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It involve a choreographed dance of multiple institutions and individuals over long periods.

Today’s policy announcement is typically yesterday’s thinking. Policies like ideas are usually path-dependent.

“Aarthikam Chintanam” or “thought(s) on finance or economy” is a monthly column that will explore the evolution of economic policy ideas in India.

The media tends to sensationalise the big days of economic reform such as February 20 2015 (the day that inflation targeting came) or May 11 2016 (the day on which the Insolvency and Bankruptcy Code or IBC was passed). Though as symbolic milestones these days are important when we look deeper these major reforms are not a sprint but a relay race. They involve a choreographed dance of multiple institutions and individuals over long periods. Developing and nurturing ideas and the committee process are key elements through which this works.

Newspaper headlines announced inflation targeting with a simple storyline. India had a sustained inflation problem. On February 20 2015 the Reserve Bank of India (RBI) was given this formal objective. But the story actually runs from the 1990s all the way (potentially) to 2025. Back then there was a long period when the RBI forced the USD/INR exchange rate to Rs 31.37 a dollar at a time when there was a lot of capital inflow. The RBI bought dollars which flooded the market with rupees and kicked off inflation.

The RBI leadership of the time — C Rangarajan and S S Tarapore — was highly cognisant of these difficulties. They understood the constraints imposed by the “impossible trinity”: No country can retain monetary policy autonomy and manage its own exchange rate and have capital account openness. They had the strategic insight that the way forward lay in an open capital account coupled with a flexible exchange rate and then monetary policy would be tied down to deliver an inflation target. These ideas were then socialised and refined within the RBI.

In 2007 the Percy Mistry committee recommended that India adopt inflation targeting. This was reiterated by the Raghuram Rajan committee in 2009. The insights of the previous years proved to be prescient when consumer price index (CPI) inflation breached 5 per cent in February 2006 and India went into a sustained inflation crisis

In 2013 the Financial Sector Legislative Reforms Commission (FSLRC) led by Justice B N Srikrishna recommended the procedures through which the monetary policy committee would work and the RBI would be held accountable to deliver low and stable inflation. This was followed by the Urjit Patel committee on monetary policy reform set up by the RBI which reiterated the by then consensus view. For the end-game a two-step strategy was developed at the Ministry of Finance (MoF). The “Ways and Means Agreement” of the late 1990s through which monetisation of the fiscal deficit by the RBI was stopped began as an agreement between the RBI and MoF and later became the Fiscal Responsibility and Budget Management (FRBM) Act. In a similar fashion the plan was made to first establish inflation targeting through a “monetary policy framework agreement” between the RBI and MoF and later amend the RBI Act.

The technical work for this was done in 2013 and 2014 and the agreement was signed between Rajiv Mehrishi and Raghuram Rajan on February 20 2015. This was followed by amendments to the RBI Act. The RBI Act of 1934 had a preamble that described the establishment of the RBI as a “temporary” measure. It is fitting that in February 2016 these words were removed for the RBI had finally found a purpose and a conceptual foundation

The new framework rapidly delivered results. The sustained failure on inflation of previous decades was replaced by headline inflation (year-on-year CPI inflation) that generally stayed within the required range from 2 to 6 per cent. For the first time in India’s recent history monetary stability is within reach.

At the same time there is considerable work to be done so that small changes in the policy rate are able to impact upon the economy so as to achieve greater inflation control with a narrower band of possible values for CPI inflation and smaller changes in the policy rate. This will require implementing the well-established agenda for reform of banking regulation and bond market regulation which will perhaps take another five years. If this works out the saga of India’s monetary policy regime runs from the candid acknowledgement in 1934 that the establishment of the RBI was a “temporary” measure to the clarity of the RBI leadership in the early 1990s to the second generation of reformers that got it done in 2015 and 2016 to make the inflation targeting framework work fully by about 2025. These are long journeys and each wave of reformers passes the baton on to the next one.

A similar story is seen with the bankruptcy reform. The first banking crisis of India in the late 1990s brought the problems of debt recovery to the fore. The first milestone here was the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act 2002 which gave lenders the power to recover collateral when there was a default on secured credit. The Raghuram Rajan committee of 2009 first talked about the need for a full-blown bankruptcy code.

