FFC period.

On May 12, RBI released its annual study of state finances. Appendix Table 1 has a statement on combined fiscal deficits of States. The number for 2015-16 is 3.6% and that includes UDAY – restructuring of State Electricity Boards – related expenditure.

In the final analysis, what all this means is this:

The main impact of farm loan waiver and the implementation of the Seventh Pay Commission recommendations will be on quality of state expenditure–less for good projects/ desirable schemes and more for sops. Tamil Nadu has perfected this over the years without violating the FRBM limits. In case, any one has forgotten, Tamil Nadu offers Amma Idli, Amma water, Mangal Sutra, wet grinders, laptops, free electricity to farmers and free and subsidised rice at the fair price shops.

So, this post is all about clarifying the quantitative aspects of fiscal deficits of Indian states. The evidence is mixed. Violations by individual states have been reasonably widespread even after FRL in 2005 and in 2006. Overall, combined GFD/GSDP of States has remained below 3.0%, however. Going forward, as to whether  the quantum would also violate the 3% rule, judgement is reserved.

The quality of their expenditure might deteriorate in the coming years, unless the Goods & Services Tax collections far exceed expectations.


(1) Ragini Bhuyan’s well researched article in MINT shows that credit rating agencies do have a bias against emerging economies and not just India:

As a 2013 paper by Andrea Fuchs and Kai Gehring of the University of Heidelberg showed, ratings agencies tend to favourably rate their home countries as well as countries that share strong economic ties with the home country. This may explain why China, the US’s largest trading partner, is rated much better than other emerging market countries by US-based ratings agencies.

The ‘real illusion’ in India

It is nearly two weeks since I wrote the piece titled, ‘Raghuram Rajan has the last laugh’. I cannot believe it is almost two weeks!

In that post, I had mentioned what the Government of India needed to do:

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. [Link]

But, this was not the Plan B I had in mind. The Government of India is setting up an anti-profiteering authority to ensure that the tax credits accruing to businesses under the new ‘Goods and Services Tax’ (GST) is passed on to consumers and that there is no profiteering. Perhaps, the government is paranoid about the inflation impact and hence, of the Reserve Bank of India’s tight money policy. It desperately wants low interest rates. Or, it is really worried about popular backlash that could arise if profiteering were rampant. More likely both. Alas, the road to hell is paved with good intentions.

This morning, I read my friend Niranjan’s piece in MINT on Money Illusion. I think, if I understood him well, his point is that the public are used to high inflation rates and expect their nominal earnings to rise at a certain rate based on their own estimates of what the inflation is. Since prices are rising far slower, probably, incomes and earnings of certain categories of the society – small businesses, wage-earners, may be? – are rising far too slowly. Naturally, they feel unhappy about it. Hence, they may be holding back their spending, etc.

Although the real growth rate is around 7%, the nominal growth rate is lower – around 10% to 11%. But, society is used to nominal growth rate of around 15% and the concomitant growth in many nominal quantities. That is not materialising and hence, they feel that growth is suffering. That is money illusion. This can also become a vicious circle. Or, it probably, has already.

As hypotheses go, this is not a bad one.

But, I have some reservations on Niranjan’s hypothesis:

(1) The 7% growth rate that is reported under the new methodology and new base year 2011-12 may not be the same as the 7% in the old methodology with the old base year, 2004-05. In other words, we do not have a benchmark. Under the new methodology, the potential growth rate of the economy may be 10% or 12%. Who knows? May be, that is a reason, the inflation rate is declining. NO, scratch that. I have a better hypothesis that follows.

(2) Some nominal quantities such as credit growth are really low, even after one adjusts for lower nominal GDP growth and also for the fact that electricity boards may not be borrowing as much as they used to from banks as before, after UDAY (debt restructuring for State Electricity Boards). Further, many FCNR (B) loans taken by Indian businesses are being unwound now.

Notwithstanding these special factors, it is difficult to argue that credit growth numbers are better than they really are. They do indicate both absence of demand for credit from potential borrowers and banks’ capacity to supply credit.

(3) The implicit assumption he is making is that the Indian economy is indeed growing at 7% real and it is the absence of inflation that makes us feel that there is no growth, because we are used to thinking in nominal terms.  Actually, I question the premise that we we are indeed growing at 7%. I very much doubt that.

