Subramanian talks about the reasoning behind govt’s economic response to Covid-19, highlights key reforms that will help growth, remains wary of another virus peak and calls for new entrants and innovations in the banking sector to introduce more competition. The session was moderated by Executive Editor (National Affairs) P Vaidyanathan Iyer.
P VAIDYANATHAN IYER: It’s about seven months into the financial year. Do you think the worst is over given that the first quarter (Q1) was very bad for the corporate sector?
The recovery since Q1 and the unlock phase has been robust, with some important subtleties. Firstly, manufacturing recovery has been more robust than the service sector recovery. And this is displayed through several indicators. If you look at the manufacturing PMI (Purchasing Managers’ Index) for September, it was at a seven-year high and has since increased. The levels of activity are not only back to pre-Covid levels but also compared to the same time last year, they are doing well….
If you look at the service sector, the October PMI has come close to 53, which suggests that apart from a couple of sectors, which are more impacted by social distancing, like travel and tourism, other sectors are improving. What we are seeing is two-paced recovery with the V-shaped recovery… I would, though, continue to be cautiously optimistic, given the second wave that has come in Europe… And given our festive season and the onset of winter, it is one downside risk that I want to be cautious about… All necessary steps that we have been taking to control the pandemic must continue with as much intensity so that we don’t have a recurrence. Even without a lockdown, if the pandemic numbers do rise, that will bring back uncertainty in terms of consumption. And that is something we have to guard against.
P VAIDYANATHAN IYER: In Q1, urban growth had slowed down but rural markets were not as impacted. But in Q2, the spread of the virus has been higher in rural areas than in urban areas. Now, companies are reporting lower sales in rural areas. How do you see the movement of the virus in terms of it affecting economic activity?
Urban areas contribute far more to economic activity than rural areas. While one does not want the pandemic spreading anywhere, from an economic perspective, the impact will be lower in rural areas than in urban areas because the ability to socially distance tends to be, on average, harder in the urban areas… So, from that perspective…, unless we have a second wave, we seem to be past the first peak. As a result, the impact on economic activity will taper down. But, within that, urban areas being less impacted than rural areas will also help in terms of the impact on economic activity.
P VAIDYANATHAN IYER: During the lockdown, the focus of the government was to take care of the most vulnerable by ensuring cash transfers and provision for food. Do you think that support has been adequate through the Pradhan Mantri Garib Kalyan Yojana and Atmanirbhar Bharat package?
When you look at the Atmanirbhar Bharat package, there is the aspect of ‘how much (is) fiscal spending?’. Within that (is) ‘how much cash transfers to the poor?’. The third aspect is about the series of reforms, especially labour reforms, that have been launched… Labour reforms were a conditionality as part of the 1991 loan from the IMF. And yet, for three decades, we didn’t have it. This is just one example. But these reforms are also as important. We need to look at the government’s response in its totality and not in a partial sense. If you take that total perspective, there are two or three key aspects that stand out.
First, faced with the chance of the pandemic expanding, one of the key principles that guided the government’s response was that while GDP growth will come back, and the evidence is that it is coming back, human lives, once they are lost, cannot be brought back. That’s the humane principle…
Second, we have to try and convert this crisis into an opportunity by launching seminal reforms. And the reforms have been focused on enabling more job creation by focusing on primary (agriculture) and secondary sectors (manufacturing). These create far more jobs especially at the bottom of the pyramid, which is quite important.
The third aspect is fiscal spending. Economic crises, a health crisis in this case, stem from demand. And demand is something that has to be worked on to get the economy back to its vitality. From that perspective, fiscal spending is important… Following the Asian financial crisis, we had GDP growth rates in 2000, 2001 and 2002 of 3.8 per cent, 4.8 per cent and 3.8 per cent, respectively. It was fiscal spending together with reforms that ended up bringing growth back to over 8 per cent up until the global financial crisis. Given that economic crises originate from slackness in demand, the role of fiscal policy in furthering demand is something that economists always advocate. So, from that perspective, there is scope for fiscal spending in the remaining months, especially given the fact that this year, India is going to have a current account surplus. In Q1, we had a current account surplus of $19.8 billion. That performance was partly because of the slackness in demand, and, therefore, imports being lower. But even if things are not as rosy as in Q1 from the current account perspective, it is quite likely that we may still end with about 1.5 per cent to 1.8 per cent of GDP as the current account surplus. And for an emerging country like India, a current account deficit, not surplus, of about 2% is recommended. A current account deficit means that you’re investing more than you’re saving, which is what emerging economies must do. That means there is a definite fiscal space, which can be used to push demand. And that can be done primarily by focusing on infrastructure because it has a large multiplier (effect).
