Moody's rating action and the Rs 28 trn revenue push

The present growth slowdown is the combined impact of many factors, some unavoidable. First, the informal shift to inflation targeting happened at a time when the Indian economy was recovering from the high inflation episode. The emphasis on controlling inflation meant a benign neglect of growth. Second, the asset quality review (though necessary) and the prompt corrective action mechanism initiated during the downswing of the business cycle made banks rightfully conservative in lending. Three, the introduction of several structural measures (like GST, that were delayed for long) and implemented within a short period did have an impact on economy in the short term despite their intentions being noble. Fourth, the ultra-conservative fiscal hawkishness and calibrated monetary tightening during 2018, particularly when the economy was beleaguered with capital outflows, choked systemic liquidity and dampened the animal spirits. Fifth, the recent NBFC crisis choked market liquidi­ty from non banks. Finally, the subdued gl­obal economy ensured external demand re­mained weak and failed to stimulate de­mand. Together, these factors depressed sentiments and stymied demand.
 
The objective of this piece is not to do a post-mortem of the reasons for the slowdown. Rather, our aim is to first underst­a­n­d some of the common fallacies resulting in policy mistakes that could have been avoided. Next offer some out of the box thoughts on tackling the slowdown. In this context, the measures announced by the government to set up an alternative real estate fund is a step in the right direction.
 
Now the mistakes. First, given the supposed lack of fiscal space, should rate cuts by the RBI continue? The cumulative red­u­­ction of the policy rate by 135 bps since F­e­bruary should be given adequate time to permeate down and stimulate demand. It is almost certain that more rate cuts will ha­ppen in the current fiscal and the external benchmarking might ensure upto 50 bps lending rate reduction over the next fo­u­r to six months. However, we are now w­o­­rried that too low rates of EMIs on housi­n­g and automobiles, while spurring d­­­e­­­mand momentarily, may fuel debt-fi­n­a­nced consumption and lead to greater credit offtake. The latter might turn illusory if weak sentiments continue. More importantly, bank depositors must be compensated at least to the extent of his/her interest income adequate to meet inflation.
 
Second, did the AQR and, specifically, the subsequent PCA norms, choke bank lending? Empirical evidence shows that penalising banks for past actions is not the best way to make the financial markets work better. Markets remain fundamentally procyclical, and punishing them for past mistakes may increase such procyclicality, especially during a weakening growth cycle. Interestingly, in the US during the savings and loan crisis, the larger institutions were deliberately kept out of the PCA norms.
 
Third, the overemphasis on 3 per cent fiscal deficit defined in the Maastricht T­r­­eaty and adopted wholeheartedly in In­d­ia in times of growth weakness results in costs far outstripping the benefits of ma­cro stability. As an example, the fiscal conservatism prevented growth from returning and now we are stuck in a trap as with low growth, the fiscal deficit will jump and there might be more rating action like that of Moody’s (thankfully, markets have discounted that). But in such circumstances, often the use of non-tax revenues to meet fiscal deficit by the government could be fallacious — non-tax revenue growth is inelastic to GDP growth.
 
Higher non-tax revenue growth can cause sectoral imbalance. A case in point is the telecom sector which witnessed an increase in leverage in 2010 when a major spectrum auction happened. Leverage which stabilised in FY17, increased in the past years. For FY19, the leverage ratio has increased largely due to an erosion in the net worth. The alternative to targeting fiscal deficit is that like most advanced economies and several emerging market economies India should target a structural deficit, which serves as an automatic counter-cyclical stabiliser.

The stimulus must come from fiscal policy which would immediately stimulate consumption demand and investment demand later. Lower income tax rates may be necessary to stimulate consumption demand while a corporate tax rate cut would spur investments with a lag.
 
There are a couple of things the RBI and the government can do in the current context. First, given the crisis of confidence in the financial markets it is imperative that central banks don’t forget their primary function of being the lender of the last resort. Alternatively, it is imperative that the RBI backstops against good quality collateral. They must be identified to ensure the stability of NBFCs so that they can meaningfully withstand any worsening of the situation, both in terms of access to liquidity and in terms of absorbing potential losses. The provision of liquidity is the ultimate responsibility of any central bank and it has been successfully done by the US Fed during the 2008 crisis and later. Why can’t we?
 
Next, aggressive monetisation of government assets. Let us put some numbers to it. According to OECD statistics, in 2010 government financial assets had amounted to 33-43 per cent of GDP in eurozone countries like Greece, Ireland, Portugal, Spain, France, Germany and so on. In 2018, these countries have aggressively used such enormous wealth to their own advantage. There are various ways of doing this. An obvious one is the privatisation of some of the state’s assets, and using the proceeds to reduce the stock of government debt. Disposing government assets has no effect on the fiscal position and can also address liquidity problems.
 
We did a dipstick analysis in the Indian context and found that for 212 CPSE/state government entities, the total stock of such wealth could be at least Rs 28 trillion or 15 per cent of GDP. Interestingly, the government can even securitise such assets and use them to offer protection to bondholders or to guarantee the backstop for the fi­n­­ancial sector in case it wants to avoid ma­rket volatility and does not want to dispose of public assets that are strategic in n­ature — such as telecom, energy and so on.
 
Finally, the government is doing the correct thing in addressing sector-specific problems. NBFC, telecom, roads, power and real estate are sectors that require attention and there must not be any negative sector specific policy surprises in the current uncertain environment.
 
The author is group chief economic advisor, State Bank of India. Views are personal