If we drop the pretense that we are growing at 7% or thereabouts, then there is no money illusion to speak of. The angst is real.

I think one of the reasons – it, too is a hypothesis – that India’s inflation rate is declining – and it does not preclude economic explanations – is that economic uncertainty has increased relentlessly in the last one year +. It is still rising and that it has dampened economic activity and hence, weakened aggregate demand except for personal spending to a limited extent. Hence, there is no inflation impulse. Yes, yes, I am aware that, in India, food items has a weight of 45% in India’s consumer price index (CPI) and that the prices of agricultural produce have been declining. In fact, even Wholesale Price Index (WPI) inflation is low and the weight of food in that is not this high. It is more weighted towards manufacturing. So, my hypothesis is highly plausible.

Why do I say that uncertainty has been rising relentlessly? India’s tax terrorism has been relentless – many tax circulars and notifications have been issued and then withdrawn or clarified (The SARAL form was changed to include declaration on assets and then withdrawn and taxation of mutual fund transactions in third-country locations was announced and clarified and amended later). There has been badly designed tax amnesty schemes. There has been the pursuit of black money. Retrospective taxation remains in the statutes.

Now, there is an anti-profiteering authority. It is not possible to arrive at a mechanical or mechanistic interpretation of profiteering. But, that risk now exists. Going by past record, that risk is non-trivial.

Then, there was the pursuit of non-performing assets guided by the Reserve Bank of India, under the previous governor. In any case, loan growth had slowed under the weight of bad assets in the books of banks and under the weight of high liabilities in borrowers’ balance sheets.

There has been the note-ban exercise which created its own uncertainties, besides acting as barriers to transactions in rural commerce, in agriculture. The All India Manufacturers’ Organisation (AIMO) had done surveys that found extensive impact on rural employment. Now, AIMO has actually sought a postponement of GST. Unlikely to be conceded.

The real estate sector, awash with black money, has been hit by the note ban. Then, they have had the Real Estate Regulation Bill. Anecdotal evidence suggests that real estate sector activity has considerably slowed. It showed up in the national income statistics for the fourth quarter of 2016-17. I do not think it is over yet. Probably, it is just beginning. Then, there has been the benami transactions bill. There is a new bankruptcy code and, may be, the mother of all uncertainties, GST. Hope not.

The icing on the cake is the anti-profiteering authority. The more the government wants to curb and check and prevent profiteering, the more it is going to strike at the roots of economic activity. It is failing to follow the 80-20 principle or management by exception.

Some or many or most of these government measures, legislative proposals may be good for the long-term while some may offer mixed benefits. But, they are inevitably short-term negative for economic activity.  They are essential surgeries, may be. But, painkillers are needed during and after surgery. Further, the recovery is aided with nutritious diet and vitamin supplements. Where were they? Except for Foreign Direct Investment (FDI), nothing much.

No relief from tax terrorism, no reduction or simplification in tax rates, no reduction in operating costs for businesses through reduction in labour costs (payroll deductions), no privatisation, no banking sector reforms. There were lots of promises of reduction in inspector raj.  How much of it has materialised? How many laws have been repealed out of the earmarked laws for repeal in the Union government and in State governments?Indian companies were supposed to have one single corporate ID. I doubt if it has materialised too. Happy to be corrected.

I think the government is missing the problem completely. In general, the government has displayed extreme risk-aversion in the design of its schemes, making static assumptions on revenue foregone, etc. No allowance made for improved activity and compliance on account of lower rates, for example. This risk aversion could be the consequence of a controlling or untrusting mindset. Or, it could be the mindset of the senior bureaucrats in the Ministry of Finance who guided many of these policies. Or, they could be simply reflecting the mindset of the Minister concerned or the Prime Minister. Any or some or all of the above could be influential factors.

The truth is that economic uncertainty in India is not an illusion. It is not money illusion that is behind the absence of ‘feel good’. Given all that has happened with government’s policy decisions and legislative changes – good, bad, hasty, measured, sound, unsound – it is just that Achche Din is becoming an illusion.  This time, it is not a money illusion but a ‘real illusion’.

