Economy sending mixed signals: CEA

Chief Economic Advisor Arvind Subramanian. Photo: Prashant Nakwe  

Days before the Reserve Bank’s monetary policy review scheduled for Tuesday, Chief Economic Advisor Arvind Subramanian said India’s economy is below potential and needs monetary support. In an exclusive interview to Puja Mehra and TCA Sharad Raghavan , he also took up questions on reforms, his warning of deflation and the difficulty in interpreting the latest data on India’s growth, China and other global economic developments and their implications for India. Full text:

You'd said India's closer to deflationary territory but at the same time you maintain India's GDP growth this year will be 8 percent plus. Are the two trends consistent?

When I mentioned it, I said price-wise we are close to deflation. Now, there is no accepted word for negative inflation and disinflation is too complicated a word. So whereas I meant deflation to connote rapidly decelerating inflationary pressures, it was interpreted as an indication about economic activity which it was not meant to be.

In a sense, there are at least two manifestations of the deflation I am talking about. One is agriculture. Prices are down. Apart from onion prices, of course, and one or two commodities, in agriculture we do see depressed incomes because prices are down and the monsoon being what it is.

The second thing is that when nominal GDP starts decelerating as it has, it has implications for the fiscal as well. So, that’s another manifestation of the deflation. So its very much related to the deceleration of price pressures which I wanted to highlight in referring to the totality of price developments.

But now we come to your question about how do you reconcile growth with this. Remember that the projection that we had in the Economic Survey was based on four factors which I want to run through. One was oil prices coming down sharply, second the cumulative effect of reforms, three was the monsoon and at that stage the monsoon was predicted to be good… and fourth what I said in the Survey was that as inflation comes down the monetary situation will ease. So that 8 per cent is conditional on what we expected about monetary policy. So, one could argue that if monetary policy deviates from expectations, our growth projections have been correspondingly different.

The second point is that the economy is sending mixed signals. The signals are unambiguously pointing to a pickup, an improvement in economic activity. But on the pace, we do get mixed signals. For example, indirect tax revenue numbers are doing very well, direct tax revenue numbers are not doing so well. Real credit growth numbers are actually doing better than people think. Everybody looks at the headline nominal credit growth but actually at a time of such sharp disinflation, you have to look at real credit growth, which has recovered, and real credit growth to the consumer sector is growing at something like 15 per cent. Stalled projects have also come down, but at the same time exports are in negative territory. But one must be careful about export volume growth.

You know, the headline dollar numbers should be deflated by some price index which most people haven’t done because internationally also there is deflation so I think volumes are not doing as badly as the headline dollar numbers would suggest, both on the export and import side. But nevertheless, trade is down. I think that private investment is still challenged. So, in that sense, therefore, the economy is still well below potential and that’s the sense in which you can completely logically say that even though it’s recovering and full of potential, therefore it needs monetary policy support because we are below potential we are not going to aggravate inflationary pressures.

What does the complete divergence in the trend lines for growths in the GVA and the GDP over the last three quarters imply? (One is a 'V' and the other an inverted 'V')

Certainly in the latest quarter and the quarter before, the divergence between the two has been because of indirect taxes and that is essentially the problem. It has to do with how indirect taxes are treated in the quarterly accounts and the national accounts. To put it differently, in the annual numbers, I think you will see a slightly different picture of the GDP at market prices than you see in the quarterly numbers. Essentially, what’s happening is that because of the excise on petrol and diesel our indirect tax collections have been rising very strongly. This year, for the first five months, the growth has been 36 per cent. This has been the case since November last year when we started raising the excise. So when indirect taxes go up and subsidies come done, and both have been happening, GDP at market prices diverges substantially from the GVA at basic prices.

To give you an illustration of the difference in the way the quarterly numbers and annual numbers are calculated, let’s say in the quarter indirect taxes went up by 36 per cent. In the quarterly numbers, because of the methodology that is followed, only about 7-8 per cent is allowed to be treated as market contribution to GDP. In the annual numbers, what happens is that indirect taxes are deflated by the CPI so if there is a 35 per cent increase the real increase will be 28 per cent-29 per cent because the CPI is only 4-5 per cent. So that’ll get corrected at the end and what will happen is that for the last quarter real GDP growth will be reduced real GDP growth and for the first quarter it will be revised upward.

