The Narendra Modi government has been facing criticism from most quarters over its handling of the economy, especially after the latest numbers showed that the official GDP growth rate for the July-September quarter has slumped to a six-year low of about 4.5%.
While the government has said that India’s growth has bottomed out and will begin to revive in the next few quarters, economist Rathin Roy, former part-time member of the Prime Minister’s Economic Advisory Council (PMEAC), disagrees.
“There is no domain expertise that can be used to make a statement such as growth has bottomed out or growth has not bottomed out in an economy that is not in a steady state,” Roy said in an interview with HuffPost India. “The slowdown that we are witnessing is structural. You can talk about bottoms and troughs and peaks when the slowdown is cyclical.”
Roy, director of New Delhi-based National Institute of Public Finance and Policy (NIPFP), and fellow part-time member Shamika Ravi were dropped from the Council in September.
Roy told HuffPost India that while he was part of the PMEAC, he gave a written input to the government warning that India’s economy was heading for a structural slowdown because of demand contraction and suggested that any supply-side measures would be unproductive or partial. This was in November 2018, two months after Infrastructure Leasing & Financial Services Limited (IL&FS) defaulted on debt repayments.
“I never heard from anyone in the government on my input, and I have no idea what became of it,” Roy said.
Roy suggests that to expand the consumer base from just about 10-15% of the population to about 50%, government policies ought to focus on the consumption of five goods and services—food, clothing, affordable housing, health and education—which would transition millions of poor and lower middle classes into prosperity.
“The consumption of these five things should be the bedrock of growth going forward,” Roy said.
Edited excerpts from the interview:
The latest GDP numbers show that economic growth has slowed to a six-year low of 4.5%. The government has said that growth has bottomed out, and the economy will clock “solid growth” rates after March. Do you think growth has bottomed out?
When the growth rate is low, it is more likely that it will be higher in the next quarter. And it is more and more likely that the lower growth rates fall, a statement is issued that growth has bottomed out will be true.
I’m not an astrologer so I will not speculate [but I can tell you this] that there is no domain expertise that can be used to make a statement such as growth has bottomed out or growth has not bottomed out in an economy that is not in a steady state. The slowdown that we are witnessing is structural. You can talk about bottoms and troughs and peaks when the slowdown is cyclical. The more important question is for how long would growth stay at or near 5%. Whether it has bottomed out or not is irrelevant: It could be 4.5% or 4%. We need to start thinking about how to get out of this situation we are in and not worry about whether the situation is going to get worse. And we need to get back to growth rates of 6-7% and more—this is where India ought to be.
Gross fixed capital formation (GFCF)—a proxy for investment growth and considered to be a key indicator of the health of the economy—has fallen to 1% from about 9.7% in the same quarter last year. There is a feeling of recession on the ground.
There are some sectors where we have recession but the economy as a whole is not in recession as conventionally defined. Since India is a growing economy, under no circumstances will India touch recession in the foreseeable future. Although a huge proportion of the population living on minimum wage has no access to goods and services with relatively higher prices due to supply-side constraints, I think that the Indian economy should normally grow, even without significant supply side reforms, at least at 6%. So there is a growth recession in the sense that the Indian economy is operating below its full growth potential.
In May this year, during the tail end of the Lok Sabha elections, you said on television that India’s economy is headed for a structural slowdown. You were one of the first economists to point it out.
I have been consistently writing about it. Yet no one seemed to pay the least attention to it.
When I was a member of the Prime Minister’s Economic Advisory Council (PMEAC), I had presented a written input to the government in November 2018 [that warned about the economy heading toward a structural slowdown]. I had conveyed in the note that the slowdown had nothing to do with the actions of the present government, and I argued that we needed a medium-term solution, chiefly in changing the composition of demand because the constraints in growth were not from the supply-side. I mentioned that any supply-side measures to check the slowdown would be unproductive or partial because the problem lay with domestic demand. I never heard from anyone in the government on my input, and I have no idea what became of it.
I was somewhat surprised that the government only took cognisance of the fact when I said it on television six months later—it does not bode well for public policy that we only pay attention to something when it is said on television.
Many experts have said that the present slowdown is a result of demonetisation and a messy rollout of the GST. But according to you, the origin of this slowdown is deeply rooted in the structure of India’s economic model. How so?
Over the years, the government has attempted to execute very important structural reforms in the governance of private economic activity, especially the governance of credit and finance. But we have not accompanied these with necessary and complementary structural reforms in public governance and public administration, whether it is our regulatory framework, contract settlement framework or tendency to micromanage and constantly tinker with the rules of business that govern how people do business. For instance, the number of circulars issued by the RBI and finance ministry on various matters. Even today, we exhibit the behaviour of a third world command-and-control economy.
