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Despite the resounding public support corroborated by the landslide victory of the Narendra Modi led Bharatiya Janata Party, the party has gained notoriety for reaching a unique milestone as a series of its top economic personnel quit from their prominent positions citing dubious and vague ‘personal reasons’. Viral Acharya, the latest member of this club that includes Urjit Patel, Arvind Subramanian, Arvind Panagariya and Raghuram Rajan, put forth his resignation last week – six months before his tenure was to end. Unlike his colleagues, Acharya was quite the vocalist on the controversial issue of the eroding autonomy of the Central Bank and had raised concerns on this matter last October, while speaking at the AD Shroff Memorial lecture in Mumbai. He had alluded to a cricketing analogy where he juxtaposed the functioning of the Finance Ministry to playing a T-20 cricket match where the growth of runs is prioritised over the loss of wickets, while the Central Bank places both factors on an equal footing to produce good results. This was a discreet ploy to call the Finance Ministry out on its dominating disposition and its anti-cyclical profligacy. But this uncalled-for desertion, at a time when Arvind Subramanian points out an overestimation of the GDP and where other people have expressed concerns in similar contexts, reflects the long-standing nature of these ideological conflicts.


Although, the Economic Advisory came to the defence of its estimates by clarifying how Subramanian’s paper was torturing the data to confess an overestimation, citing how correlations had flipped in the 1980-90s even when there was no estimation methodology revision like that of 2011. Additionally, it was observed that for empirical convenience, the sample-size chosen was too small to give a reliable analysis. However, even if we disregard this specific paper afflicted by wishful thinking, we cannot overlook the fact that the members of the same Economic Advisory, especially Rathin Roy, have cautioned the arrival of a middle-income trap as a result of a Late Converger Stall that the Economic Survey of 2017-18 had elaborated upon. The Indian economy is perhaps going to exhibit a period of hysteresis, where stickiness of the wages can aggravate the unemployment situation by driving up the non-accelerating inflation rate of unemployment (NAIRU) or in simple terms, the natural rate of unemployment. Overall, there is no denying that the growth rate of the nation might not maintain the same resilience in the near future, as is reflected in the sharp decline in the 2019 Q1 growth rate, which stands at a 20 quarter minimum. Major economic indicators like passenger vehicle sales, core industrial growth, current account and trade balance and rural wages have all turned red. Aggregate demand in the economy has slowed down, and price signals (inflation and wage data) reinforce the picture of a slowing economy.


The fiscal and monetary policy responses have been quite identical. While there have been speculations of an expenditure hike in the Union budget, the monetary policy has already eased out in response to the figures, by cutting the repo rate by 25 basis points to 5.75%. The latter, however, has happened under the non-technocrat Governor Shaktikanta Das, whose stance, the Rajan-era economists do not agree with, as witnessed by the resignation of Acharya immediately after the tax rate cut. But the nation’s growth has declined, so shouldn’t a rate cut be the obvious and appropriate response? Where lies the difference of opinions in this economics 101 scenario?


Both Urjit Patel and Viral Acharya belong to the Rajan era of the Indian economy, wherein the conduct of the Monetary Policy underwent a fundamental revamp post the formidable challenges posed by the Global Recession. In Urjit Patel’s Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework, 2014, he elucidated on how there was a broad consensus that a more definite focus on price stability is the principal – though not sole – objective of the monetary policy. This report, similar to the 1985 report on the Monetary Policy by Dr Sukhamoy Chakravarty, emphasised the need for a long term framework to achieve monetary stability and set up an independent Monetary Policy Committee (MPC) in 2016 to cushion these aims in periods of conflicts of interest with the government.


Rajan wanted to re-establish the classic ‘faith’ of the public in the central bank and put an end to the suspicion and scrutiny with which their policies were greeted, by keeping inflation low and stable despite the state of the economy. He acknowledged that there is a short-run trade-off between growth and inflation, conceding how inflation targeting through rate hikes will suffocate growth in the shorter run. But he admitted that he was not a fan of growth simulation by rate cuts because the mirage would break down as soon as the prices begin to rise. And then the only way to fool the public again is to generate higher inflation, thus creating an inflationary spiral. He believed that growth generation through real productivity simulation while simultaneously maintaining low and steady inflation through rate hikes would lead to greater monetary stability. This way, the people will be convinced of the Central Bank’s ability to maintain steady prices even when it finally cuts down the rates to generate demand in the long run. This plan was not chaos-proof – it led the inflation level to stoop below 2% in 2017, but mostly, it did manage to establish to the investor, ‘faith’ in Rajan and his colleagues.