Whose standards are poor?

Collectively, by 2019, the farm loan waivers of all States and the estimate floating around of the total amount of  500 and 1000 rupee notes that were returned being in excess of the amount of estimated legal tender of both these denominations by about 1,00,000 crores of rupees amount to almost Rupees 4.1 lakh crores or Rupees 4.1 trillion. India’s GDP in March 2017 is now estimated at Rupees 152 trillion. So, this amounts to 2.7% of GDP as of March 2017. Of course, by the time 2019 comes around, the GDP will be high and hence, this percentage will be lower. But, it should be at least 2% of GDP.

This is what ‘Business Standard’ wrote:

As demands for farm-loan waivers grow across Punjab, Haryana, Tamil Nadu, Gujarat, Madhya Pradesh, and Karnataka–after Uttar Pradesh and Maharashtra wrote off loans worth Rs 36,359 crore and Rs 30,000 crore respectively–India faces a cumulative loan waiver of Rs 3.1 lakh crore ($49.1 billion), or 2.6% of the country’s gross domestic product (GDP) in 2016-17. [Link]

The ratio is overstated in their report. 3.1 out of 151.8 = 2.0% of GDP. Anyway, they have not taken into account many things including the possibility that Indian banks collected more notes than what RBI had reckoned was in circulation!

Nonetheless, the story in ‘Business Standard’ from ‘Indiaspend’ is worth a read. In addition, read this story in ‘Times of India’ and weep.

In recent years, India’s fiscal consolidation at the Union level has been already undone by the profligacy of States, even before taking the restructuring of the debt of their Electricity Boards into account. This is what the economists from JP Morgan wrote in a recent report:

As the RBI’s latest study on state finances (May 2017) confirms, the consolidated deficit of the states increased from 2% of GDP in 2012-13, to 2.2% in 2013-14, to 2.6% in 2014-15 and – here’s the real concern – to 2.9% in 2015-16, despite the much higher fiscal transfers from the Center, under the Fourteenth Finance Commission, from that year onwards.

These are all excluding the UDAY liabilities, which can be deemed to be one-offs. Including UDAY, the consolidated state deficit is estimated at 3.6% of GDP in 2015-16 and 3.4% of GDP in 2016-17.

But, the numbers for 2015-16 are Revised Estimates (RE) and for 2016-17 are preliminary estimates. Actual numbers could be lower or higher. For example, including liabilities on account of UDAY, RBI had earlier expected the States’ consolidated deficit in 2015-16 to be of the order of 3.3% of GDP and it is now estimated at  3.6% of GDP. Incidentally the original budget estimate for States’ combined fiscal deficit was 2.4% of GDP. Presumably, that was before taking UDAY into account. You can see one of the tables of the RBI report on State finances published on May 12, 2017 here.

These numbers do not include additional, recurring annual liabilities on account of the States implementing the Seventh Pay Commission report.

Here are some additional key points from the JP Morgan Report:

Furthermore, with most states yet to implement their Pay Commissions, and with a non-negligible fraction of state revenues coming from stamp duties – which are under pressure on account of stress in the real estate market – the challenges for state finances are only likely to grow, even without growing risks of proliferating farm-loan wavers.

The consolidated general government deficit could be of the order of 7.0% of GDP already by the end of March 2017. With all of these – farm loan waivers, Pay Commission implementation, UDAY final bill, bank recapitalisation (it has hardly begun), etc., where are we heading in terms of the consolidated fiscal deficit?

Can we now sit down and assess calmly whose standards are poor?

Who pulled the plug on Lehman Brothers?

We must thank Professor Laurence Ball at the Johns Hopkins University for filling a very important information hole on the demise of Lehman Brothers. He has done a wonderful service although, for reasons beyond your control, there are unanswered questions. The decision was taken by Hank Paulson, the then Treasury Secretary, although he had no locus standi to take that call.

Several questions cropped up in my head on reading his 218-page long paper published last year on the bankruptcy of Lehman Brothers:

(1) Is there no consequence for Bernanke not responding to the FCIC request for information on Lehman Collateral and his refusal to provide the information?

