Raghuram Rajan says India's GDP contraction should alarm everyone
Raghuram RajanIANS (File photo)

Raghuram Rajan says India's GDP contraction should alarm everyone

Former RBI Governor underlines importance of Government-provided relief at this juncture

New Delhi, September 7, 2020

Former Reserve Bank of India (RBI) Governor and well-known economist Raghuram Rajan has said that the 23.9 per cent contraction in the Indian economy should alarm everyone and and underlined that Government-provided relief became all the more important at this juncture.

"This has been meager; primarily free food grains to poor households; and credit guarantees to banks for lending to small and medium (SMEs) firms, where the take down has been patchy," Dr Rajan, who is currently the Katherine Dusak Miller Distinguished Service Professor of Finance at The University of Chicago Booth School of Business, said.

"The government’s reluctance to do more today seems partly because it wants to conserve resources for a possible future stimulus. This strategy is self-defeating," he said in an article posted on LinkedIn.

The former IMF Chief Economist's remarks came a week after the August 31 release of the quarterly GDP growth numbers for the first quarter of FY 2020-21.

He said the numbers would probably be worse when the estimates of the damage in the informal sector come in and compares with a drop of 12.4 per cent in Italy and 9.5 per cent in the United States, two of the most COVID-affected advanced countries.

"Yet India is even worse off than these comparisons suggest. The pandemic is still raging in India, so discretionary spending, especially on high-contact services like restaurants, and the associated employment, will stay low until the virus is contained," he said.

Arguing for government-provided relief, Dr Rajan said, "If you think of the economy as a patient, relief is the sustenance the patient needs while on the sickbed and fighting the disease. Without relief, households skip meals, pull their children out of school and send them to work or beg, pledge their gold to borrow, let EMIs and rent arrears pile up…Similarly, without relief, small and medium firms – think of a small restaurant -- stop paying workers, let debt pile up, or close permanently. Essentially, the patient atrophies, so by the time the disease is contained, the patient has become a shell of herself.

"Now think of economic stimulus as a tonic. When the disease is vanquished, it can help the patient get out of her sickbed faster. But if the patient has atrophied, stimulus will have little effect. Even if they start earning, indebted households will not consume freely, especially if they believe they have to manage further periods without livelihoods or government help. Similarly, even small and medium firms that have stayed open but have huge unpaid bills and interest will not be able to function well. Without relief measures, the growth potential of the economy will be seriously damaged," he said.

According to him, government officials who hold out the possibility of a stimulus when India finally contains the virus are underestimating the damage from a more shrunken and scarred economy at that point.

"Obviously, because of the pre-pandemic growth slowdown and the government’s strained fiscal condition, officials believe it cannot spend on both relief and stimulus. This mindset is too pessimistic, but the government will have to expand the resource envelope in every way possible, and spend as cleverly as possible. It also has to take every action that can move the economy forward without additional spending. All this requires a more thoughtful and active government. Unfortunately, after an initial burst of activity, it seems to have retreated into a shell," he said.

Dr Rajan said that, on the resource front, India could borrow more without scaring the bond markets if it committed to return to fiscal viability over the medium term – for example, by setting future debt reduction targets through legislation, and committing to honest and transparent fiscal numbers with a watchdog independent fiscal council.

"In addition to borrowing, it should prepare public sector firm shares for on-tap sale, to take advantage of every period of market buoyancy. The current period of buoyancy already looks like a missed opportunity. Many government and public sector entities have surplus land in prime urban areas, and those too should be readied for sale. Even if sales do not take place immediately, preparations for sale, as well as an announced time-table, will give bond markets greater conviction the government is serious about restoring fiscal stability.

"Turning to government spending, the key will be to prioritize. MNREGA is a tried and tested means of providing rural relief and should be replenished as needed. Given the length of the pandemic, more direct cash transfers to the poorest households, especially in urban areas that do not have access to MNREGA, is warranted.

"The government and public sector firms should clear their payables quickly (something that has been talked about for years) so that liquidity moves to corporations. In addition, small firms below a certain size could be rebated the corporate income and GST tax they paid last year (or some portion thereof), with the rebate tapering off with firm size. This would be an objective way of helping small viable firms based on a hard-to-manipulate metric, even while rewarding them for their honesty. Finally, the government will likely have to set aside resources to recapitalize public sector banks as the extent of losses are recognized," he said.

Dr Rajan said the private sector should also be urged to give a helping hand. Cash-rich platforms like Amazon, Reliance, and Walmart could help smaller suppliers get back on their feet, even funding some of them. All large firms should be incentivized to clear their receivables quickly, he said.

"As the various payment moratoria come to an end, a number of entities will be unable to repay. Instead of reacting in a piece-meal way, the government should have a well-thought-out plan to deal with the coming financial distress," he said.

"Given the depth of the contraction, stimulus will also be needed, especially investment in infrastructure construction which creates jobs and increases demand for all manner of inputs like cement and steel. The center should replenish the coffers of the state governments, which typically spend more on infrastructure. This can be accounted for as part of the GST dues the center owes the states. In addition, the center should notify shelf-ready projects that are in the National Infrastructure Pipeline for implementation. Given the lead time for such spending, all this should happen now," he said.

"Reforms can be a form of stimulus, and even if not carried out immediately, a timeline to undertake them can boost current investor sentiment. The world will recover earlier than India, so exports can be a way for India to grow. For that to happen, the government has to reverse its recent raising of tariffs so that inputs can be imported at low cost," he said.

"To improve our competitiveness, long debated reforms to land acquisition, labor, power, and the financial sector should be implemented, as should recently announced reforms in agriculture. Temporary half-baked 'reforms', such as the recent suspension of labor protections in a number of states, will do little to enthuse industry or workers, and give reforms a bad name.

"India needs strong growth, not just to satisfy the aspirations of our youth but to keep our unfriendly neighbors at bay. The recent pick-up in sectors like autos is not evidence of the much awaited V-shaped recovery. It reflects pent-up demand, which will fade as we go down to the true level of demand in the damaged, partially-functioning, economy.

"No doubt, the government and its bureaucrats are working hard as always, but they need to be frightened out of their complacency and into meaningful activity. If there is a silver lining in the awful GDP numbers, hopefully it is that," Dr Rajan added.


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