In a new paper published by Harvard University’s Center for International Development, Subramanian, former chief economic advisor, and Josh Felman, former IMF resident representative to India, have argued that the economy is facing a “twin balance sheet” problem from bank loans to real estate routed via non-banking financial companies in the post-demonetisation period. This, they warn, would make it difficult to arrest the current slowdown. Earlier, he had concluded that India’s growth had been overestimated by 2.5 percentage points (2011-12 to 2016-17). While official estimates pegged growth at 7%, actual GDP is likely to have been 4.5%, he had said.
HARISH DAMODARAN: You have said that the economy seems headed for the intensive care unit, while Manish Sabharwal (Chairman, Teamlease Services) says it’s in rehabilitation…
The only way to get a good reading is to look at the indicators. If you just look at the basic numbers, say, on consumption, investment, trade and taxes, they are all either in negative growth territory or barely positive this year. Thus, non-oil import growth is about minus 5%, non-oil export is also negative, nominal growth in GST and direct tax collections, only about 3.5 to 3.6%, which is basically zero in real terms. If you look at these numbers from a comparative perspective, it does not resemble even the 2002 slowdown. During that slowdown, GDP growth was 4.5, but all the above numbers were actually in the positive to fairly positive growth territory. The current slowdown has greater resemblance to that of 1991. It may not really be so in terms of macro (stability) numbers — foreign exchange is sound, current account is sound and inflation is sound — but in terms of real growth indicators, it (the situation now) resembles much more 1991-92, when we had a growth of 1.1%.
Then, of course, if you look at the electricity generation numbers over the last 28-29 years, never have you seen almost zero growth… For a country where energy access is poor, to think that energy generation and demand are going to be close to negative growth territory is unheard of. So, I think that all these objective indicators point to something very serious. Moreover, this slowdown itself creates a lot of stress. If your nominal GDP growth is going to be 4-5% and interest costs are like 12-14%, how will there not be stress? Then, we know that the finance system is just completely jammed… Also, to get you out (of the slowdown), the conventional short-run bullets you have are monetary and fiscal policy. But we have seen that monetary transmission is completely gone. The fiscal space is completely evacuated because, if you look at the true deficit, last year we ended up — look at what the CAG has said — close to 9%, which is also J P Morgan’s estimate. This year, the fiscal situation is going to be even more challenging… So, the indicators are looking grim and there are no short-term bullets.
Let’s also focus on investment for a second. For sometime we did public investment, then in 2000s we did PPP (public-private partnership) investments. Now the PPP model is completely discredited. So, how is private investment going to come back? I think we have to do a lot to be realisitically hopeful that things are going to turn around.
HARISH DAMODARAN: You are saying that this is as bad as 1991, but in ’91, the problem was very clear with hardly a month of forex reserves and high global oil prices. This time, what is the problem?
Yes, in India, we are used to crises that are triggered by the three Fs — food, fiscal and foreign exchange. Those are macro crises. We are used to crises that way and also how to recognise and respond to them. This time around, it’s a very unusual situation because we have had a long, slow-bleed crisis beginning just after the global financial crisis. The whole financial sector has been deteriorating; exports and investments have been deteriorating for a very long time. It is very puzzling. Nothing dramatic has gone wrong but it’s been a slow bleed for a very long time… I think the fact that our GDP measurements have been over optimistic, it has kind of fed this sense that maybe things are not too bad. So, this measurement is misleading us to some extent, and the fact that it’s a slow bleed, the situation that we are in is unfamiliar… It has sprung a surprise on us. Remember, until eight months ago, we were seen as the world’s fastest growing economy. Suddenly, how do you get here? I think it’s been unfamiliar and has to do with the financial system… that’s why I think it happened as severely as it happened, and we have not been able to recognise it because it’s not dramatic… It’s like a collective social cognition apparatus has been unprepared to recognise this kind of problem, what we call the ‘twin balance sheet (TBS) crisis’.
SUNIL JAIN: By when do we see this becoming a familiar kind of crisis (that shows up in real data)?
Suppose you have slow growth for a very long time, it is possible that our current account will not deteriorate. Slow growth can also mean that inflation may come down because there is a temporary blip in demand. But that’s also down. So, I think, that two places where it will manifest itself are in real sector growth, incomes, jobs and corporate layoffs. And, it is going to show up in the fiscal (deficit) as well. Already we can see that states are cutting back on spending, The Centre also doesn’t have money. So, this is not going to manifest itself in the form of a conventional crisis. It’s going to be slow. That’s why it’s not going to be dramatic, and therefore be more challenging for the policymakers.
