Moody’s on Modi reforms: India needs more endorsements to spur economic confidence

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Updated: November 22, 2017 4:50:11 AM

Positive animal spirits begin as positive narratives, turn into tangible investments which ultimately turn into a virtuous economic cycle. Economic optimism is a force multiplier.

Economic optimism is a force multiplier. Economic pessimism, more often than not, leads to gloomy outlook and a vicious economic cycle. (Reuters)

Economic pessimism doesn’t die of old age. In the recent past, the BJP’s old guard, the likes of Yashwant Sinha and Arun Shourie have poured scorn on well-intended, though not well-implemented, structural reforms. They weren’t half as vociferous when BJP’s opposition, the corruption-ridden UPA government led by Manmohan Singh was in power. Perhaps because Manmohan Singh was one of their Oxbridge kinds while the current PM is an HMT (Hindi Medium Type) chaiwallah. At least, the old guards in the BJP, even if they haven’t benefited from the HMT Chai-Wallah, can pour more positive-tea than scorn. Now, the government has got a more credible cuppa of optimism from the Moody’s, a rating upgrade primarily based on structural reforms. It is support for structural reforms from a neutral observer and may well act as a stimulus for economic animal spirits. John Maynard Keynes argued that economies have animal spirits. Since the last couple of years, the Modi government has been trying to call upon this spirit in the Indian economy. Keynes argued that economic activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic. He reasoned that economic agent’s decisions to be positively invested, the full consequences of which are drawn out over many years in future, can only be taken as the result of animal spirits—a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. The Indian economy needs both improved macroeconomic fundamentals grounded on vital structural reforms and positive animal spirits.

Positive animal spirits begin as positive narratives, turn into tangible investments which ultimately turn into a virtuous economic cycle. Economic optimism is a force multiplier. Economic pessimism, more often than not, leads to gloomy outlook and a vicious economic cycle. Macroeconomic fundamentals at least on key parameters except job growth, have never looked better. Current account deficit which was over 4% of GDP when the Modi government took over is now 0.7%. Inflation, which was above 8% in May 2014 is now 3.5%. Foreign exchange reserves have increased more than $100 billion since May 2014. Fiscal deficit is now 3.2% and has decreased by more than $22 billion since May 2014. Yet, the naysayers choose to never mention the improved indicators.

The rating upgrade could act as a stimulus for positive animal spirits in more ways than one. For starters, it would better the India investment story for FDI. It should lower borrowing costs for the government’s programs such as the recently unveiled Rs 2.11 lakh crore capital infusion in public sector banks. Again, the naysayers choose to see the cup as half-empty. They have apprehensions that the government may increase spending, especially as we get closer to 2019 election. This may cause fiscal deficit to increase further and may crowd out private investment even more. I will reason why both fears are a bit unfounded. Back in the 1990s, we knew why we feared deficits. They raised interest rates and crowded out private borrowing. In 1991, the short-term interest rate was above 12%. The gross fiscal deficit of the government had risen to 12.7% in 1990-91. Since these deficits had to be met by borrowings, the internal debt of the government accumulated rapidly, rising from 35% of GDP at the end of 1980-81 to 53% of GDP at the end of 1990-91. With higher borrowing, the borrowing cost increased for the government. This meant that the interest rate for private borrowing was, for the most part, much higher, choking off investment and economic growth.

Enter Manmohanomics. The postulate was simple: Bring down deficits, and you’d bring down interest rates. Bring down interest rates, and you’d make it easier for the private sector to invest and grow. Make it easier for the private sector to invest and grow, and the economy would boom. The postulation was spot-on. By the end of Singh’s tenure as finance minister, the gross fiscal deficit of the government had dropped to 6.28% of GDP and the short-term interest rate had fallen to 5.75%. And the economy had, indeed, recovered significantly in those five years. The deficit reduction increased confidence, helped bring interest rates down, and that, in turn, helped generate and sustain the economic recovery, which, in turn, reduced the deficit further. The macroeconomic story is much different today. Interest rates now are well below 7% and chances of crowding out investments is low. The problem with misplaced frightening consequences of high deficit is that the pessimists are applying the framework of the 1990s to the economy of the 2017, with predictably gloomy outlook. Yes, there would be reason to worry about the deficit closer to May 2019 elections but not right now. And there may be a crowding out effect then but of a different kind. As we get closer to elections and as the government becomes more myopic, the politically-compelling government schemes such as loan-waivers may tend to crowd out the more meaningful fiscal programs that enhance job creation. But for now, the economy is in good shape. The rating upgrade is not misplaced. And, we need more such positive endorsement from neutral agencies to spur economic optimism and confidence. As Keynes once said, “When the facts change, I change my mind. What do you do, Sir?”

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