This asymmetry, I think, has caused a lot of stress. Similarly, poor GST implementation has also caused a lot of stress. So when you have ramshackle public administration, a poor regulatory system and contract enforcement, when the institutions responsible for these are weak, insufficiently skilled and intellectually under-sourced, and when things like regulation and governance are undertaken as administrative tasks, you have a problem. This has been our problem since 1991—the structure of public administration is inefficient, and it has been such for a long time but there is complete bipartisan disinterest in fixing this. Let me give you an example: India’s is the only functional government in the G20 that still operates an annual budgeting exercise. Other countries have moved to medium-term budgeting that certainly improves the quality and effectiveness of fiscal policies.
So when you seek to implement far-reaching and important reforms without having the necessary governance and regulatory apparatus to execute those reforms successfully, you end up causing stress. This is the kind of stress that we have witnessed in our fiscal, financial and infrastructure space.
So there is a growth recession in the sense that the Indian economy is operating below its full growth potential.
The economic slowdown became a public issue only after IL&FS defaulted in September 2018. But in 2017, data suggests that close to 17% of the entire banking system was non-performing, and former CEA Arvind Subramanian had warned of a “twin balance sheet” problem as early as December 2014. Surely the RBI and government would have known what was coming their way.
I can’t speak for others. I agree that there were signs [of a coming slowdown], and when I picked it up, I conveyed it to the government.
I think there was considerable overlap amongst many on the question of structural fault or weakness. There were many who rejected it outright, specially those who believe in business cycles, and at the same time there were many who did acknowledge that there was a structural challenge confronting the Indian economy going forward. See, it’s a bit like a complex medical condition when the problem is structural, and even if they identify it, they are not able to act on it without the consent of the patient.
There appears to be no medium- or long-term economic thinking that is driving the Modi government. Within three months of the budget announcement, finance minister Nirmala Sitharaman convened multiple press conferences and announced new measures, developments that were read by some as an attempt at damage control via reactionary policy intervention and the government being out of touch with economic realities on the ground. Would you call it a case of executive inefficiency?
I do not know enough about the internal working of the Finance Ministry to be able to answer this. This is for the government to respond to. I only comment or react to policies that I think ought to be implemented. For example, I’m critical of the fact that government is refusing steadfastly to implement a medium-term fiscal framework despite my pointing out repeatedly that this is hampering the government’s instrumentation capabilities, and I will keep advocating for it.
But to be fair to the government, many of the recent announcements have been necessary and important. Particularly the decision to put foreign currency sovereign bonds on the backburner was a very good decision.
But the government rolled it back only after there was a criticism over issuance of sovereign bonds in dollar terms that would have led to a negative fallout.
The government made an announcement in the budget. Many including me sought active and urgent reconsideration of the decision and the government then paused in implementing the decision. This was a responsive reaction and government should be congratulated for this. These are difficult times and I believe that the government has done a lot of listening. If I’m dissatisfied, it is because some of the things I think the government ought to have listened to, it has chosen to do otherwise, but that is its prerogative.
Electorally, this is the most politically stable government since liberalisation in 1991, yet there has been criticism that at a time of an economic slowdown, the government is not moving ahead with necessary and urgent reforms for fear of loss of political capital.
I think it is myth that to think coalition governments are weaker. There is no basis for this argument. To expect highly of a government that has a political majority is to ignore the fact that the political forces are not mapped one-to-one on all political parties. So all political parties have to deal with a set of political forces, and if those political forces do not allow reforms that are good, then you will not get them.
You mentioned about how Indian textile industry is losing to competition from Bangladesh and Vietnam. In its first term, the Modi government envisioned a ‘Make in India’ initiative to revive the manufacturing sector. Today, the latest data indicates a negative growth in manufacturing output, What, according to you, went wrong?
Make in India was a good initiative and it was a good thing that it didn’t make a distinction between exports and home market. It was a better initiative than going for Special Economic Zones (SEZs). But what it could not do was answer an important question—Make what in India? The government said that make anything you can in India. That is fine but there were trade-offs. For instance, there is a plot of land where you can build an airport but you cannot also use it to build low cost housing. To the extent that these resources and inputs are scarce, you have to take a decision about what to produce—it is the oldest question in economics—and for who?
And as I have said, we need to build an ecosystem where people can consume the five things—agriculture, low cost textiles, affordable housing, health and education—and I don’t think they are consuming these at affordable prices and without any subsidies. This is a much bigger problem than Make in India.
You have also said that the Indian economy is headed for a ”middle income trap″. Indermit Gill, the former World Bank economist who coined the term, told me earlier this year that unless the Indian economy witnesses a sustained investment growth in the long term, it could fall into the trap. Interestingly, he said that India shouldn’t be too obsessed with manufacturing at this time, and as long as investment growth is robust—be it in manufacturing, services or agriculture—it would avoid the trap.
I would say it is important to ask about the nature of these investments because who is going to demand the things into which these investments are put? So if you think that investments in airports and aviation is going to support the demand in growth, then I’d ask why not use the same investments in resource-scarce railways—wouldn’t it support your growth better?
