Former RBI boss warns that bad loans will mount in the banking sector
The pandemic is India’s greatest emergency perhaps since Independence, says Raghuram Rajan
NEW DELHI :
Former Reserve Bank of India (RBI) governor Raghuram Rajan has urged the Narendra Modi administration to prioritize spending on the poor and warned that bad loans could rise due to the coronavirus pandemic, calling it the nation’s “greatest emergency perhaps since Independence".
Rajan, who is currently professor of finance at Chicago Booth, US, said in a blog post that prioritizing spending on the needy could help them see them through the crisis months ahead. Failure to do so could have consequences, he said, citing the mass movement of migrant labour that has already taken place.
“Another would be people defying the lockdown to get back to work if they cannot survive otherwise. Spending on the needy at this time is a high priority use of resources, the right thing to do as a humane nation, as well as a contributor to the fight against the virus," Rajan said in his blog posted on LinkedIn.
The economist, however, said that India cannot, at the same time, lose sight of its financial constraints. Unlike developed economies such as the US or Europe, which can spend 10% of GDP without fear of a ratings downgrade, India has entered this crisis with a huge fiscal deficit, and will have to spend even more, he said.
A ratings downgrade coupled with a loss of investor confidence could lead to a plummeting exchange rate and a dramatic increase in long-term interest rates in and substantial losses for India’s financial institutions, he said.
Many economists have been urging the government to come out with a fiscal stimulus package to salvage the economic growth rate and save jobs, arguing factory closures and a lockdown are set to take a heavy toll on economic growth.
According to Shamika Ravi, director of research at Brookings India, India need not wait any longer before announcing a big fiscal stimulus package. “We should be prepared for a strategy of ‘whatever it takes’ to fight back the coronavirus pandemic and its impact on the economy. That means, we should be having a response that works out to 4-5% of GDP. Our initial response—the welfare package—was very humanitarian in nature. Overall, given the uncertain nature of the pandemic, we will have to frontload the economic response," she said. “India cannot afford to wait for long to get clarity on the impact of the pandemic before announcing the economic response."
Rajan, who had previously served as chief economist at the International Monetary Fund, also warned that bad loans will mount in the banking sector, including in retail loans as unemployment rises.
“The RBI should consider imposing a moratorium on financial institution dividend payments so that they build capital reserves," he said.
He suggested that the government accept responsibility for the first loss in incremental bank loans made to small businesses, up to the quantum of income taxes paid by such entities in the previous year. This, Rajan argued, will recognize the likely future contribution of small businesses to the exchequer and reward them with easier access to funds.
He recommended the strong measures as the coronavirus pandemic has affected jobs and businesses in a bigger way than even the shock caused by the global financial crisis of 2008-09. He said that with the right resolve and priorities, however, India could take control over the situation and set the stage for a better future.
The three-week lockdown, he said, is the first step, which buys India time to improve its preparedness. “We should now plan for what happens after the lockdown, if the virus is not defeated. It will be hard to lock down the country entirely for much longer periods, so we should also be thinking of how we can restart certain activities in certain low-infection regions with adequate precautions," he said.
Rajan also urged the government to take the support of people with proven expertise and capabilities to manage the situation. “It may even want to reach across the political aisle to draw in members of the opposition who have had experience in previous times of great stress like the global financial crisis," he said.
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