The process of cleaning up and restructuring balance sheets of non-financial firms needs to resume and accelerate
The economic crisis is much more complex, and will be more difficult and costlier to turn around.
We all know that India is in a precarious position, because of the twin crises of health and the economy. The health crisis is easy to understand, in that there is a single cause, the novel coronavirus. The remedies are also relatively straightforward to conceptualize, if difficult to implement in a consistent, sustained manner. Social distancing, hand washing and early detection and treatment are not a complicated formula for control. Implementation is another matter, and India is like many other countries in its inability to steer government resources towards targeted health investments, and to nudge or direct individual and social behaviour in the right direction. The good news here is that accomplishing these tasks is not financially burdensome, and simply requires better governance and political leadership.
The economic crisis is much more complex, and will be more difficult and costlier to turn around. Its roots are quite deep, and the pandemic and lockdown were merely the straw that may have broken the camel’s back. Of course, the metaphor here can be misleading, since matters can be turned around with good policy, whereas a broken spine is typically irreparable. Nevertheless, the vision of possible disaster is worth it if it focuses policymakers’ minds. When the current ruling coalition originally came to power, the problems with the economy were already emerging. Corruption and inefficiency had allowed poor quality investments to be made at a level that was threatening India’s financial system.
There were policy reforms to allow for more effective restructuring and cleaning up of balance sheets of financial companies, by doing the same for the non-financial companies that were the source of the problem. But judicial quirks, demonetisation, and a problematic roll out of a new tax system for businesses all took attention away from the primary task of the needed restructuring. The pandemic and the poorly planned lockdown could not have come at a worse time for this process.
Meanwhile, India’s exports had been slowing down, the government was struggling to achieve fiscal deficit targets, and the central bank was working hard to bring down stubbornly high inflation and inflation expectations. None of the components or policy levers of economic growth were moving in the right direction.
With respect to exports, the national government had been failing to maintain low and efficient tariff structures, and doing little to remove logistics bottlenecks, enter into new trade agreements, or integrate into regional supply chains. This was a problem that preceded the change in ruling parties, though the problems have gotten worse since then. The central bank did not seem able to deal with real appreciation of the rupee, as capital inflows were strong. It wanted to manage inflation, but did little to improve the transmission of monetary policy, and it was unable to see the growth slowdown coming, as it focused on bringing inflation under control. Falling savings and investment rates were a symptom of the wrong direction of the economy.
Essentially, India had lost its way in terms of structural reforms that it needed to make to keep the economy growing at 7% or more, let alone to reach double digit growth rates that would open up a path to East Asian-style development. It did not do things it should have done when times were good, and it will be harder to do these now that times are bad. Is there a path to recovery?
First, the process of cleaning up and restructuring balance sheets of non-financial firms needs to resume and accelerate. Bankruptcy as restructuring is painful and costly, but much less so than bankruptcy as liquidation, though in some cases, the latter is the best route to take. This process will allow financial firms’ balance sheets to be cleaned up, and new lending to resume more robustly.
Second, the central bank needs to figure out how to improve monetary policy transmission, especially if it is to do any kind of inflation targeting. In this regard, the use of an inflation measure heavily affected by food prices, when agricultural markets are highly regulated and subject to volatility and manipulation, is hardly ideal. Here, the push for domestic agricultural marketing reform will help a little, but improving production conditions, risk management for farmers, and international trade as a stabilizer will be vital.
Third, India will only grow quickly and sustainably when industry beings to take off. Here we include information technology in all its various forms as part of industry. The pandemic has accelerated the increasing role that digital technology was already playing in the economy. Whether for finance, marketing, service delivery, or education, digital technology has the potential to allow for leapfrogging and rapid catch-up. In this respect, the role of public investment in digital infrastructure has been dismal, and instead India is relying on near-monopolies in many parts of the digital value chain. Spectrum is not allocated to maximize economic growth, and there is minimal investment in universities that can drive more rapid innovation.
Finally, India’s last decade has been increasingly about battles for political succession and dominance, nationalism, and cultural pride. Technical analyses of economic growth and clear strategic thinking have receded into the background, so that goals of economic growth, and schemes and missions accompanying these goals, have lacked well-defined roadmaps for implementation. Changing this situation is the most important step to recovery.
The author is Professor of economics, University of California, Santa Cruz