Opinion | An out-of-the-box solution for India’s stimulus problem

In October 2008, the Reserve Bank of India (RBI) announced a backstop facility to help mutual funds (MFs) survive redemption pressure. Panicky investors selling MF units caused its net asset value to plummet, reinforcing the panic and selling. The backstop gave them indirect liquidity support. Its mere announcement calmed nerves and the redemption pressure eased. The facility never had to be used, since MFs had adequate liquidity to cater to moderate levels of redemption. Indeed, India survived the Lehman crash and mortgage crisis in North America. Never mind that the accompanying fiscal stimulus of 2009 proved excessive and lasted much longer than desired, leaving behind high inflation, made worse by the currency tantrums of 2013.

Rewind to that famous summer of 1991. With foreign exchange stock of less than a billion dollars, India chose an emergency airlift of gold to pledge as collateral for a dollar loan. Unlike the MF backstop, this was not just a verbal promise, but was also matched by the physical transfer of bullion to Zurich. The larger point is that the country chose to pledge gold rather than suffer the ignominy of a default. It’s a different matter that many other countries, including developed ones, have in the past defaulted and gotten away, even getting a better rating than India. That’s geopolitics, but the fact remains that India averted a default. Subsequently, landmark economic reforms were announced, economic growth took off, the pledged gold was retrieved in less than 18 months, and foreign exchange piled up.

These two anecdotes are worth recalling as they have elements of out-of-the-box thinking, without crossing the boundary of recklessness. The present crisis, too, is of gigantic proportions. There is simply no alternative to injecting a strong dose of fiscal stimulus to revive aggregate demand and economic growth. There is a near consensus on the imperative of a fiscal rescue package. The debate is on its size and composition.

Can we afford 5% of gross domestic product (GDP) , equivalent to ₹10 trillion, as additional fiscal spending? There are principally four objections to this. It could lead to inflation, push up interest rates and crowd out private investment, depreciate the currency, and hurt India’s sovereign credit rating. Risks on account of the first three are benign. But the fourth risk is worth pondering. What level of debt can India sustain, especially with growth so weak? Won’t the economy collapse if we indulge in rampant print-and-spend? The fiscal deficit limit imposed by the Fiscal Responsibility and Budget Management law will anyway be breached, simply because the denominator (GDP) is shrinking. Rating agencies worry about debt servicing capability in the future. Would there be adequate growth in tax revenues tomorrow to pay for the debt binge of today?

Can fiscal spending be expanded without increasing the burden on Indian taxpayers later on? The solution may lie in the concept of “promoter lending”. Debt is only one side of the balance sheet of a sovereign. It also has an asset side, which can be monetized. We are not talking about selling off land parcels, which the state has plenty. Or even selling spectrum at sky-high prices, which is currently infeasible. The asset which is readily available is the sovereign share holding in companies, and these could be pledged. This possibility has been suggested by former finance commission chairman Vijay Kelkar. Promoters routinely raise funds by pledging shares in their companies. In case the share value falls, they bring more shares or cash to keep the loan well collateralized. Else, the lender has the right to sell these shares. In the same spirit, India’s government can consider pledging its shares in public sector enterprises (PSEs), whose custodian is the department of investment and public asset management (Dipam). This could be structured not as “loan against shares”, but as a repurchase obligation transaction between RBI and the government. It could be a five-year repo, and the loan-to-value ratio can be 100% based on current stock market conditions. Dipam’s website mentions 58 listed companies, with a market value of about ₹10 trillion even in these subdued times. That’s 5% of GDP. In addition, the government could consider pledging shares of the unlisted Life Insurance Corporation of India, whose market debut value is expected to be another 4% of GDP. But we need not wait for its listing, and can pledge its shares even now. Even the shares held by Specified Undertaking of Unit Trust of India, or Suuti (value: ₹50,000 crore) could be pledged. RBI has already announced three-year repo funds for banks at very low interest rates. Surely, PSE shares-based repo loans to the sovereign can be at 3%. This would reduce the weighted average cost of borrowing. It will also not upset rating agencies because repo loans do not imply any future taxation and do not increase the debt burden. They bypass and hence do not disrupt bond markets, and do not amount to outright monetization.

Additional funds of, say ₹5 trillion, can be deployed as guarantees to loans to small and medium enterprises, for tax reductions and deferrals, goods and services tax compensation to states, urban unemployment support, and direct cash injections. Just like the 2008 rescue of MFs, we could discover that an out-of-the-box solution like “loans against shares” to the government works like a charm. It could even decrease India’s sovereign debt burden, rather than increasing it.

Ajit Ranade is an economist and a senior fellow at The Takshashila Institution