ExplainSpeaking| How robust is India’s economic recovery post Covid-19 lockdown?
The government’s policy in terms of the lockdown was a humane one, focusing not just on the here and now, but for the long run because one of the pieces of research that got highlighted from the Spanish Flu episode was that geographical regions that had the lowest death rates were the ones that bounced back the fastest. Therefore, from a long-run perspective, that was the right thing to do.
P VAIDYANATHAN IYER: Are you worried about debt levels becoming unsustainable or a downgrade by credit rating agencies? Is this why the government has not aggressively gone ahead with fiscal spending?
First, you have to look at debt dynamics, which is affected by the interest rate growth rate differential. In other words, the extent to which the interest rate that is paid on debt is lower than the growth rate. If you look at India over the last two decades, the interest rate growth rate differential has been about 4 per cent, which means growth rate has been 4 per cent higher than interest rate. This is what provides debt sustainability. There is a lot of research in this area which shows that when the growth rate is much higher than the nominal rate of interest, debt sustainability is not a problem. In fact, higher the growth rate, lower the debt….
Second, foreign savings are providing us the opportunity to do fiscal spending.
The third is important from a macro perspective, especially for emerging economies. The 2013 ‘taper tantrum’ (the collective reactionary panic that triggered a spike in US Treasury yields) is a good example. It happens from overheating of the economy; overheating manifests in imports being excessively higher compared to exports. During the taper tantrum, the current account deficit (CAD) reached close to 6 per cent of GDP — a very high and intolerable level. (In such a case) inflation goes up because demand outstrips supply. This gets reflected in inflation and CAD. So, during the taper tantrum, the inflation was in high double digits. The combination of very high CAD and inflation is what emerging economies become vulnerable to. Now, look at the Covid crisis, which is very different from the typical emerging market crisis. First, it is a demand shock — decrease in demand. This then leads to current account surplus… So in other words, the potential impact on growth is something that we have to be wary of. Therefore, it is important to do fiscal spending.
The last is sovereign ratings. They are definitely impacted by the fiscal situation but they’re also impacted by growth. So, in this trade-off balance between growth and fiscal spending, right now, we have to lean on growth because that is what is most important… Even when a sovereign downgrade has happened in India, the impact, whether you look at it in terms of foreign exchange markets, equity markets, fixed income markets, or foreign portfolio investment, has not been that large… So, the bottom line is that this is a crisis, where we need to focus on growth.
SANDEEP SINGH: In September and October, data on economic indicators were looking up. How do you see the sustainability of that beyond the festive season? Also, despite the government’s push for credit growth, we are not seeing banks pushing the envelope. What is your opinion about the same?
Every year, this is time for the festive season. And year-on-year comparisons are done so that seasonality does not impact growth numbers. So, I think to attribute it only to the festive season is conceptually quite not right. In terms of sustainability, I think the only downside risk right now is a possible second wave. If that does not happen, I think recovery should continue. But because we are still amidst the pandemic, I would mention that as a big caveat… If pandemic numbers start increasing, uncertainty will increase… And it will have its impact. So that is one key area where there is a downside risk. But from the medium- to long-term perspective, and especially if you see why manufacturing is doing well… a part of it is because the need for social distancing is not as much, as in activities like travel and tourism, as well as due to the sector getting buoyant. This is because of the series of reforms that have been launched.
Labour market reforms have the potential to push manufacturing sector growth. From about 44 laws, we have now come down to four codes. Definition of wages, salaries, bonus, strikes etc, were written differently across these 44 laws. This made compliance difficult. The number of sections has come down significantly due to this reduction… The ability to cater employment to demand conditions gets enhanced significantly through the use of full-time equivalent, which is contractual employment (in) which workers have all the benefits of a permanent worker, except that it will be on (basis of) contracts, that can be tailored based on timing. So, particular industries can tailor their contracts based on demand conditions.
Another sector is agriculture, an area where value-added growth has been low because of various restrictions, of which the APMC ones were significant, and the Essential Commodities Act was another. Those have now seen reforms as well. The primary and secondary sectors, which account for significant employment, and, thereby, demand creation, now have enormous potential. So, from the medium- to long-term perspective, I see growth being robust, once we get through the pandemic.
An Expert Explains| Second wave, what next?
