Global economy facing disruptions, India can't be decoupled: Rakesh Mohan

Country has to tailor its actions in response to international crises, says economist and former deputy governor of RBI

A repo rate of six per cent is "pretty normal" if the retail price inflation is expected to come down to four per cent in two years, said Rakesh Mohan, president of the Centre for Social and Economic Progress (CSEP) and member (part time) of the economic advisory council of the Prime Minister. The policy rate stands at 5.90 per cent. Mohan, a former deputy governor of the Reserve Bank of India, spoke to Indivjal Dhasmana about the global slowdown, its impact on India, the bad assets of public sector banks, the government’s production linked incentive schemes and other issues.

Here are edited excerpts from an interview:

Many analysts, including economist Nouriel Roubini, have predicted that the US and the rest of the world are about to face an ugly and long recession starting 2022-end. Growth in merchandise exports from India has already started decelerating. Do you see any severe impact of such a recession on India?

The current period is characterised by a kind of uncertainty that the world has not seen for a very long time, including the period of the North Atlantic financial crisis (NAFC) of 2008-09, which was the last financial crisis affecting the world. We don't know what is ahead of us because of both Covid and the Russia-Ukraine war. We have also had a continuous, almost unprecedented, regime of very low interest rates and low inflation across the world for about a decade and a half. Since the NAFC, this low interest rate regime has also been accompanied by significant liquidity expansion through quantitative easing, including that after Covid, in almost all the major jurisdictions. The experience of low inflation seems to be changing but we don't know how and when it is going to end. No one had earlier seen an inflation rate of 7-10 per cent in the Western Europe and the United States for at least 40 years, if not longer. People don't really know what is causing such high inflation rates, apart from energy issues caused by the Russia-Ukraine war. They may also be a result of the extended monetary accommodation since the NAFC. So almost all central banks are now in a tightening mode.

Given these disruptions, there is no question that the global demand will slow down because of all the three reasons cited above. Besides, there are demographic changes with population growth going down everywhere which would affect the global growth in the medium term. In that context we can't expect to be untouched. Even though we are among the better performing economies in the world, we have to be aware that we are part of the global economy and there can be no decoupling. We have to be very conscious of everything going on in the world and tailor our actions accordingly.

You have talked about inflation. The retail price inflation has not come down despite the monetary policy committee hiking its policy rates since May this year and in fact stood at a five-month high of 7.41 per cent in September. Could it be that the panel is tightening monetary policy even as the problem is coming from the supply side?

First of all let me tell you I have never been a votary of the inflation targeting framework. Leaving that aside, the impact of the monetary policy actions has a very long lag. The impact of actions taken today would come in 4-6 quarters from now. To expect results now when monetary tightening had just started in May is mistaken. One of the negative impacts of the inflation targeting framework is that it has led people to have excess faith in the power of central banks and monetary policy to curtail inflation immediately. Second, we can't really say that the monetary policy is tight yet. With a repo rate of 5.9 per cent and inflation rate of 7.4 per cent in September, real policy rates are still negative. If you say that expected inflation two years from now is about four per cent, one could conclude that a six per cent policy rate now, i.e. a real policy rate of a 2 percent, is about right and pretty normal.

While inflation is not coming down, the index of industrial production shrank 0.8 per cent in August. So going ahead, do you think that MPC will be in a dilemma to boost growth or contain inflation?

This is the most difficult question faced by most central banks today. But the important question to ask is how much interest rates are responsible for a slowdown in the economy. If we are expecting a nominal economic growth rate of 12-15 per cent in India this year and beyond on the basis of real economic growth rate of 6-7 per cent which most forecasters are pegging it at, and inflation rate of between 4-7 percent, then nominal lending rates of 8-10 per cent are not particularly high.

Finance minister Nirmala Sitharaman has also touched upon the twin issues of slowing economic growth rates and rising inflation rates. She recently said the budget for 2023-24 will target both high inflation and slowing down economic growth. What broader points do you think should come up in the budget to do that?

