BackMoving from slogans to policies and programmes
We must raise the rate of investment in the Indian economy and push for reforms which will increase efficiency and productivity
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Slogans are the “front end" of economic strategy. They are the catchy formulations designed to capture public attention without making it clear how exactly the objective will be achieved.
“Sab Ka Saath Sab Ka Vikas", is the current slogan of the National Democratic Alliance (NDA) government. It is almost a repackaging of the 11th Plan’s somewhat academic title “Inclusive Growth", into a much catchier Hindi version. It sounds good, but it needs to be translated into quantitative targets. Performance can then be measured against these targets, and policies and programmes outlined that will achieve these targets.
Growth targets
Vikas means development and the most commonly used measure of vikas is growth of gross domestic product (GDP). So let us start by identifying the growth target being promised. Sab Ka Vikas also implies a distributional assurance but I leave that for another column.
In the old days growth targets were laid down in Five Year Plans. In the “post planning world" that we now live in, they have to be inferred from other official documents. The first Economic Survey of the NDA government, published in February 2015, said that the “economy was poised to move to double digit growth". No specific date was mentioned for the new dawn, but four years later, we are certainly nowhere near double digit growth. Two recent pronouncements by the prime minister (PM) are relevant in this context. First, he said we should try to become a $5 trillion economy by 2025. Second, he has said the time has come to move to double digit growth. How does performance thus far stack up against these targets?
Most independent analysts think that GDP (GVA, or gross value added concept) will grow by about 7.4% in 2018-19. If this is achieved, the Narendra Modi government will have averaged about 7.2% per year in its five years. This will be about the same as that under United Progressive Alliance (UPA) II, despite the benefit of an oil price bonanza. It will be well below the growth rate of 8.4% delivered by UPA I.
NITI Aayog, in its “Three Year Action Agenda" published a year ago, said the economy could get to an “8%-plus" trajectory in another “two to three years if not sooner". This would imply a significant acceleration from 7.4% in 2017-18 to something above 8% in 2019-20, and even higher subsequently. The International Monetary Fund’s (IMF’s) April edition of the World Economic Outlook projected India’s GDP growth exceeding 8% in 2021. These are projections of what is feasible if (a) policies followed are sufficiently supportive of growth and (b) the external environment does not deteriorate. Since the external environment has deteriorated—with threats of trade wars growing by the day and also a firming up of oil prices, we may see a downward revision in the IMF’s projections in the revised edition due in a month or so.
This suggests that GDP growth may not clock “8% plus" in the next two years. However, even if we grow at only around 7.5%, we will still be the fastest growing large country among the emerging markets. We will not be on course to meet the PM’s target of becoming a $5-trillion dollar economy by 2025. That would need growth rate of 8.5% over the next eight years.
Our real problem is that 7.5% growth will not be enough to create the number and quality of jobs we need. It will also not significantly increase our global footprint or clout in the next few years. For those outcomes we have to aim much closer to the PM’s target of double digit growth. The lowest double digit number is 10 and we should try to work out what is needed to achieve 10%.
China did grow at more than 10% per year for 30 years. But they reformed relentlessly from 1980 onwards to achieve this feat. They also faced a much more supportive global trade situation. The question to ask is are we in a position to take the steps needed to achieve something along these lines? Even if we can’t get to 10%, can we at least get to 9%? UPA I actually averaged 9.3% growth in the three years 2005-06 to 2007-08? Setting a target of “9% plus" requires action on two broad fronts. We must raise the rate of investment in the economy and push for reforms which will increase efficiency and productivity.
The rate of investment
The rate of investment (gross fixed capital formation as a percentage of GDP) had reached a peak of 33% in 2007-08 and then declined to 31.8% in 2011-12. The new national accounts series raised the base year ratio for 2011-12 to 34.3%, but it also showed a continuing decline from that level to 28.5% in 2017-18.