The Budget speech of 2015 had a paragraph about a new bankruptcy framework for small and mid-size enterprises. At the MoF this opportunity was enlarged into a project to build the bankruptcy code. The experience with FSLRC (2011-2015) had given a new level of confidence and process understanding on how such complex policy projects could be organised. This led to the appointment of the bankruptcy legislative reforms commission led by T K Viswanathan. This produced an interim report with small incremental modifications to the Companies Act and then the full report with a draft bankruptcy code. Researchers from Vidhi and Finance Research Group of Indira Gandhi Institute of Development Research helped draft the law. This law was enacted in May 2016. There are more examples like goods and services tax anti-money laundering laws etc which are similar in nature. What we see in all of them is the journey of ideas committees and eventually drafting of law over a long time horizon (from 2002 to 2016) where the baton was passed from one generation of reformers to the next. India needs more of these in all sectors and certainly in the areas of finance and the economy.

The writer retired as a secretary to GoI and is now a professor at the National Council of Applied Economic Research. Views are personal

(D B Gupta is Senior Advisor and Sanjib Pohit is Professor at NCAER. The views expressed are personal.) 

The study noted that 79% households reported a fall in income with 29% of them left with literally no source of income.

For restructuring the Indian economy we need to strengthen the household economy. The National Council of Applied Economic Research and the Nossal Institute for Global Health University of Melbourne conducted a study called ‘Social Economic and Health Impact of COVID-19 in the States of Uttar Pradesh and Odisha’ during June 9-18—the unlock 1 period. It covered 2100 households from four districts two each from Uttar Pradesh and Odisha and assessed the situation on three parameters: before during and after the lockdown from economic social and psychological perspectives.

The economic shock as a consequence of multiple lockdowns is deep and wide. The study noted that 79% households reported a fall in income with 29% of them left with literally no source of income. The job market also underwent a concomitant swing in the form of 11% of the households shifting their occupations.

The economic situation was further aggravated by the emergence of supply shortages and in-migration. About 16% households faced supply shortages of essential items like food vegetables milk eggs and cooking fuel. Surprisingly about 11% households could not even access medicines during this pandemic. The monthly remittances suffered a severe blow as 11% of the households reported in-migration. The households caught between dwindling incomes and emerging supply shortages adopted a diversified coping mechanism to meet expenditures on essential items. While 53% households acknowledged receiving government assistance 41% of them borrowed money. In addition 20% of the households even reduced the consumption of essential items.

A closer look at the data establishes the existence of three undercurrents: spatiality casual employment and the place of agricultural sector in the economy.

Given the diversity of our country the transmission of Covid-19 and its repercussions have wide spatial variations across almost all the variables between Uttar Pradesh and Odisha. The proportion of households reporting reduction or even total loss of income and shift in occupation is lower in Odisha as compared to Uttar Pradesh. The proportion of households reporting reduction in income was 81% in Odisha and 76% in Uttar Pradesh. Also UP households faced supply shortages of food items and vegetables while for those in Odisha accessing cooking fuel eggs meat fish and medicine was the prominent concern.

Among all the major occupation groups the households in casual employment account for the highest proportion with respect to reduction or loss of income shift in occupation (18%) and accumulation of debt (71%). Agricultural households have managed the economic shock better being second to households with regular salary.

In addition during the unlock 1 period as a sign of economic revival as many as 72% of the households returned to work. The high proportion of casual workers among these households does indicate the possibility of distress-driven resumption of economic activities. Also 55% of the households expect either improvement or no change in their perception about their financial situation in the next 12 months but 33% of the households sense a likely deterioration in their financial situation.

Despite these odds these people have a high degree of trust and confidence in the government. While 95% of the households supported the lockdown strategy 92% exuded confidence in the government’s ability to tackle the crisis. The government continues to be the most reliable brand for the people especially the poor.

Management of these undercurrents involves actions on three fronts. First the benefits transfer system must be revamped to incorporate increased coverage and seamless accessibility through integration of portability—as 47% of the households still report non-receipt of any government assistance. Second effective and institutionalised decentralisation of the governance ecosystem cannot be delayed. Last to address the menace of casualisation of employment India must learn to generate enough good-quality jobs. These steps would embolden household economy and feed into the larger structural transformation of the Indian economy.

