More observations on the Indian Economy

Continuing on posts here, here, here, here, and here.

Most of the analyses on the problems afflicting the Indian economy have sought to find out the one cause. In the process, they expectedly present partial diagnosis and therefore limited prescriptions.

Vivek Kaul and Sayantan Bera have good articles that highlight the collapse of demand and rural distress. In the circumstances, even with the 9% total fiscal deficit, the calls for fiscal restraint, here and here, are baffling. Dr Rangarajan puts the issues in perspective nicely here.

Anyways, some interesting thoughts from different sources.

1. Monika Halan posits an interesting situation. While the tightening of norms (need for Aadhaar and PAN on large volume transactions in areas like gold and land) have squeezed the spending of black money, the channels of its generation (the regular channels of corruption at all levels) remain unabated. In the circumstances, as black money is accumulating, its outlets are choked.

Some part of it appears to have found its way into the financial markets, into SIPs and stock markets. But the rest are biding their time,

But there is still plenty of money waiting on the side. What happens to the cash money? Will it come into the system or keep waiting? At the moment, it does look as if people are waiting. Waiting to see the old way come back where the circle of cash can resume and in the meantime they are just sitting on cash. While holding cash, they worry about the ₹2,000 note that could get replaced by the ₹1,000 one anytime. That they will find a way to convert that useless into a useful note one more time is sure, but the effort and cost is getting tiring. If the old way does not return, then this cash will have no option but to come back into the system through consumption and investments. Which will happen first is possibly the question on which India’s future as an economic power depends. Will this government be able to kick-start consumption to tide over the current slump and rekindle the economy, hold on to power for the cash economy to give up or will the push back against formalization find a political voice.

This presents an intriguing possibility. A relaxation of the drive against black money can potentially provide an outlet for the black money and thereby kick-start demand and revive the investment cycle. While there is not data to prove this, it is a perfectly plausible argument that a significant share of the expenditures on consumer durables and gold came from black money, which has been squeezed by the ongoing drive against it.

The asymmetry between generation and spending channels for black money also means that some part of those generated could now be moving into the financial markets through SIPs and stock market purchases. Are these contributing to keeping the markets immune from all the economic woes? In other words, are the markets becoming a preferred channel for money laundering - converting black money to white?

2. An article by Gautam Vashisth and Om Chaudhry points to two phases of real estate boom in India. They claim that the first from 2005-11 was financed by banks and private equity, and the second from 2011-16 was financed by NBFCs (their loan book grew 3.5 times at 30-35% annually to reach $32 bn) and private equity.

But this graphic from Arvind Subramanian's latest paper points to something interesting.

As can be seen, NBFCs apart, private sector banks led the credit flows into the real estate in the 2011-19 period. In fact, the public sector loan book has remained largely stable in this period. What are the quality of those private sector loans? What share of them are now stressed?

What are the exposures of various types of institutions - public sector banks, private sector banks, NBFCs, foreign private equity - to stressed real estate assets? If public money is used, how does the nature of these institutions impact the type of bailout? 

It is yet more evidence to refute the idea of private banks in India being paragons of virtue, one of the primary reasons for privatisation of banking sector. As Board and chief executive level decisions at Yes Bank, ICICI, Axis, and RBL have shown, there is little to choose.

Btw, the bad bank proposal is a half-baked prescription. I have blogged here and here about resolution and bad banks. Just carefully thinking through the processes necessary to resolve real estate loans will make it abundantly clear.

3. More on the demand-slowdown in the Indian economy, from Jahangir Aziz. Good summary.

But rather than characterising it as an "aggregate demand slowdown", I am inclined to describe it more appropriately as a return to the normal state of local demand based growth, without any of the external tailwinds. Unfortunately, the Can India Grow? hypothesis is starting to bind now.

It is just that stripped off all props (external demand, stimulus, transfers etc), the real demand (obviously weakened by the combined effects of demon, GST, regulatory overkill, plus the dampened animal spirits) is now surfacing. This is the "structural demand" issue being highlighted. All we can do now is to mitigate the dampeners and push the economy to its (relatively low) natural demand frontier, and simultaneously work on expanding that frontier with the longer-term reforms. Hope that some tailwinds will emerge which we can ride opportunistically to get a boost on the output side.

On the external demand/trade/globalisation, I think it is incorrect to simplistically say that the headwinds are responsible for India's stagnation or that the export path to growth has come to an end. For sure, the days of booming trade growth is past. But it is not as though trade volumes have shrunk, only that its growth rates have declined. The export engines of countries like Vietnam and Bangladesh have not encountered any similar problems. 

In fact, since 2011, India has been among the worst performing exporter of goods and services. It should actually be worse, since if we take only merchandise exports, the country would appear to have fallen off some cliff. Something is going on - we are clearly doing far worse than pretty much most of our competitors. It would be useful to get into more deeper analysis of the major export categories.

As to the immediate challenges - using government expenditure to trigger aggregate demand, while simultaneously using all tools available to de-clog the credit markets (both banks and NBFCs) appear to be the only game in town.

4. What is also really hurting the economy is the steep decline in nominal growth rates, halving from 12% to 6.1% over the September 2018 to September 2019.

When nominal GDP falls so steeply, its impacts are felt widely. An economy entrapped in a low growth and low inflation environment creates several problems. It squeezes consumers with stagnant incomes and producers with reduced pricing power. The result is low consumption and investment on the private sector side. The low nominal GDP growth (and low inflation) exerts pressure on debt-sustainability since the real value of debt and its share of GDP keeps increasing. It also lowers the tax revenue collections, thereby exacerbating the already high fiscal deficit. Finally, at a nominal growth rate of 6%, it will take 12 years to double the economy.

All this also raises questions about the 4% inflation target with a +/- band of two percentage points. This orthodoxy on very low inflation, borrowed from the requirements of developed economies, does not square up with the experiences of the East Asian economies in their rapid growth decades. One more example of how orthodoxy may have contributed to the ongoing economic stress.

5. For the fiscal puritans and their sacrosanct 3% fiscal deficit limit, here is how the US has followed counter-cyclical fiscal policy.

Note that just the federal fiscal deficit shot up to 10% of GDP in the aftermath of the Great Recession.  Also note the consistent pro-cyclicality. And here we are hesitating to raise the deficit by half a percentage point or so. In fact, is there an example of fiscal accommodation during a growth slowdown with a deep demand slump, which has led to restoration of economic growth?

Clearly IMF does not trust the fiscal disciplining abilities of developing countries. In the IMF's world, what is sauce for goose does not appear to be sauce for the gander!