In a freewheeling chat with Radhakrishnan Chonat and Aartie Rau, former RBI Governor D Subbarao speaks about issues prevailing in the economy, and the outlook going forward.
Q: Even as the economy contracted last year, we were taking comfort from the projected ‘V’ shaped recovery. But now a second wave of the pandemic is upon us. Do you think this will derail the recovery?
I will not say it will derail the recovery, but it most certainly will disrupt it. The extent will depend on the intensity and duration of the second wave, and the government’s response by way of restrictions on mobility – partial or total lockdowns. Let us see this in perspective. Last year, at the peak of the first wave, we feared that the economy will contract by as much as 10%, or even 15%. Fortunately, the contraction has been contained at 8%. That is painful, but still comforting, relative to the pain of a 15% contraction. Estimates for growth this year vary from a conservative 10% to as high as 13%. But we must remember that this rebound is on a low base of last year’s output. Even if we clock growth of 13% this year, the level of output in FY22 will still be lower than what would have been in a no-pandemic situation. And if the second wave does not abate soon enough, this recovery will be at risk. The IMF too confirmed this view when, in its latest World Economic Outlook, it said that its projection of growth this year for India was 12.5%, with downside risks owing to the resurgence in cases.
Q: What do you think the government should be doing to maintain the pace of recovery?
The answer is simple – break the chain of transmission by strictly enforcing preventive measures. Around the world, and here in India too, it’s now a race between the virus and the vaccine. Fortunately, unlike most emerging markets, we are able to produce our own vaccines, but the pace of vaccination is disappointing. Even so, vaccinating a billion people will take time. The solution, in the short term, still remains Covid-appropriate behavior. It’s disturbing that people have become nonchalant towards preventive measures. That has to be checked by imposing severe penalties. We can’t afford even partial lockdowns, not to speak of a full lockdown, simply because the economic costs will be very heavy. Also remember, the policy space for any kind of stimulus now is much more limited than it was last year. Given that the fiscal position is already overstretched, the government has no space to borrow more. The RBI, on its part, has no room for further easing in the face of firming inflation pressures.
Q: You were among the first last year to predict a ‘V’ shaped recovery. If we are able to beat the pandemic soon, do you think we can be assured of a ‘V’ shaped recovery?
First, a ‘V’ shaped recovery does not mean much as it is coming on a low base. The important thing is to get the economy onto a high-growth trajectory and sustain it there. That will take a lot more than just beating the pandemic. Note that our economy was already slowing even before the pandemic hit us. In the four years before FY20, annual growth had slowed from 8% to 4%, owing to structural factors such as declining investment and slowing productivity. We need to fix them through vigorous policy initiatives and their implementation.
Moreover, many analysts have said that what we are getting is not a ‘V’ shaped recovery but a ‘K’ shaped recovery, which is to say that an important consequence of the pandemic has been to sharpen the inequalities. What a ‘K’ shaped recovery means is that the higher income segments of the population have seen their wealth and incomes grow, whereas the bottom segments have experienced the reverse – loss of jobs, loss of income, loss of purchasing power and loss of savings. This accentuation of inequalities is not just morally wrong and politically corrosive, but it is also bad economics as it can dent our long-term growth prospects.
Q: You spoke earlier of limited policy space should the second wave intensify. The government has budgeted fiscal deficit of 6.8% of GDP for this year, higher than expected. Do you think that is wise, given the need for fiscal consolidation?
Going into the budget, the Finance Minister was locked into an impossible trinity of sorts. She had to spend more, not raise taxes and keep borrowing under check. Something had to give, and she chose to relax the fiscal deficit constraint and borrow more. The calculation is that the additional borrowing invested in infrastructure will raise the growth rate and generate higher taxes such that the debt will pay for itself. That outcome is plausible but not inevitable.
Q: Why do you say so?
Because it is conditional first and foremost on the second wave being contained soon enough. After that, it is also conditional on the borrowed resources being spent efficiently and quickly on infrastructure. Implementation, for which we do not have a credible record, is key to realizing the planned outcomes.
Q: Do you think all this borrowing could get us into a debt trap?