Let me take a non-traditional and non-conventional view. Let us think of the budget from a medium-term view and not immediate macroeconomic management. Areas where India has failed miserably are health, education and nutrition. All NFHS (National Family Health Surveys) have shown that around 30 per cent of kids are stunted, and 20 percent are wasted, in rural areas. Thus there appears to be a major nutrition problem despite efforts by the governments in providing free or cheap foodgrains to the poor. The same thing goes for rural health. There is improvement but not adequate. In education too, ASER (the Annual Status of Education Report) is showing that outcomes are not good despite increase in numbers. These issues are not tackled in one year of the Budget, but I do believe that it is very important for the country if this Budget really indicates a major focus towards these areas with a three-year or a five-year framework. The public expenditure on health and education as a proportion of GDP in India is among the lowest in the world. Because of this, health and education are getting more and more privatised in India relative to other countries in the world. For example education till high school level is totally free in Japan, South Korea, the United States and all European countries.

Many families in India are sending their kids to private schools because education is of low quality in government schools. We also need to be cognizant of the impact of Covid on health, education and nutrition. A whole generation of kids have lost roughly two years. The same thing with health and nutrition. These are not normal budget issues but the budget should make some announcements on these and let some mission kind of action take place with significant budgetary allocations right from today. This is urgent. Hence my response in terms of the budget.

Your recent work along with two other authors clearly showed that exogenous factors were more responsible for rise in non- performing assets (NPAs) in the banking sector and blaming it on governance structure in public sector banks is not right. In this connection, what banking reforms can be taken to reduce NPAs, particularly of the public sector banks when key factors such as commodity prices are external?

Public sector banks have been improving their performance from 1995 to 2010 continuously. By around 2008, efficiency or quality parameters of public sector banks were not very different from those of new private sector banks. So, I was curious to understand why there was sudden deterioration in the quality of assets after 2009-10. We found that the fall in commodity prices after 2020, along with the overall economic slowdown had a significant impact on the rise in non-performing assets (NPAs). One of the curious features was that even when profitability of these enterprises, say steel players, went down, yet the banks kept on lending.

The only conjecture I can have is that banks could not stop lending to projects that had already started when the commodity prices cycle reversed. But that does not account for more than 30 per cent of NPAs. We are still investigating what else has happened. From these findings we can learn something. They tell us that perhaps banks need to be more diversified in their lending than what they did after 2009-10. Boards and managements need to be much more conscious of commodity price cycles and their implications for the health of borrowers, and they should have better processes to monitor the impact of other economic changes as well.

Many economists, including former RBI governor Raghuram Rajan, have criticised the production-linked schemes of the government on the grounds of protectionism, rise in prices etc. How do you assess these schemes?

One of the biggest puzzles for me, as one who was part of the team that did the 1991 reforms, is inadequate performance of the industrial sector after 2008-09 or 2009-10. Similarly, growth of exports of manufactured items also stagnated in the last 10-12 years or so, especially when these exports from India grew at a faster rate than China in value terms from around 2002 to 2012. It is quite obvious that some action needs to be taken to accelerate the growth of the manufacturing sector, particularly in the labour-intensive sectors as Arvind Panagariya has been arguing on a continuous basis. One factor that may have contributed to this is the overvaluation of the real exchange rate over the last 10-12 years. That is one of the indicators of our competitiveness being lower. One of the changes that happened since 1991 was to reduce protection in a phased manner till 2008-09. Since then there have been actions to reverse that. Industry does not have adequate pressure and incentive to be competitive if it is protected. The demand for protection could have come from industry also because of overvalued exchange rates which affected their functioning. The other issue is R&D. Countries such as China and Korea which have succeeded in the path of industrialisation have given much importance to R&D, and increasing the quality of workers and engineers. Now, China is producing more patents than the US is. Their absolute level of R&D is approaching the absolute levels of R&D in the US. R&D spend as a percentage of GDP is now higher in South Korea than in the US. Coming to PLI, whenever you do such a programme, there is no choice but to select certain sectors as we are doing.

In the economics literature there are lots of questions as to how the government chooses the sectors which are likely to do well. You can say that I will choose lots of sectors and like, venture capital funds, some will lose and some will win. But that means you will spend a lot of resources and the question is do we have these resources for something like this, when we are not investing adequately in health, education, nutrition and other public services?