In search of the right prescription

Policy predictability and an unambiguous long-term blueprint are essential for private investors

In a televised address to the nation on May 12, the Prime Minister launched the Atma-Nirbhar (self reliance) Bharat Abhiyan with a stimulus component of Rs 20 trillion, equivalent to 10 per cent of gross domestic product (GDP), to tide over the current Covid-19-related crisis. The headline number is substantial and comparable with those put together in similar circumstances by advanced economies such as the US, the UK, Japan and the European Union, where the numbers range between 10-20 per cent of GDP. He also proposed to leverage the crisis to make India self-reliant.
 
India’s Atma-Nirbhar Abhiyan therefore appears to be a mix of macroeconomic stabilisation and structural reform policies. The Indian package comprises executive announcements and not legislation. It is therefore difficult to cut through duplication to determine what is part of ongoing budgeted schemes and what is the additionality.
 
Be it as it may, to compare the size of the fiscal stimulus announced with those of other major economies, we need to strip away the monetary policy component (about 50 per cent) and credit through banks and non-banking finance companies (about 25 per cent) for micro, small and medium enterprises (MSMEs). The actual fiscal component, including the 0.9 per cent announced earlier in March, is therefore a maximum of 2.5 per cent of GDP, comparable with China’s. The new commitment (1.6 per cent of GDP) is equally divided between revenue foregone, bank recapitalisation and welfare measures such as direct benefit transfers, succour for migrant labour and farmers, Mahatma Gandhi National Rural Employment Guarantee Scheme, and health.
 
By way of comparison, at least two thirds of the $3 trillion (14.3 per cent of GDP) mandated under four Acts in the US comprises additional funds directly from the Treasury. The remaining $1.2 trillion earmarked for companies and small business is a mix of new treasury loans and guarantees. The Federal Reserve is chipping in separately through monetary easing, targeted credit support and unconventional policies, having expanded its balance sheet by over $2 trillion since March. On an apple-to-apple basis, the US stimulus is 25 per cent of GDP compared to India’s 10 per cent.
 
There is unemployment on a vast scale, dislocation of migrant labour and state governments are at the forefront of dealing with this over and above the public health crisis. However, there is very little in the Indian package for direct income support to individuals/families and for states and local governments, which comprises almost half the US package.
 
The Indian stimulus package mostly seeks to inject liquidity and credit at a time when demand for both is low. Liquidity injections by the RBI were finding their way back through reverse repo, investment in treasury bonds and stock markets rather than into real investment even prior to the Covid-19 crisis. Credit offtake was weak, and the large overhang of non-performing assets made banks reluctant to lend. The big role assigned to them in the stimulus package can only add to this stress. Bank recapitalisation and sovereign guarantee for MSME loans provides some mitigation, but the devil lies in the details and implementation. 
 
The roots of the current crisis do not lie in the financial system, where providing liquidity plays a big role; nor is this a typical recession where the cost of money set by monetary authorities has a major role. There is a sudden sharp contraction in both private and corporate incomes on account of public policy. Fiscal policy needs to do the heavy lifting in emerging markets, as in advanced economies.
 
The objectives of the structural reforms proposed by the PM are unclear at this stage. Is there a shift in focus from making India globally competitive in an open market economy, which is implicit in Make in India, to making India self-reliant in a closed non-market one? The PM also talked of making India competitive in global supply chains. But the two objectives undercut each other. Self-reliance is reminiscent of the Nehru-Indira Gandhi era of import substitution industrialisation that led to a high-cost, low “Hindu” rate of growth characterised by inefficient resource allocation. A license-control-permit Raj and high tariff barriers were the bedrock on which this model operated.
 
Several post-colonial countries initially followed this model in view of the industrial success of Soviet Russia, and their earlier experience with the “imperialism of free trade”. With East Asia changing tack in the 1970s, China in the 1980s, and the collapse of the Soviet Union coinciding with our own balance of payments crisis of 1991, this model was abandoned by every country that grew rapidly, including our own. Sans imperialism, free trade worked for them, as they were more competitive. It makes economic and geopolitical sense for emerging markets like China and India to defend free trade and globalisation at a time western countries seem disenchanted with both.
 
Surely, the intention is not to turn the clock back! There would be areas where the country would not be competitive, so tariff walls would need to be raised to make investment in those areas profitable, or state subsidies given, neither of which is compliant with the World Trade Organisation. Would the state then step in and invest directly in these areas? It is also difficult to see India self-reliant in areas such as POL (petroleum, oil and lubricants) or diamond roughs, which are a major part of the economy.

A significant share of the stimulus announced so far comprises liquidity infusions by the Reserve Bank of India

 
This is not an argument against structural reforms or self-reliance in strategic areas. It is about their appropriateness and timing. Market-oriented agricultural reforms announced by the finance minister are in the right direction. However, they are nothing new, awaiting implementation. Structural reforms need fiscal support to cushion the pain, over and above the fiscal support to counteract the pain of crisis. The Covid-19 crisis has created short-term unemployment on a massive scale. Labour reforms at this juncture will only magnify the pain, making several job losses permanent and magnifying the travails of migrant labour. Painful structural reforms in the midst of a crisis was the original sign of International Monetary Fund (IMF) structural adjustment programmes, often leading to a further decline in growth. The success of India’s IMF programme was contingent on consistently bucking fiscal deficit targets.
 
India remains the fastest growing major economy because it is in a demographic sweet zone and remains a demand-driven economy in a demand-constrained world. The paramount objective at this point is to get back to potential growth by stimulating demand and getting the confidence of private investors back on the one hand, and expanding credit supply by cleaning up bank balance sheets (which is long overdue) on the other.
 
Investor confidence has been hit by policy unpredictability arising from demonetisation, roll-back of tax reforms, increasing government intervention, and now the suddenness of the lockdown and micromanagement. There are added fears about the prognosis of Covid-19 for India, on which Tuesday's address had little to say. More uncertainty now about the trajectory of the Indian model going forward would frighten investors further. Policy predictability based on an unambiguous long-term blueprint that is seen to be adhered to is essential for investor confidence in a market economy. The author is RBI chair professor, ICRIER