To cut a long story short, at a time when indirect taxes are increasing a lot, the methodology creates these artificial divergences which will get smoothed out in the annual numbers.

The CSO follows standard practice. For quarterly data it follows IMF recommendations. That is, the taxes should grow in line with the base. For annual data, the recommended practice is that it should be deflated by CPI, which seems like the correct way of treating indirect taxes. At a time when tax collections are increasing rapidly, the two methods will send mixed signals. However at the end of the year there will be revisions which will iron out the differences.

How will this indirect taxes effect play out on the implementation of the GST?

In principle, GST should be a revenue neutral rate so in itself it should not suddenly lead to an increase in indirect taxes.

Just like the global exports slowdown, India's exports have been shrinking for nine straight months. What would be your advice for this be to the Prime Minister? Of course the global economic scenario isn’t conducive at the moment for it but what do we need to do?

That the international scenario is not conducive is an important caveat because remember that in the period of 8.5-9 per cent growth, manufacturing exports were growing in the low 20 per cent annually and services exports at 30 per cent annually. So you have to take that into account when you talk about what the realistic growth could be going forward. But that being said, I do think the question is a legitimate one: how do we get it back? I think, in the short run, of course, the answer is the public investment programme. The diagnosis in the economic survey always was that private investment was weak because of balance sheet issues and therefore you need public investment in the interim to kick-start the economy.

So that’s the short run thing. The medium term thing is that the reform agenda of the government needs to be carried forward. For example, regarding the tax uncertainty, the AP Shah committee has been set up, progress is being made, all the stuff relating to GST, ease of doing business. Once you implement all these things, that’s the manner we raise growth to the 8-10 per cent range.

Without sorting out the issues surrounding the factors of production — labour, land and capital — can India really hope for double-digit growth?

The list of reforms is long. But basically what I am saying is you have to increase the supply potential of the country.

Now on that, I think each one has his or her list of priorities of what is important. Some will say labour laws, some will say land, some will say GST, some will say ease of doing business. I think, analytically for me, I can’t honestly and in good conscience say I know what is more important that the other. We have to do a lot of what is on this list. And then the challenges are, one, how fast we do it, what are the political constraints, and two, do you do it at the Centre, or do you let the states do it? So, India being such a vast and complicated country, questions about priorities, speed and pace of reforms becomes quite challenging.

Regarding land laws, I think the decision to let the states take the lead on this is a very good one. States are in a better position to address some of these issues. Similarly, labour laws being done by the states as Rajasthan has shown is a good way of doing reforms. I’ve read a lot on labour in India and honestly I am trying to find my way in terms of what is important. In the Economic Survey we are trying to do something big on understanding labour markets and bring a new and fresh perspective on it: what is important, what should be done, should it be done by the Centre, should it done by the states? Is it just a labour market issue or does it also have to do with urbanisation, basic education?

What working economic policy strategy does India need at this moment to deliver on PM Modi’s promise of creating 100 million jobs?

The 8-10 per cent growth target I think is a necessary condition for generating all these jobs. And also remember that the view in the Economic Survey was, and I stand by it, that because we are a complicated democracy and not in crisis, the appropriate yardstick for measuring performance is whether we are seeing a “persistent, creative and encompassing incrementalism”. That’s something we must recognise. Much as we may wish things get done quicker, this is the reality.

Can India get back to 8 per cent-plus growth within the tenure of this Government?

Oh, yes, getting to 8-10 per cent growth is something that should hopefully be possible earlier than 5 years. What are the bottlenecks? The balance sheet of firms, that’s why I think clearing the stalled projects is important. Discoms are a big problem. The government is going to treat those with a great deal of urgency. The tax issues have led to a lot of uncertainty and bad blood. Addressing that will be a great start. GST of course is another very important reform, and an area where all of us are disappointed it couldn’t have been done faster. But it can hopefully get done soon and that should help in kick-starting public investment. Then, when I talk about balance sheets, it has to do with both corporate balance sheets and banking balance sheets, and there we have started on the whole recapitalisation thing.

One of the striking differences between China and India is that China has had convergence within the country. Poorer regions have been growing faster than the richer regions. In India, even now, 30 years after our growth took off in the late 70s to early 80s, we don’t see convergence across regions in per capita GDP growth. And it also struck me that possibly one reason could be that we don’t have enough labour mobility within the country.