That is a legitimate worry. Our debt-to-GDP ratio as we entered the crisis was already over 70%. Because of the huge borrowing last year and this year too, that ratio will go up as high as 90%. The problem with a high debt GDP ratio is that interest payments keep on increasing year after year and eat into resources available for other developmental spending. That will derail growth prospects. The FRBM Committee determined that a sustainable debt-to-GDP ratio for India is 60%. To bring the debt GDP to this level we need high growth. If high growth is absent, we will sure head into debt sustainability problems.
Q: How can the RBI help support growth?
Contrary to popular perception, there is no tension between growth and inflation. The best and possibly the only way the Reserve Bank of India (RBI) can support growth is by delivering low and stable inflation. Only in a situation of price stability can investors and consumers take informed decisions that will spur growth. But it is also important to remember that the monetary policy can only raise growth to its potential level; it cannot raise the potential output level. For that we need to deploy fiscal and governance policies.
Q: In 2013 we had taper tantrums when you were the governor. That was because of the unexpected announcement by the US Fed that they will start tapering their quantitative easing policy. Capital flowed out of India and the rupee crashed. In the current situation too, there are fears that the Fed might start normalizing its policies. Is a repeat of the taper tantrum situation likely?
The one-word answer to your question is ‘unlikely’. Let me explain why I think so. First and most important, we have huge forex reserves today, not just in absolute terms but even in terms of months of import cover. That means we have ample firepower compared to 2013. As we know from experience, just the availability of reserves is sufficient to ward off exchange rate volatility. Secondly, in 2013, we had huge fiscal and current account deficits. In normal course, that should have resulted in the depreciation of the rupee. But the huge capital flows occasioned by the QE policies of advanced economies prevented such an exchange rate adjustment. And when the Fed raised the possibility of tapering the QE, the rupee went into a sharp correction and in fact overcorrected to some extent causing a huge disruption.
That said, it’s important to recognize that even from today’s position of relative comfort on the size of reserves, we are not totally insulated from changes in the Fed policy stance. After all, the price of every financial asset in the world is linked to the benchmark US rate. Any tightening of financial conditions in the US will mean tightening of financial conditions everywhere. So, any move towards policy normalization in the US will have implications for financing the fiscal deficits of the Centre and the states. Last year, even though the fiscal deficit was high, financing the huge borrowing of the Centre and states did not prove to be a challenge because of the current account surplus and capital inflows. That combination is unlikely to repeat this year. We are heading for a current account deficit and also will have to be prepared for capital outflows. That will make it more challenging to finance the fiscal deficits of the Centre and states. In sum, if and when the Fed embarks on policy normalization, we may not have exchange rate pressures but we will have domestic financing pressures.
Q: You were Governor during the global financial crisis (GFC) of 2008. Is this crisis caused by Covid 19 different from the global financial crisis?
Yes, and in a big way. The GFC was caused by reckless piling on of risk and regulatory looseness. It originated in the financial sector, and then the contagion spread to the real economy. The crisis required first and foremost a financial sector solution via restoring confidence in the financial markets and unwinding troubled assets. In contrast, this crisis, caused by the coronavirus, originated in the real economy and then transmitted to the financial sector. The basic solution has to come from science via treatment and prevention. Until that happens, governments and regulators have to undertake holding operations to control the depth and duration of the economic downturn.
Q: What big economic shifts do you see in the post-covid world?
When asked what he thought of the French Revolution in the 1970s, the former Chinese Premiere Zhou Enlai is reported to have said, ‘It’s too early to say.’ By that yardstick, it’s too early to predict any post-crisis economic shifts when we are still in the midst of the crisis. But let me hazard some guesses based on what I’ve read. For one, work from home is going to be a wider practice than before, with huge implications for commuting, urban planning and indeed work culture. Inequalities between and within countries will widen, with not just political but even macroeconomic implications. I don’t believe globalization will go away, but it will go through a course correction. There will be an acceleration of digitization and automation will hollow out unskilled and possibly even skilled jobs, which in turn will have implications for the comparative advantage of nations and trade patterns. Global supply chains, I think, will survive, but there will be some realignment to reduce dependence on a single country like China.
Q: How have you handled the lockdown and restricted mobility? Read many more books and seen more movies than before?
Before the pandemic broke out, I used to spend extended time outside India at academic institutions or to attend conferences. That’s stopped now. As per reading books, I am embarrassed to say, my reading of books has come down. You get bombarded with far too many short blogs and articles and somehow, they displace books in reading priority. I keep telling myself that I must check that, but have yet to succeed.