Montek Singh Ahluwalia’s Method of Combating ‘Very Serious Slowdown’

The former deputy chairman of Planning Commission, Montek Singh Ahluwalia launched his book, Backstage The Story Behind India’s High Growth Rate Years, on Wednesday, during an event attended by many dignitaries in Delhi. Also present during the occasion was former prime minister, Manmohan Singh. Although not a memoir, this book weaves events from Ahluwalia’s personal life with India’s journey through economic reforms in the last 30 years during which Ahluwalia had not only had a front-row seat to witness the economic history of this country but also actively participated in it.

According to India Today, during the launch of the book, Ahluwalia pointed out “There is no question that we have ventured into a period of a very serious slowdown…the lowest quarterly growth rate in recent times is 4.5 per cent. If you compare that with the first seven years of UPA when the growth rate averaged 8.4 per cent, 4.5 per cent is really low. And, it is not just the growth…the way it affects people is a high rate of unemployment, especially a high rate of unemployment among the young. So, I call that a crisis…but the question is do we recognise it is a crisis?”

In his book, Ahluwalia has given some effective ways in which the current slowdown can be handled. He writes:

With the abolition of planning, we no longer have official targets for the growth of GDP. The target now talked about is making India a $5 trillion economy by 2024–25. This calls for an average growth rate of about 9 per cent in real terms over the six-year period from 2019–20 to 2024–25. With growth below 5 per cent in 2019–20, and only a slow recovery expected next year, achieving an average of 9 per cent for the period as a whole is simply not credible. We will certainly get to $5 trillion, but it will be a few years later!

A more realistic target would be to try to reach a growth rate of around 8 per cent per year as quickly as possible. This is certainly necessary if we want to continue to reduce poverty and generate the employment needed to satisfy our young and aspirational labour force. Is 8 per cent growth feasible? India did achieve GDP growth of 8.5 per cent in the first seven years of the UPA, but a return to that growth rate is easier said than done.

The most important issues of immediate importance that can revive the Indian economy are ensuring macroeconomic stability and fixing the banking system, said Ahluwalia in the book. He writes:

Macroeconomic stability is a precondition for investor confidence in a private sector-led economy. The principal indicator associated with macroeconomic stability is the general government deficit, i.e. the central and state government deficits taken together. The IMF’s World Economic Outlook database shows India’s general government deficit for 2019 at 7.5 per cent of GDP. This is much higher than the deficit for other comparable countries, such as Indonesia (1.9 per cent), Malaysia (3 per cent), Thailand (0.2 per cent), Bangladesh (4.8 per cent), the Philippines (1.1 per cent) and Sri Lanka (5.7 per cent).

The CAG’s observation that the Centre’s fiscal deficit may be underestimated adds to the problem because it suggests that the combined deficit, properly measured, may be closer to 9 per cent. As the net financial savings of households—the pool of savings from which the government and the corporate sector can draw—is around 11 per cent of GDP, a combined deficit close to 9 per cent leaves only about 2 per cent of GDP for the private corporate sector.

The crowding out problem may not appear to be relevant at present because private investment is depressed, rural consumption demand has fallen, and there is excess capacity in many sectors. Attention is therefore focused on the need to stimulate aggregate demand, which could involve a temporary increase in the fiscal deficit. This may make sense in the short term, although much depends on the nature of the stimulus. A cut in income tax rates will benefit upper-income groups and may have relatively little impact on aggregate demand. Additional expenditures on

public programmes that stimulate demand in rural areas will be much more effective, especially if they are linked to productive investments.

Whatever the decision on the fiscal deficit in the short run, we must be quite clear that continuing with a high fiscal deficit in the medium term will jeopardize growth because it will crowd out private investment. As a medium-term objective, we should therefore plan to reduce the combined fiscal deficit by 3 to 4 per cent of GDP over a five-year period. This will be difficult enough, but the scale of the fiscal challenge in the medium term is actually much larger because the government also needs to spend much more in a number of critical sectors such as infrastructure, health, education and defence.

Talking about the banking sector, Ahluwalia pointed out that it in severe stress of large NPAs (Non-performing assets) in public sector banks arising from loans given during the boom period which have become non-performing. Whatever its origins, the problem must be speedily resolved if growth is to be revived, said Ahluwalia in the book. The ex-chairman of Planning Commission writes:

Banks have to take the haircuts needed and the resulting capital erosion has to be made up by recapitalization, so that public sector banks can expand credit at a pace consistent with resumption of growth. Until recently, banks did not have reliable ways of getting defaulting borrowers to cooperate. The Insolvency and Bankruptcy Code (IBC) enacted by the NDA in 2016 is a game changer in this respect because it has provided the banks with a credible mechanism to initiate recovery. Predictably, the process was delayed by defaulting borrowers raising various legal issues, but the Supreme Court’s decision on Essar Steel, which allows Arcelor Mittal to take over the company, has resolved most of these issues.

The IBC is a major structural reform but it is only a first step. The next step is the recapitalization of public sector banks. combined with reforms to prevent the same problems from recurring. The government seems willing to put up capital for recapitalization, but there is no evidence of willingness to give up the government’s majority ownership in public sector banks.

Internationally, majority government ownership is seen as inconsistent with sound commercial banking, but no part of the political spectrum in India shares this view. If we have to work within the constraint that the government must retain majority ownership, the only option is to implement the reforms recommended by the P J Nayak Committee in 2014.

A key recommendation was that the government should distance itself from the management of public sector banks by creating a holding company and transferring all the government shares of public sector banks to this company. The holding company would appoint reputed professionals to the boards of the banks, and the public sector banks would become board-managed institutions.

The top managements would be appointed by the boards, not by the government. The Ministry of Finance would not issue any directions to public sector banks, thus ending the present anomaly where public sector banks are subject to dual regulation by both the RBI and the ministry.

Backstage, The Story Behind India’s High Growth Rate Years has been published by Rupa Publishers.

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