An investment rate of 28.5% may suffice for 7%-plus growth, but it is certainly not enough to bring about a substantial acceleration to 9%. Ideally, we need to increase the investment rate by 4 to 5 percentage points of GDP to get the economy back to a 9% growth trajectory which was achieved in 2007-08. Furthermore, at least half the additional investment needs to be in infrastructure.
Policies and programmes to increase productivity
What are the policies and programmes that will achieve this objective? Action will be needed on several areas, but in this column I discuss just one: fixing the problems facing public sector banks . If we fail on this count, we can forget about even 8% growth.
Two years ago, the finance ministry enumerated four “R"s that were critical for fixing the banks: recognition, resolution, recapitalization and reform. Recognition was satisfactorily accomplished as an outcome of the asset quality review triggered by then Reserve Bank of India (RBI) governor Rahguram Rajan in 2015. The scale of non-performing assets (NPAs) turned out to be much larger than earlier thought. The latest Financial Stability Review released by the RBI shows the problem not getting better. It is likely to worsen next year.
Resolution made very little progress because bankers were reluctant to accept any package which involved large haircuts. This problem has now been resolved with the RBI directing the banks to refer their troubled assets to the insolvency process under the new Insolvency and Bankruptcy Code. This ensures a time-bound resolution of a large proportion of NPAs through either takeover or liquidation. Bankers will be able to justify accepting large haircuts as long as they get a better deal than what they would get under liquidation. Thus far, the courts have resisted the attempts of vested interests to stall the process and the first few successes have begun to come through. However, it is clear that successful resolution will involve substantial haircuts for the banks, leading to large losses. This will increase the scale of recapitalization needed.
The government has rightly taken the view that recapitalization without reform of the public sector banks would achieve little. Unfortunately, they have yet to take the next step of outlining a coherent strategy of recapitalization and reform. The government has five options, each of which poses problems. They don’t have to choose one option for all banks. Some banks could go through one route while others take another.
(i) Government could try to attract new private capital into the public sector banks and allow the government’s equity to be diluted below 50%, but without giving the new investors any strategic partner status with a role in management. It is not clear that substantial investment would be attracted on these terms, but in any case the government must outline the governance reforms it is willing to put in place in banks where the government will now have technically a minority stake, but still a dominant one.
(ii) Attract new private sector investors into the banks as strategic partners, with some role in management. In these cases, the government would have to reach an agreement with the new strategic partner on what role it will have, and this could be built into the shareholders agreement. The arrangements can be tailor made.
(iii) Retain majority control and recapitalize through the budget. This option implies bearing a large fiscal burden. The PM has recently reaffirmed that the government will stick by the fiscal consolidation path announced. This may rule out any substantial budget-based recapitalization. In any case, the government should outline what governance reform is intended for banks which will remain majority government owned. An obvious reform crying out for implementation is to make all public sector banks subject to the same regulatory oversight by the RBI that it currently enjoys over private sector banks. Governor Urjit Patel has made it amply clear that the RBI wants this reform to be implemented.
(iv) Recapitalize banks through a public sector financial institution, as is reported to be under consideration in the Life Insurance Corp. of India/IDBI Bank case. This avoids a budgetary outgo, but it is too obviously a subterfuge and will adversely affect the credibility of the government’s commitment to reforms. In my view, it is best avoided.
(v) Leave the bank with inadequate capital, and have the RBI trigger prompt corrective action effectively limiting expansion in commercial credit, and making the bank a “narrow bank" investing all its resources in government securities.
Each of the options involves some difficult decisions, but since going below 50% requires legislative amendments, time is rapidly running out. If we end up with no decision before the next election, we will have lost a whole five years in making progress on a critical area. The finance ministry will have done what bankers are often accused of doing in the context of managing NPAs: kicking the can down the road for their successors to take up!
Montek Singh Ahluwalia was the deputy chairman of the erstwhile Planning Commission. Comments are welcome at views@livemint.com.
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