When Urjit Patel, took over, he had a ‘Modi’s Man’ image, a speculation that was proved incorrect in its entirety, when he became the first Governor since 1957 to resign before his tenure. This withdrawal from the duty was a clear indicator of the faltering autonomy of the institute, as the government demanded a greater dividend and started a contention over the tightening process of last year. Ironically enough, this was not as per Rajan and Patel’s MPC report but was a response to the Federal Funds Rate hike by the USA and the trade war of the previous year. Presumably, the government wanted an eased up monetary policy to fund its political ambitions for the elections, by injecting unnecessary liquidity in the economy.


The representatives of the government, however, have kept reiterating that the plummeting of the money supply, as measured by M3, led to a shortage of money in the economy and reduced the system’s capacity to lend, adding to the distress of the economy. Their stance is that since global demand is anticipated to remain weak and private investments expected to remain pallid, the onus of reviving India’s growth engines lies with them. The idea, in its essence, is not wrong. Consumption, the primary catalyst of the Indian economy, has considerably slowed down. The slowdown in the auto segment and consumer durables has primarily dragged down the consumption expenditure. High rates of unemployment, low income growth and high indirect taxes on consumption-driven goods are some of the key reasons for this economic slowdown. With low inflation rate and global interest rates heading lower, the government believes that maintaining the level of consumption is the need of the hour. They, hence, conclude that this is not a time for fiscal consolidation as it will lead to a negative impact on growth. A cut in tax rates and introduction of a higher exemption limit on income is much expected to shore up consumption in the full-fledged Union Budget to be released tomorrow. More accommodative tax and spending measures are indeed the need of the hour.


The Government’s Economic Advisory supports the easing by stating that much of the consumption is financed by savings. Such a consumption fuelled by a dig in savings cannot last long. Gross savings to GDP ratio has indeed been on a decline, falling from 32.1% in FY14 to the present 30.5% in FY18. Developing tax incentives in order to encourage households to save more can prominently boost saving rates. The government may opt for alternative avenues to generate revenue, like Inheritance tax, Estate duty, increase in long term capital gains tax and a surcharge for high earners in the Union Budget. Amid mounting challenges posed by slowing growth, high unemployment, declining savings and falling consumption, accompanied by a poor start of monsoon and prominent trade wars, there is an ever growing necessity for the government to ease the fiscal deficit targets and stimulate expenditure in the economy. This bid to maintain economic growth involves a compromise with the hard-won economic stability. But prioritising stability targets would mean social unrest, as lower economic growth means inadequate jobs in formal enterprises, even though it sits well in line with the perspective of the Rajan-era economists.


An increase in government recruitment can play a major role in boosting employment. Presenting higher incentives to employers for hiring may bring in some positive result. Promotion and assistance to startups and MSMEs through proper incentives would help generate employment in the economy. All this would require the government to loosen the strings of its purse. Additionally, a suppressed monsoon has increased the concerns of rural distress, thereby making intervention even more necessary. Lowering the interest rates for farmers and increasing the overall rural spend by expanding cash benefits and injecting more money into state-run banks may help stir up the rural economy. Providing tax incentives for food processing, logistics and small businesses can all contribute to reviving the economy.


A low credit offtake of financial services in the recent past has impeded private sector investment, hence putting pressure on gross fixed capital formation in the economy. This signals the necessity for the government to take up an active investment in the economy. In a bid to correct the faltering economic growth, tax cuts on businesses can play a big role. An introduction of a uniform tax rate and scraping off of additional taxes like dividend distribution tax is much expected. Higher spending in infrastructure and announcement of large projects can prove to be a big push for the sector.


When we look at the bigger picture, it is evident that the fiscal profligacy will persist through this year’s Union Budget. And it is supported by the concerns regarding growth that resurfaced for the economy. The Monetary policy has also shifted its stance to accommodative since the minor rate cut, which at that point was, in fact, necessary, but delivered little transmission mechanism for the borrowers. The right wing of the political spectrum has been praising Shaktikanta Das for loosening the economy up, both in terms of the rates and the regulations. Expanding on the latter, RBI has allowed banks and NBFCs to restructure MSME accounts which were in default with an aggregate debt exposure of Rs. 25CR or below. These were classified as standard accounts from January 1. The establishment of the IND-Accounting Standards, which was to bring a more conservative approach towards bad loans, has also been deferred indefinitely. Viral Acharya, in his AD Shroff Memorial Lecture, had said,

Sweeping bank loan losses under the rug by compromising supervisory and regulatory standards can create a façade of financial stability only in the short run…

He had, perhaps, precisely foreseen the situation. The issue that the nation faces is too ingrained and systematic to be recovered through the monetary policy alone. Rajan’s idea would have undermined these minor growth disruptions – his approach had a questionable gestational lag that surpassed his tenure, but, more importantly, it was worth a shot.


By Riya Kaul & Sakshi Agarwal

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