There are two or three things here that is important. One is the social constraints on mobility but others include urbanisation. People don’t want to move to Bombay because the higher salaries don’t compensate for the rental costs and the quality of life. So maybe employment creation has as much to do with rental markets. The other thought that struck me is that to the extent that you have social constraints, what it means is that the expected differential has to be that much greater to offset the greater rentals and social cost of mobility.

I can’t prove this to you but my sense is that when India boomed in the 2000s, migration would have picked up to a greater extent than before. My hypothesis is that, yes, in the 80s and 90s we grew at about 6-6.6 per cent. In the 2000s, at about 8.5-9 per cent. And 6-6.5 per cent is not bad but maybe that was not enough to overcome these social costs of mobility. In that sense, China being much more homogenous, the expected differential has to be less than in India because you don’t have the social cost so that’s why we need more rapid growth and need to address the urbanisation constraints. The returns have to be much higher to compensate for these high social costs.

What is the state of the Chinese economy? And, what does its state imply for the world and for India?

What is going on China, I think, is really important but I think we don’t know fully how it is going to pan out. Because there are at least three defensible views. One is the view of my former colleague Nick Lardy of the Peterson Institute who is a real expert on China who says that there is over-hype about manufacturing declining. If you look at the services indicators, which is now a much more important part of the economy…

50 per cent…

Yeah, exactly, and that’s not doing badly so it is overhype.

The second view is that there is something going on but it is a temporary wobble and that the authorities maybe lost control to some extent but they will regain it and things will be back on track. The third view, which is probably a low-probability view but not something that can be ruled out, is that actually the interaction between economics and politics could generate something that is much more serious. Willem Buiter of Citi has this kind of apocalypse view on China. I don’t think any one can honestly say which of these is bang on. I kind of veer towards the second view that it is a temporary wobble and that China will regain its footing but it will regain its footing at 5-7 per cent growth. Not 10.5 per cent. I am a big believer in convergence, which is that as countries become richer they start slowing down. China has grown gangbusters for 35 years. As I always say, the puzzle about China is not why it is slowing down now but why it didn’t slow down earlier. And therefore the slowdown is normal. And that slowdown will be in the 5-7 per cent range. In fact in my book, Eclipse, my medium term growth for China is about 5-5.5 per cent and I stand by that.

If that is the medium term forecast for China, then it throws up more challenges and opportunities for India. First, as the PM has clearly said, I strongly believe in a win-win view of the world. If other countries grow well, it is good for the world. If China grows rapidly, it is good for the world it is good for India. If China slows down, it will throw up challenges and part of that is not just the general decline inevitably in export opportunities for us but also there are sectoral challenges. China has so much capacity: especially steel and related sectors and that could have a bearing on our steel sector and that could pose problems for us.

China is slowing down by moving away from manufacturing to services so the net effect on commodity prices will be even greater for that reason and therefore if you combine that with all that is happening with the supply side on the oil market then we are in for relatively soft oil prices which gives us a cushion. It will allow us to maintain that macro stability which is so important for the launch to 8-10 per cent growth going forward. In some ways you can think of this as a positive supply shock for infrastructure in the sense that because commodity prices are down—steel, cement, iron, all the things that go into building infrastructure — so it is a supply shock to infrastructure, which given that we need so much infrastructure, is positive. But these are all statements about opportunities and potential. There are no guarantees in this business on the outcomes. You convert opportunities into reality by doing the things that we need to do.

How real is the threat of a currency war?

I think the latest number coming is that China’s current account surplus is coming back to 5 per cent of GDP. From 11 per cent it had come down to 2 per cent and now it has gone up back again, so that is one thing that is noteworthy. The second thing that is noteworthy is that what started these worries of currency wars is that China’s moved to a more market-based exchange rate. In the old days, if China had moved to a more market-based exchange rate, market pressures would have led to the currency to appreciate. But now when this uncertainty about China, especially about both the growth slowdown plus the ability of policymakers to manage this plus whatever has happened on the political side, it seems like there are also capital outflow pressures which will then lead to the Chinese currency softening. The possibility of the Chinese currency depreciating cannot be ruled out. Of course it is going to be interesting to see whether China will use its reserves to prevent this depreciation or not. So. in a sense it’s back to the policymakers. Xi Jingping said yesterday (Wednesday) that we are not going to have currency wars so it is going to be a test of the Chinese authorities. Even if confidence comes back and there are upward pressures, will the Chinese allow those pressures to do their thing and will they start buying again? And, conversely if there is outward pressure, will they intervene to prevent the depreciation? So, I think it is going to be a policy issue we will have to watch in China.