SUNIL JAIN: You talked about the twin balance sheet crisis. Where do you think this government went wrong?
Firstly, the twin balance sheet problem has now become a four balance sheet problem. We now have NBFCs (Non-Banking Financial Companies) and real-estate sectors. So, that’s kind of making the problem worse. The origin (of the problem) is the fact that all this excessive lending took place. By the way, one of the heroes in this episode is Ashish Gupta of Credit Suisse, whose ‘House of Debt’ report first came out in 2010-11. That is when we should have started to address the problems. Between then and almost 2015-16, we were in denial about the true state of the problem. In my book, there is a chart about what the RBI was saying were the NPAs (non-performing assets) of banks… It’s only after AQR1 (asset quality review) that we started even publicly acknowledging the real NPAs. So, the fault is not only of this government, but also of the regulator.
Second, when we first did the balance sheet crisis analysis, we had this debate about setting up a bad bank. There were two things in my view that delayed action. One is, you know, the official GDP numbers were not bad. When the growth is 6-7%, what’s the problem? We have still not come clean on the magnitude of the problem (of estimation). We initiated the bad bank discussion in 2015 or so. But then the problem was that the government was new and it was quite vulnerable to the criticism of ‘suit-boot ki sarkar’. So, at that point, any executive-led process (of taking bad loans off the books of regular banks) was not going to be easy and that’s why the government did the IBC (Insolvency and Bankruptcy Code), for which it deserves a lot of credit. But then a combination of prolonged slow growth and now a second TBS have made matters even worse. If you really be honest, it begins with the inattention in 2010. The under-reporting of the NPA problem until 2016, the initial bad bank discussion happening but saying, ‘Oh, let’s not do this’… Remember, if you’re vulnerable to the charge of suit-boot ki sarkar, then resolutions that require write-offs are going to be difficult and so we had to do the IBC.
ANIL SASI: In your first Economic Survey, a little over four-and-a-half years ago, you painted a fairly rosy picture of the economy. Was that a genuine estimation error or was there some miscommunication?
No, absolutely not. In 2014, all us had the sense that this was the real moment… The oil prices were down, there was a big political mandate, there was a genuine sense of optimism. I generally don’t write things I don’t believe in. And you can see in all my four years, the surveys… someone documented the four surveys over time, and they became more and more sober. And that was in keeping with the way things evolved.
ANIL SASI: The oil bonanza and even the crises that have unfolded subsequently, the NBFC crisis… It was almost very clear that the banks were not lending, NBFCs were doing the heavy lifting. Why was it such a big surprise only when it unfolded? It was only after the IL&FS (Infrastructure Leasing & Financial Services) went belly up that the NBFC problem was recognised.
There are two things. One is your oil pressure…To analyse the last 8-10 years, you have to be able to explain a long-term slowdown, the fact that it did not completely collapse, then the phase that happened with the second credit boom and then the collapse. In a way, there are three phases going on here. And part of the reason things did not (slow down) earlier on was because of the oil prices, which did provide a temporary cushion both for the fiscal and for consumption, and that’s why when exports and investments collapsed, the economy still did 3-4-5%.
Look, we all have views on demonetisation. But, for me, one of the surprises was that post-demonetisation, when the credit boom happened… And of course it was partly due to demonetisation because money came back to banks, money came back to mutual funds. They financed the NBFCs and that’s why you had the credit boom. Then the credit bubble burst… The question is why? All episodes like this, of serious stress, require a trigger and some fundamental kind of unsustainable ponzi scheme kind of stuff. The trigger was IL&FS. Now, IL&FS is a catastrophic fault of regulation by the regulator. How can this behemoth Rs 90,000 crore escape all the notice of regulators? That I think is just absolute failure of the system, especially the regulator. But it’s not just IL&FS, we had a series of things. So, one of the things was that regulation was seriously flawed.
When the NBFC started lending, there should have been much strict monitoring of how much they were lending and where they were lending. Let me give you one example: When the banks got the money, instead of them lending directly to real estate, they lent to the NBFCs to lend to the real estate. Why? Because of the risk attached. So, if I make a loan and make it to an NBFC, the risk for that is much lower than if I make it to the real estate. Now, these were the things that the regulators should have spotted. The one lesson we have learnt is that we need to fundamentally overhaul the regulatory system, but that’s easier said than done. Anyone who says he can really fix this is talking nonsense… In the UK they tried the regulator outside the Central bank (model), even that did not work. It has to be something where the regulator is genuinely inspired by this ‘only the paranoid survive’ kind of mentality. And their attitude is that my job is just to find out where the mess in the system is… You need that kind of overzealous thing here.
