The news from the economic front cannot get more depressing. First, the Central Statistics Office (CSO) on Tuesday released its advance estimates for the current fiscal, pegging down the growth estimate to 5 per cent. This was in sync with the Reserve Bank of India’s growth estimates. This estimate is the lowest in the last 11 years.
The very next day, the World Bank put expected growth at 5 per cent, down from the earlier estimate of 5.6 per cent.
More importantly, in the CSO numbers, manufacturing growth was estimated at 2.5 per cent, a sharp fall from 2018-19’s estimate of 6.9 per cent. This is also in sync with the general mood and trends seen in the corporate sector, where gross capital formation has been falling continuously the last few years.
More worryingly, there has been a steady decline in private consumption over the years, though the government has withheld releasing the NSSO data, citing problems with methodology.
‘Big-bang’ measures
The government, for its part, over the last few months, has been coming up with measures to reboot the economy. First was the move to consolidate public sector banks and streamline their functioning with the aim of reducing the bad loans and stressed balance sheets of banks.
Then came the next ‘big-bang’ reform of cutting corporate tax rates, where existing companies will pay only 22 per cent and the new ones 15 per cent.
A few weeks ago, Arvind Subramanian, former Chief Economic Advisor, came out with a damning assessment of the economy which, he said, was in the intensive care unit.
In a joint paper with Josh Felman, former IMF India chief, Subramanian says that first came the ‘twin balance sheet’ problem, where loans taken by infrastructure firms started turning ‘bad’ resulting in the bad loans mess, especially in the public sector banks.
Now he says that this ‘twin-balance sheet’ problem has morphed into a ‘four-balance sheet’ problem, with the IL&FS crisis sparking off a major downward spiral in the NBFC or ‘shadow’ banking sector. Apart from the two original sectors – infrastructure companies and public sector banks; we now have two more sectors — NBFCs and real-estate companies.
The risk-averse environment
Given the stressed balance sheets of public sector banks, real-estate firms turned to NBFCs for loans which, in the absence of bank lending, turned into a major source of finance. When the real-estate bubble burst, the NBFCs got into deep trouble, starting with IL&FS, staggering under a ₹90,000-crore debt.
All these factors, according to Subramanian and Felman, have led to a deeply risk-averse environment, leading to high interest rates.
As far as remedies are concerned both these economists are clear that the standard macro-economic tools of monetary and fiscal policies will not work. In the monetary realm, cutting interest rates won’t work in an environment beset by risk aversion. Despite the RBI cutting the repo rate last year, lending rates are still ‘punishingly high’, at 6 per cent and above.
The paper’s authors also say there is no space for fiscal stimulus, given the already precarious fiscal situation. And expanding the deficit will further increase interest rates and crowd out private investments.
Is there a way out?
According to Subramanian and Felman, there is no easy way out of this mess. The solutions will decidedly be in the medium to long term.
First, the Centre will have to fix the ‘four balance sheet’ problem. This includes the five Rs — recognition, resolution, regulation, recapitalisation and reform.
Recognition will entail the start of a new asset quality review to cover banks and NBFCs. Under resolution, first, the IBC (Insolvency and Bankruptcy Code) needs to be better aligned with incentives. And, second, ‘bad banks’ or asset reconstruction companies for the real estate and power sectors need to be created. In terms of regulation, better oversight of NBFCs is suggested and for recapitalisation to be linked with reforms. The authors also recommend cutting down the number of public sector banks.
All eyes are now focused on the Budget, which is barely three weeks away. There is talk of a cut in income-tax rates to put more money into people’s pockets to increasing spending and consumption.
But Nobel Laureate Abhijit Banerjee, in a recent interview, said there is no evidence to suggest that a cut in tax rates will fuel growth. He says there is an urgent need, in the short term, to put more money into the hands of the rural poor, for which the expansion of MGNREGA is essential.
These are truly distressing times for the economy. For the government, there is no magic wand that can set things right immediately. But the very least the government can do is to acknowledge that we are in the midst of a crisis instead of incessantly talking about creating a $5-trillion economy.