The economic narrative in India has rapidly evolved. As recently as October, the policy was focused squarely on preserving macroeconomic stability as external imbalances rose to unsustainable levels and the rupee came under relentless pressure. With global crude prices collapsing since then and domestic food prices remaining exceptionally benign, stability concerns have receded.
Instead, rising agrarian distress and the (chronic) headwinds confronting small and medium enterprises (SMEs) have taken center stage. Extrapolating from this, some are fearing a more generalised and sustained slowdown. This has inevitably led to calls for some easing — fiscal, monetary, regulatory. The agrarian distress has already resulted in 10 states announcing farm loan waivers over the last two years. Now, there is a growing clamour among commentators to introduce unconditional cash transfers to serve as income support for distressed farmers nationally, as has been attempted in Telangana and Odisha. Separately, with food inflation dramatically undershooting and pulling down headline inflation with it, markets are expecting imminent rate cuts. Finally, banks continue to argue for some regulatory easing and forbearance. In other words, 2019 could witness an inadvertent confluence of fiscal, monetary and regulatory easing.
This would be a very dangerous path to tread, in our view. First, fears of a growth slowdown are overstated. Near-term prospects have meaningfully improved, as crude prices have collapsed, monetary conditions have eased, and banks have quickly stepped in to fill any void left by non-bank-financial-companies (NBFCs). Crude at $60 in the coming months versus $75-80 in the first half of the fiscal, will amount to a meaningful positive terms-of-trade impulse that boosts household purchasing power, increases farm margins and creates some fiscal space.
Second, bond yields have fallen by almost 70 bps from their highs and, even accounting for some increase in NBFC spreads, monetary conditions have eased to a two-year low. Third, non-food bank credit growth has picked up sharply, accelerating to a four-year high of 14 per cent, suggesting banks are quickly and increasingly stepping in to fill some of the NBFC voids. Finally, while the collapse in food prices hurts farmers’ purchasing power and rural consumption, it helps urban consumption. Yes, year-on-year growth in the second half of 2018-19 will moderate sharply — but largely optically on account of adverse base effects from the sharp growth at the end of last year — and, therefore, should be looked through.
Further, we estimate “output gaps” in India have virtually closed, reflected in rising capacity utilisation and the firming of core inflation recently. Against this backdrop, the confluence easing in 2019 — inadvertent as it may be — would simply exacerbate underlying imbalances and sow the seeds of future macroeconomic instability.
Fiscal exhaustion: Fiscal space is particularly constrained. We estimate the total public sector borrowing requirement (Centre, state, off-balance sheet, central public sector enterprises) was still a hefty 8.2 per cent of GDP in 2017-18, the same level as five years ago. To be sure, the Centre has been bringing its deficit down, but this has been completely offset by state deficits, off-balance sheet borrowing, and central public sector-enterprise borrowing rising commensurately.
Unsurprisingly, this has led to fiscal exhaustion among markets. The slope of India’s government yield curve has continuously risen in recent years, as borrowing remains elevated, and policymakers remain wary of more foreign participation in the market, while correctly trying to reduce financial repression within the banking system. The upshot: For any given overnight interest rate the RBI sets, benchmark 10-year borrowing costs in the economy are higher than they used to be. The implication is clear: Any fiscal relaxation at this point will become counter-productive, pushing up borrowing costs and crowding out economic activity.
Fiscal imbalances also have their external counterparts. The current account deficit (CAD) is simply an economy’s investment-savings gap. Public dis-savings remain elevated. Therefore, the main reason the CAD narrowed is because private investment slowed so sharply. If the private investment cycle picks up — as we all hope — the CAD would balloon, unless the public-sector imbalance reduces. In other words, without more fiscal consolidation, we will always be choosing between a sustainable CAD and higher private investment.
The policy challenge: There is, therefore, absolutely no space for new unfunded liabilities. The pace at which farm loan waivers have been proliferating is worrying, even though budgetary allocations have been much lower than announcements. As is well known, loan waivers are a particularly blunt instrument suffering from the familiar pitfalls of vitiating credit culture, addressing the symptom, not the underlying cause, and disproportionately favouring larger farmers who rely on institutional credit.
Consequently, a slew of commentators have proposed direct, unconditional, cash transfers as income support for farmers. A variety of proposals have been mooted from paying farmers the difference between market prices and minimum support prices (MSPs) in cash, to a broader quasi-universal basic income that covers 25-50 per cent of the population, costing anywhere from 1-5 per cent of GDP based on their expansiveness.
The question is how will this be paid for, given that India’s fiscal cup runneth over? The policy challenge, therefore, is to either find the fiscal space for cash transfers by reducing existing subsidies and welfare programmes, or to offer either existing product subsidies or equivalent cash transfers, but not both. In the current environment, both options look politically daunting.
Could the RBI’s excess capital pay for income support? Even without going into the merits of this, it’s important to understand the economic impact. For starters, any RBI special dividend will either be one-off or staggered over a few years, whereas any new farm-income-support creates a perpetual liability. Second, from an accounting perspective, the fiscal deficit will not widen because the additional expenditure will be paid for by the transfer of capital from the RBI. But we should not conflate the accounting with the economics. If the transfer, for example, is spent on cash transfers — instead of retiring public debt — the “effective fiscal impulse” will increase by the full quantum of that spending tantamount to a fiscal stimulus, with the attendant implications on pressurising macroeconomic imbalances.
Monetary and regulatory easing : Will the pressure on the fiscal be accompanied by monetary and regulatory easing? The collapse in food inflation has meant that headline CPI has been undershooting market and RBI expectations and prospects of some monetary easing have risen in the first half of 2019.
Separately, there is growing market/bank clamour for some regulatory easing towards banks. Policymakers must eschew this. NPAs appear to have peaked, the IBC has changed the debtor-lending balance of power, the government has injected more capital, and credit growth has increased smartly in recent months. The tough medicine of the recent years has finally begun to bear fruit. Lowering lending standards through any regulatory easing at this stage, risks undoing accruing gains and triggering a fresh wave of NPAs down the line.
Don’t draw the wrong lessons: 2019 has begun with benign crude prices, providing much-needed breathing space to India. But India cannot get complacent in this environment and inadvertently indulge in any excesses. India’s growth prospects have improved, and there is no case, or space, for an inadvertent confluence of fiscal/regulatory/monetary easing.
More fundamentally, it’s important we don’t draw the wrong lessons from the last five years. Policymakers must be complimented for pursuing some tough — but necessary — medicine in recent years: Inflation targeting, asset resolution in the banking system, and a reduction at least of the central fiscal deficit. This progress should not be mistakenly held responsible for the collapse of food inflation or the continued unviability of the SME sector. Resolving the stress in agriculture and SMEs is imperative but requires well-known supply-side reforms to improve scale, productivity and viability.
Instead, if the political consensus for keeping inflation down weakens on account of the collapse in food prices, or the political consensus to resolve the twin-balance sheet problem softens, so as to hasten credit-flow to certain sectors, or the political consensus to stick to a path of fiscal consolidation back-slides, the hard-earned gains of recent years risk being eroded. We think that would be a travesty. Let’s not throw the baby out with the bathwater.
This article first appeared in the January 11, 2019, print edition under the title ‘No easy transfers’