'It is good the government and the RBI are not taking the easy road by encouraging large loan write-offs in the hope that growth will pick up.'
Having watched the end of the UPA regime and the beginning of the Modi government as the International Monetary Fund’s (IMF) senior resident representative in India since August 2012, Thomas Richardson says he sees a fair amount of consensus on the major policy changes needed to reduce poverty and provide jobs. Despite the ongoing logjam in Parliament threatening to delay crucial reforms such as the Goods and Services Tax (GST) and easier land acquisition for industry and infrastructure, Richardson, who has spent 22 years with the IMF so far, is optimistic about India’s growth prospects and direction of reforms.
Speaking to Arun S of FE, Richardson said with adequate forex reserves and positive sentiments around its medium-term outlook, India is not likely to be hit by a rate hike by the US Federal Reserve whenever it occurs. While declining to comment on short-run monetary policies just ahead of the Reserve Bank of India’s (RBI) policy review on August 4, he, however, did say that the IMF is still of the view that it is important to maintain a fairly tight stance of monetary policy to achieve the medium-term inflation path that the government and the RBI had agreed upon. (Edited excerpts from the interview).
Q: What are the major challenges faced by the Indian economy now?
A: Two years ago, in the summer of 2013, the main worries were three: the high fiscal deficit, the wide current account deficit (CAD), and excessive inflation. Of these three, inflation and the CAD have since been brought down significantly, and they look more manageable now. While the fiscal deficit has come down, in our view there should be more ambition to reduce it further. A government (Centre plus states) deficit of 6.5% to 7% of GDP is very large by international standards and makes India vulnerable to external shocks.
A fourth major concern is that global investors are now consistently raising the issue of poor quality of the balance sheet of the corporates and banks. Although the “problem loans” have increased in recent years, in our view the level of systemic risk is modest. Indian banks are relatively well capitalised and well supervised. But high non-performing assets have limited the room for them to give fresh loans and made it tough for infra companies to take loans and carry out new projects. We are starting to see some green shoots in the project data, though, and hope the investment cycle would pick up.
Q: What is your assessment of the way the bad loans are being tackled?
A: It is good the government and the RBI are not taking the easy road by encouraging large loan write-offs in the hope that growth will pick up really quickly. The argument instead is that writing off bad loans creates moral hazard and leads to more bad loans down the road and is therefore avoidable. Rather, the corporate governance at Public Sector Banks (PSB) could be improved by bringing in top quality management. PSBs should have an arm’s length relationship with the government so that they can act more like private-sector banks and survive competition.
There is a set of best practices, including those proposed by the Organisation for Economic Co-operation and Development (OECD), on how countries can best manage state owned enterprises and public sector units (PSU). The OECD guidelines include setting up an independent board of directors, applying the best international accounting practices, filing public disclosures and listing on stock exchanges. They also advise hiring managers who are fit and proper and experienced in the discipline; not government officials but private sector professionals. In India, there is some move towards bringing in that modernised governance framework for PSUs, at least in the banking sector.
Then there are bigger structural issues leading to bad loans, including delays in clearances and difficulties in land acquisition. Some projects initiated 4-5 years ago were conceived when people thought India would grow at 10%-plus forever. It is possible that growth would get back up to 10%, but you should not assume it. It could also be that some projects have design features that were not optimal, and the promoters may have gambled a bit. So there is scope for haircuts. When investors or promoters are making high returns, they have to accept the risk of high losses also.
Q: You said there should be greater ambition to further reduce fiscal deficit. Some economists have argued that a slight fiscal slippage is fine provided capital expenditure is increased to revive growth. What is your view?
A: The government (Centre and the states together) spends about 25-26% of GDP, which is arguably a bit low. This affects mainly the health, education and infrastructure sectors and their quality. But the general government deficit is 6.5%-7 % of GDP, which, as I said, is too high. The implication is that India’s government sector needs more revenue not only to boost spending but also to reduce fiscal deficit and allow greater private investment. At 18-19% of GDP, India’s general government revenue is below its emerging market comparators in Asia.
Only three-to-four crore entities (people and firms) are taxpayers in India. China, which is similar to India population-wise, has around 30-plus crore tax paying entities. The Tax Administration Reform Commission Report argues India should double its taxpayers to six crore entities, which is good if achieved in 3-4 years. Going from three crore to 30 crore entities will take time. For example, India has to build up tax records management capacity. But there is definitely scope for widening the tax net.
Also, if the GST system works efficiently, firms will want to join it because they will be able to get credit on inputs. But they won’t get input tax credits unless they are registered taxpayers. Their competitors who are registered taxpayers will be efficiently taking the input tax credit. Unregistered firms, without the input credit, will be charging their customers more, making them noncompetitive. A clean GST with a modest headline tax rate will not only be good for growth, as it will reduce trade barriers across state borders, but will also encourage people to join the tax net. The government will then have more tax revenue to spend on high priority items like health and education.
Also, a good tax system will find the tax evaders. The government could use the Aadhaar number, match it to the tax database, find the cheaters and bring them into the tax net. Ultimately, if the tax revenue is spent on providing public services in an effective manner, more people will want to be part of the system.
Q: It is being argued that the IMF has moved away from pushing a ‘trickle down’ approach to growth to a ‘bottom-up’ approach. The IMF recently mentioned the “need to lift the ‘small boats’ to generate stronger and more durable growth”. What does this mean in terms of policy changes by the Indian government, which has to a certain extent followed the ‘trickle down’ approach as well?
A: I don’t agree that the IMF has advocated the ‘trickle down’ approach. It may be that the IMF is now better at communicating our views than 10-15 years ago, but we have long felt that growth alone is not enough to reduce poverty. You can have rapid growth and growing inequality if the benefits are captured by the high income group.
Also, there is a fair amount of research now at the IMF to suggest that inequality is bad for growth,that extreme inequality actually undermines growth. Countries with more equitable distributions of income tend to grow rapidly and become more sophisticated. India can undertake a number of policy reforms to promote equitable distribution of growth. For instance, you can take policy decisions promoting female labour force participation, which is both good for growth and good for equity.
Q: A working group report published by the IMF had talked about India’s “uncertainties about receptivity to foreign investment”. Recently the government, maintaining the extant foreign investment restrictions in banking and defence, said it does not want ‘fly by night’ operators. There are foreign investment restrictions on sectors considered important such as insurance and retail. What is your view?
A: In most countries where I have worked, government officials are keen to get inward foreign direct investment, to promote growth, jobs, good governance and technical expertise. But India is an unusual place. It is the only place where I have seen that foreign direct investment is viewed with some suspicion. India has the advantage of being such a gigantic market that it can afford to be choosy and perhaps stand-offish, but in the process you are sacrificing some growth. Every time you push foreign investment away, you are making India a little bit poorer and not giving consumers here better options. Of course, there could be national security reasons why you are reluctant to open up some sectors to foreign investment.