I have identified five areas—agriculture, low-cost textiles, affordable housing, affordable health and affordable education—the consumption of which should be the bedrock of growth going forward plus whatever we can do to boost exports.
So you are saying that future economic growth would be driven by the transition to prosperity of India’s huge lower-middle class [according to a paper by Sandhya Krishnan and Neeraj Hatekar, the size of the lower middle class with per capita daily expenditure between $2-4 is about 400 million]
I prefer to look at this this way: At a time when our growth story is dependent on the aggregate demand of the top 15% of the population, I want it to be—and rather quickly—about the top 25%, eventually reaching the top 50% at affordable prices and without any subsidy.
Essentially, as an economist, this means that I need to worry about what the minimum wage is giving people. And if it doesn’t give them these five things and they need subsidies instead, then I certainly need to intervene in the pricing structure to make sure this is not the case—I’m not talking about the poor here because someone who is earning the minimum wage should not be in poverty.
I do not think that the RBI's core capacity today is sufficient for the job of governance and supervision that the RBI is charged with.
Since liberalisation in 1991, India has witnessed stagnation in income distribution meaning income inequality has risen. Both the NSO’s latest Consumer Expenditure Survey (CES) and company sales data suggests that consumption has fallen. So a narrow home market is getting narrower and industry is taking a hit because they don’t have a market abroad to sell. Do you think unchecked income equality over the last two decades is a boomerang that has come back to hit the economy?
This is a symptom of what I have been saying. One of the symptoms of people who are at minimum wage and are unable to consume the five basic goods that I have mentioned, would be income inequality—if income growth was equal, then they would be able to afford these goods.
But it is not just income equality. For instance, take the textile sector. It is not that they can’t buy a Rs400 shirt, it is that they are not able to get it from domestic producers and therefore import it from Bangladesh or Vietnam. In the case of health and education, they are trapped because you can’t go to Bangladesh or Vietnam for it. Take housing, and they are trapped. In agriculture, we do not have a business model to produce and see food at affordable prices. Hence, imports hurt farmer incomes.
The point is if you look back, economic liberalisation was not executed and finished the way it was supposed to be. So, if it was done right, we would have far lesser inequality. On the one hand, you have an inequality of opportunity in the country and on the other you have the heavy hand of the administrative government restricting opportunity and intervening with regulations to no discernible benefits in terms of equity. Our labour codes do not promote equity, and hence a bulk of our labour is unregulated. We have liberalised, but we have allowed a distorted housing market for people in the top 100 million in order to provide them with huge amounts of capital gains and wealth, and we have allowed it to grow, which in turn has enhanced inequality. This is not what anybody would have expected from liberalisation.
So a lot of the inequality that arose in the last 30 years is not because of economic liberalisation, but it is because we continued to be a command-and-control economy to a large extent. The state opened up opportunities and markets to the top 100 million of the population, but kept the rest essentially in a rationed environment. They suffered lack of access [and the pain of] distorted relative prices.
Former Prime Minister Manmohan Singh recently said that there is a toxic atmosphere in society under the Modi government and a distrust in public institutions could lead to deterioration of economic activity. Do you think undermining public institutions would affect growth? Are there any inter-linkages between the health of public institutions and robust investment growth?
I don’t believe public institutions are being undermined. I think they are functioning reasonably well. The problem is somewhere else and it has nothing to do with undermining public institutions—it has to do with their core capacity, which is weak. I do not think that the RBI’s core capacity today is sufficient for the job of governance and supervision that the RBI is charged with. The core capacity of our economic institutions is administrative, and we need to build regulatory and governance capacities. We are not making this transition. What we need is rules and frameworks that operate with no exceptions, and remain transparent, robust and predictable and not subject to day-to-day peripatetic tinkering.
In 2008, while delivering a lecture at the Bombay Chamber of Commerce and Industry, former RBI governor Raghuram Rajan had said that “the next ten years will determine whether we will attain our place among the group of nations like South Korea and Taiwan that made their way from poverty to moderate prosperity in a couple of generations, or whether the last few years of growth have flattered only to deceive.” It is prophetic reading it today.
I don’t think we were deceived. The consequences of that bad growth was that, to some extent, it created the twin balance sheet problem during the investment boom between 2004-11, what I like to call the Kingfisher good times. Those were glorious years and it was very clear that they were structurally not going to be glorious forever. Dr. YV Reddy [former RBI Governor] has written about it in his autobiography. But when the party ended, I think we managed the economic fallout rather well. We managed to make sure that the economy grew at reasonably high rates, till the structural problems came up. And to solve the structural part is difficult because these problems tend to be opaque, not because the government is keeping it that way, but the private sector too kept them opaque. Not to mention the bipartisan failure to provide the instrumentation available to deal with it.
For me this is the biggest challenge, and nothing encompasses it more than the realm of fiscal policy—of the continued inability or refusal to implement a medium-term fiscal framework, and the persistence with annualised budgeting.