Latest global developments, for instance in the UK, are being interpreted as a sharp reaction to today’s Capitalism? Any lessons for economic policy and ideology in India?

It’s a great question. In some ways, after the global financial crisis, there was this naval gazing about Capitalism in the West, which, I thought, was a little bit overblown because the revisionism was specifically about Finance. Whether Finance had gotten out of hand and whether you may have to rein in Finance. I don’t think that any one was suggesting that Capitalism as a way of running a market economy, of course subject to the usual regulation and things was a bad thing. I think there was deep anxiety about this Anglo-Saxon gung-ho finance-led Capitalism. I think there has been a revision on that and rightly so. I don’t think you can any longer say that more finance is a good thing and more foreign finance is a good thing. And, that is valid for India as well, especially on foreign capital. The lesson of the last ten years is that one has to be cautious about foreign capital and we will be very remiss if we don’t internalise those lessons. FDI is very good. Portfolio equity is also desirable but as you get to other forms like foreign currency denominated borrowing, we need to be much more cautious. But I don’t think the lesson for India is “Oh my God, markets are bad, so we should go back to state capital”. And the reason I say that is if you think about India conceptually, we went from anti-market and pro-state to pro-business. We have reached the pro-business stage but have we gone on to a pro-market, a pro-competition stage. It’s something that we need to think about. Put differently, we haven’t reached the kind of true capitalism for us to have the kind of generalised angst about that capitalism.

What complicates matters is that because state capacity is relatively weak, we get a form of a weakly-regulated capitalism. It is easy to say therefore that the problem is with the capitalism part and not with the regulation part and that is where we need to be very clear that the problem is actually the state’s capacity to regulate.

There are many ways of looking at this. One is the whole thing of corruption and crony capitalism. There is a deeper and broader point which is that we have always known that markets have to be embedded in social contracts that are manifested through regulation. Take for example PPPs contracts that are awarded. They have to be renegotiated. As soon as we see that we say, there is the allegation that “Oh my God, they are going to favour someone and we don’t have the ability to say yes”. Sometimes, contracts have to be renegotiated and we need government structures to be able to do that. Whether that is environment regulation, labour regulation…it has to do much more with the regulation capacity of state. When that doesn’t happen, we begin to blame markets. Conceptually we shouldn’t risk drawing the wrong lessons from the evaluation of Capitalism that has gone on in the west in the aftermath of the global financial crisis.

The IIP numbers are hard to interpret. Why do they fluctuate so much?

There are two issues on the IIP numbers: One is the methodology and the revision. The other thing about the IIP numbers that one has to be careful about at this time is that these are volume indicators. I don’t want to be self-congratulatory, but when I highlighted the divergence about the CPI and the WPI, I think that is a very important point because it affects a lot of things including how we should interpret credit numbers, but also how we should interpret IIP numbers. For example, if prices are also coming down, especially input prices, then it is possible that IIP numbers being soft is not inconsistent with moderately robust value-added growth. But why doesn’t it show up in profit numbers? Part of the answer to that is that public sector companies’ profits are very robust; it is the private sector profit numbers that are not doing so well. Some of these public sector units are sitting on huge vaults of cash.

Does this tell us that there isn’t much pricing power with companies which means that levels of demand in the economy probably aren’t that robust?

Yes and no. What you just said is right. That is the sense in which all these price developments also inform monetary policy behaviour. On the other hand, the deeper puzzle is that if that is the case why aren’t consumer prices then following wholesale prices more closely? If you think pricing power is undermined, then the ability to charge higher prices to consumers should also actually be offset and that hasn’t happened. So, fundamentally the wedge between the two is something that we don’t fully understand. Hopefully with lags the two will start converging.

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Printable version | Feb 26, 2021 6:14:42 AM | https://www.thehindu.com/business/Industry/interview-with-chief-economic-advisor-arvind-subramanian/article7689614.ece

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