(2) When Prof. Ball made the FoIA request for details on the collateral from AIG against which the Federal Reserve lent, it was already 2012. By then, the collateral had been liquidated. Why was it still not feasible for the Federal Reserve to comply with Prof. Ball’s Freedom of Information Act (FoIA) request? It would not have jeopardised price discovery of AIG collateral since they had been liquidated, by then. Pity that the courts too did not agree with him.

(3) I can understand, to a degree, why Hank Paulson did not want to commit public money after the backlash he received for Bear Stearns bailout. But, did it involve taxpayer money? Lending against collateral is the job of a central bank and it is a call that it should take.

To be sure, I agree that if the collateral were of dubious value, then eventually the burden becomes fiscal. But, that is a judgement that the Federal Reserve had to make and the risk of that judgement is part of the job.

In other words, no taxpayer funded bailout should not have meant that Lehman Brothers should be barred from the Fed Primary Dealer Credit Facility (PDCF).

[I learnt from Professor Ball’s interview (see below) that, after Dodd-Frank, the Treasury Secretary has to authorise Fed lending to a stricken institution.]

(4) Why has Hank Paulson not been questioned/tried/fined/ imprisoned for overstepping his authority vs. the Federal Reserve, not to mention yelling at Cox of SEC?

(5) Why has there been no follow-up action to the Financial Crisis Inquiry Commission (FCIC) report in terms of holding public officials accountable for their decisions? The Federal Reserve had dodged information requests from FCIC on the extent of collateral available from Lehman Brothers, on the Fed’s assessment, etc., They were not given that information. Is there no consequence for that?

(6) There is some escape avenue for Paulson because he had tried to arrange a private sector solution. He had spoken to Dick Fuld on fifty occasions between July and September. The paper mentions that. He spoke to Alastair Darling to waive the Financial Services Authority (FSA) insistence on Barclays’ shareholder approval, etc.

But, he could have easily allowed the Fed to fund Lehman for sixty days for Barclays to obtain shareholder approval and let the firm fail, after that, if it did not materialise. That could have also given the system to prepare better?

(7) In an interview for the ‘Promarket’ blog at the Stigler Center at the University of Chicago Booth School of Business, Prof. Laurence Ball specifically rules out ulterior motives for the then Treasury Secretary:

Q: In the aftermath of the crisis, there were rumblings that the reason Lehman was allowed to fail while other institutions were bailed out had something to do with the fact that the government was filled with former competitors of Lehman, and they were the ones calling the shots.

A: I read that. I don’t think that’s really true. There were also stories about Henry Paulson who had been in charge of Goldman Sachs and supposedly didn’t like Richard Fuld, who was head of Lehman Brothers—that may be true, I don’t know, but I think it’s pretty clear that Henry Paulson did not want Lehman Brothers to fail and did not think this was a good thing or tried to get back at his rival on Wall Street. Paulson knew that at best he was taking a very big risk, and he did work very hard to try to arrange for some kind of private sector rescue of Lehman. The last big hope being the Barclays acquisition that didn’t work out, and he was very unhappy. In the end he did everything he could to prevent Lehman’s bankruptcy, whether he liked or didn’t like Richard Fuld. Except he wasn’t willing that the Fed put in money because of the political consequences of that. [Link]

(8) It is funny to see the slant of the interview from the ‘pro-market’ blog. They were trying to argue that the whole crisis was probably much ado about nothing because, had Lehman Brothers been bailed out, it might not have become so serious as it did and therefore what was the fuss really about?!

Never mind that there was a global real estate crisis, bank failures in a few countries in Europe, etc. The interviewers for the blog were trying to argue that the Federal Reserve made a miscalculation and did not rescue Lehman Brothers. They did not want to acknowledge that investment banks were leveraged 40:1 or that Countrywide engaged in predatory lending and that subprime mortgages had grown too much too quickly and that they were securitised multiple times over. None of these constituted a problem. This kind of market fundamentalism is actually repulsive and distasteful.

There is one explanation in their favour. Possibly, they were merely being provocative. That cannot be ruled out.

Those who do not wish to read the 218-page long paper might wish to read this short NYT Deal book article and this 18-page summary paper by Prof. Ball himself.

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.