P K Ghosh is fellow and Sumit Kumar is consultant NCAER

Loose monetary and fiscal policies can’t be sustained for long and we need comprehensive structural reforms to drive growth

The coronavirus death toll in India has crossed 50000 and is still rising though at a declining rate. The growth in daily deaths has slowed from 20% in early April to less than 2% now. The recovery rate is also rising while the mortality rate is declining. A vaccine will probably be available for mass immunization by early next year. The worst of the pandemic seems behind us. It is time now to turn to repairing the economy.

Estimates of the gross domestic product (GDP) decline in 2020-21 vary from 1% to over 15%. My assessment is of a 5% contraction a number on which there seems to be fairly wide agreement. The April-June quarter was the worst affected. Year-on-year output is still declining but at a slower rate. The decline will probably taper off by the fourth quarter. Output will then start recovering. After a brief sharp turn- around the recovery path is likely to stretch into a long pan handle as we approach the previous peak output level of 2019-20. Available data on leading indicators such as non-food credit power consumption industrial production employment goods and services tax collections and production managers’ expectations all point in this direction. This year and the next are lost years. Only at the end of 2021-22 will output be back to where it was at the end of 2019-20. India’s growth performance after that will depend on the policies that are pursued during the next year and a half. The options depend on where we are today.

The combined fiscal deficit this year correctly measured will likely amount to 10.5% of GDP or 12.5% if we also count the additional borrowing headroom allowed to states. The total public- sector borrowing requirement including the borrowings of public undertakings will be around 14-15% of GDP. Taken together with liquidity infusion of nearly 9% of GDP this amounts to a massive aggregate demand stimulus. How much of this will translate into a recovery of output and how much to higher inflation would depend on supply-side constraints. Most analysts have focused on the current recession and some have even raised fears of deflation. But in my Mint column(Demand stimulation supply constraints and recession risks) of 19 June 2020 and elsewhere I have been pointing to the risks of stagflation i.e. a recession combined with rising inflation. Unfortunately that assessment has turned out correct. Along with a sharp decline in GDP headline inflation has risen to almost 7% well above the Reserve Bank of India’s (RBI’s) tolerance band and food inflation is close to 10%.

Hence India’s expansionary fiscal and monetary policies will have to be gradually reined in reverting to fiscal compression and a tight money policy by 2022-23. The external environment is also unlikely to stimulate high growth without a strong reversal of the pandemic-led global recession and continuing geopolitical tensions. The country’s current account balance had temporarily turned into a surplus because along with low oil prices declining GDP had led to a sharp decline in imports. However as the recovery proceeds imports will rise leading again to a trade deficit and a negative net impact on aggregate demand ( i.e. aggregate domestic demand exports – imports). Given this context the only viable strategy for a return to sustainable growth of 7% or more in the medium to long term is to stimulate investment and business confidence through the resumption of long-pending structural reforms.

Space limitations prevent my getting into the details but a priority list of such reforms is as follows. The top priority is the financial sector. Bringing public sector banks under the exclusive regulation of RBI and reducing public ownership to less than 50% are necessary but not sufficient reforms as the private sector scams at Yes Bank IL&FS etc. have shown. Strengthening the supervision of both banks and non-bank finance companies is key to cracking the non-performing assets problem. Second fiscal reforms should include a sharp reduction in tax concessions and exemptions a policy reversal on discretionary ad hoc tariffs elimination of non-merit subsidies and a progressive shifting of central and state government expenditure towards education health and physical infrastructure. Third in the power sector the core reform required is privatization of distribution. The experience of states like Delhi can serve as templates for others. Fourth India needs to abolish regulations that dis-incentivize the growth of small and medium enterprises such as the Factories Act. This is essential for rapid growth of employment in industry and services. Fifth public enterprise reform. This has proven intractable but state-run firms should either win or wither in fair competition with private enterprises without repeated capital infusions at the cost of taxpayers. Sixth in agriculture the key requirement is to reform the marketing system to narrow the huge margins between what consumers pay and farmers earn.

Apart from economic reforms the quality of our governance institutions the legislature executive and judiciary also impinge on economic performance. Strengthening these is essential to sustain high growth. Finally reforms are to be seen as a process not an event. Past experience in China India and elsewhere suggests that it could take up to a decade for the process to work itself out and return us to a path of high growth.

Sudipto Mundle is a distinguished fellow at the National Council of Applied Economic Research. These are the author’s personal views.