If there is one sector that still continues to disappoint, it is the financial sector. If you look at the penetration of credit in India, the average private credit to GDP is about 52 per cent. The OECD (Organisation for Economic Co-operation and Development) average is about 162 per cent, almost three times. In the Northeast, the penetration of private credit to GDP is less than 10 per cent. So, we have a huge distance to cover. If you look at that low amount of penetration together with the quality of credit — whether it was the 1998 episode, where we had a banking sector crisis or the recent one — most of the NPAs (Non-Performing Assets) come from large corporate loans… If you take the top 100 banks globally, we have only one bank, the State Bank of India, ranked 55, for a country that is the fifth-largest economy in the world. We should have had at least six in the top 100. If you look at China today, they have 18 banks in the top 100. The financial sector has to start punching close to the weight of the economy.
ANANTH GOENKA: Do you think we should be encouraging all types of competition in the banking space?
Not only in banking, in any sector… One of the key things that stands out across sectors is that innovation is brought a lot more by new entrants, not as much by incumbents, and they are the ones that push… I think entry is a very important part of disruption and innovation in the banking sector. I quite agree that we need far more entry, we need far more competition in banks….
I will give you a comparison. We are a population of almost 1.4 billion people and we have about 500-600 odd banks. The United States, which has a population of 350 million, has about 25-26,000 banks… I think this one fact illustrates that we certainly need far more entries in the banking sector, and that will bring competition, and competition will enable the banking sector… Fintech is something that we must enable… I am someone who thinks that the combination of finance and technology is something that India must embrace to enable the financial sector to grow.
ANANT GOENKA: In America, there are a lot of banks. But just six banks command a majority of the market share….
What you have to understand is that small banks are the ones that end up lending to small firms. The small bank-small firm linkage is very important for credit penetration… These small banks typically use a lot more ‘soft information’. They are on a first-name basis with the promoter, the proprietor, and they use that soft information. So that linkage is something that we need in India as well….
ANANT GOENKA: Going forward, would you advise the government to be more liberal with platforms like WhatsApp Pay, PayTM, which want to get involved in the financial sector in some form?
Technology in finance and fintech is here to stay. Whenever an innovation comes in, whether it’s a firm or a country, they try and resist that innovation… But there is a risk of falling behind and so we must consider these. We must evaluate them for both the costs and benefits and put in all the necessary measures to ensure that the banking sector retains its stability… There is easy opportunity for growth. When other countries are able to do it, we must also ponder over it.
PRANAV MUKUL: Where is India Inc lagging behind now? And what more can be done?
Think of the entire population as an income pyramid with the richer people at the top and those that are less privileged at the bottom. If you look at the products and services, they have been primarily catering to the top 15-25 per cent of the population in terms of the income pyramid… This is what is called a margin game. Companies play the margin game, which is when you create products and services for the top of the income pyramid. You typically can charge higher margins. And, thereby, your corporate strategy is focused on that. Then there is another model, which is a volume game where your margins are much lower but you multiply that small margin by a huge scale… You create products and services not just for the top 15-25% of the pyramid, but for the entire pyramid.
I’ll give you a couple of salient examples… FMCGs, and more broadly retail and microfinance. If you look at the kind of products and services that have been created in both these sectors, they have been the ones that match the cash flow stream of those at the bottom of the pyramid. The way our cash flow stream is… we get salaries at the end of the month, once a month, but the typical person at the bottom of the pyramid either gets daily wages or weekly salaries. Their amounts are lower, but they get it more frequently. And so, a microfinance loan that makes you repay once a week or maybe twice a week… is a product or service that is catered to the kind of cash flow stream that people at the bottom of the pyramid have.
So in the context of the Atmanirbhar Bharat push by the government, given the large population that we have, and therefore, the potential demand for consumer goods and services, there is ample scope for firms to also play the volume game, not just the margin game. Yes, those firms that want to play the margin game, fine, but there might be lots of other firms which can play the volume game, and, thereby, not only benefit themselves but also benefit the country by creating products and services for the entire population, and tap into a competitive advantage that India has, which is in terms of a large population….
If you look at the Chinese growth or the growth of advanced economies, those in Europe after the Second World War, or the US after the Great Depression, all of them grew by converting large sections of their population from low-income category to middle-income category… Therefore, it is important, for corporates to see this opportunity, put on their creative hats in their boardrooms and come up with products and services that can be delivered for the entire population. That’s the main sort of nudge I want to provide… something which is good for the corporates themselves.
Why Krishnamurthy V Subramanian
As CEA, Krishnamurthy V Subramanian is a key influencer on economic policy-making in India. His idea of Thalinomics (akin to the Big Mac Index) and push for behavioural economics of nudge in Economic Surveys of the past two years have been widely noticed. Post lifting of lockdown, he was one of the first to project a V-shaped recovery in September, now reflected in economic data indicators
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