SANDEEP SINGH: As per your assessment, where are we in this slowdown trough right now?
On the trough, let me say three things. One, I don’t think anyone can say we are going to come out in three or four quarters. My sense is that things have to get worse before they get better… Also, how quickly we come out is dependent upon what we do. Of course, the external environment is there, but you know, if you take measures that can increase confidence, start fixing the financial sector, the data thing, agriculture… It’s in our hands, the government’s hands, to some extent. But the actual timing, one cannot say anything here.
BANIKINKAR PATTANAYAK: You said the belated recognition of the NPA crisis cost us. Do you think the RBI under Raghuram Rajan could have initiated the AQR earlier?
Yes, absolutely. I think so. First, the fact that it was done deserves credit. Yes, I do think it could have been done earlier. From about 2011-12 to about 2015, it was just doing ‘extend and pretend’, deny the problem. So, I do think we recognised the problem later than we should have. I don’t want to blame anyone and that’s why I said it should have started much earlier… My discomfort at this stage is that there’s a kind of ‘Oh the banks are ok, we need to do it for the NBFCs’, and I don’t have the confidence to say that, because the banks came to the NBFCs quite a bit. In politics and political economy, if collectively the country thinks the problem is small, the urgency to solve it is small.
RAVISH TIWARI: On a political level, this government and the BJP seem to enjoy greater trust of political agents, the voters. But here is a finance minister who does major announcements and the economic agents don’t seem to be impressed. Why are the economic agents not trusting the government?
On the economic side, for many years, we have had what I call the ‘foresee’ problem. Both public officials and the private sector have had a dampening effect because you fear there’s going to be a foresee activity. This in turn comes from what? We’ve had a series of corruption scandals, so the people’s, the economic agents’, faith in the government kind of fell. So that relationship I think has been impaired for a very long time. So, in a sense, we are now in a situation where this is the cumulative legacy of many, many years, and it’s not going to be easy to undo that… We need to have a situation where there’s more policy certainty and much more friendliness.
SHOBHANA SUBRAMANIAN: What are the three things that you would like to see in the Budget?
Unfortunately, I have much stronger views on things that should not be on the Budget. First is budgetary accounting. This is a serious step. Second, I would say, don’t add to the stimulus, but don’t also have some dramatic fiscal consolidation which is not going to be realistic. So, let’s get the accounting clean, let’s have realistic ambition on the targets, no individual income tax cuts — absolutely not… Also, I don’t think we should boost consumption in order to boost growth because no country grows in the long run based on consumption.
Now, the individual income-tax payers are the top 5 per cent of the population. If you really want to boost consumption, it’s the bottom 95 per cent that you have to look at. So, if you want to boost consumption you should have something like UBI (Universal Basic Income), DBT (Direct Benefit Transfer), extend PM-KISAN… So, no raising GST rates. My view is that the GST revenue performance is not bad at all. What I do think we should do, not today, but when the economy recovers, maybe in six months or whatever, is we should have a bigger reassessment of GST and get back to something close to what I recommended in my report…
I feel there are no real magic short-term bullets. I feel that the Budget should not aim to do too many surprising things. I think the policy announcement that should accompany it should be much more along the lines of what I’ve said — bad banks, IBC, agriculture, data, power… To put it differently, this is a Budget not for anything dramatic on the tax and the deficit (front). It’s a structural problem and needs structural remedies… We have run out of short-term bullets.
SHOBHANA SUBRAMANIAN: Do you support the cuts in corporation tax? Also, on personal income tax, the top is fine, but an individual pays 30% tax at Rs 10 lakh income and a corporate doesn’t pay?
I think India, in terms of personal income tax, is a country where there are much fewer taxpayers than there should be. The aim should be to get more and more taxpayers into the net.
(On corporate tax) We know that from a long-run investment point of view, India’s tax rates were far too high. The tricky thing is that on the one hand, it was a desirable long-run structural reform… The problem in all these situations is what is called the theory of the second best. We are in a second-best world. So, in a first-best world, a corporate tax cut is going to elicit a decent response. In a second-best world, when you do one thing, four other things are not in place and this may not elicit the investment that you want. This is actually a classic case of a policy dilemma.
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