A day after the release of the Economic Survey 2017-18 , its lead author Arvind Subramanian says small stock market investors should be wary of a sharp correction in market levels, and cautions the government against implementing populist measures in an election year as they could worsen the fiscal situation. Excerpts:
Is there a possibility of income tax slabs being changed given the widening tax base and increased engagement with the tax system as shown in the Survey?
Remember that the government had set up a committee and I am a kind of permanent invited member on this. I think the fact that we have set up this committee and the government has invested a fair amount of thought into this for the future is something that shows it is an important subject, and the government is going to be thinking about it constantly. Whether it happens in this Budget or the medium term, we’ll wait and see.
You have cautioned against two key risks in the future: rising stock market levels and rising oil prices. How do we prepare for these? For rising oil prices, would preparation involve reducing the excise duty?
Oil prices are a fact of life, you have to deal with it. You just want to make sure that you are clear about when this shock happens. Whatever the impacts on the domestic economy, how do you cope with them? For example, if it means inflation is going to be above your target, monetary policy will have to react accordingly. If it means your budgetary numbers are going to look worse, then you say, ‘Do I have to cut elsewhere if I have a fiscal deficit target.’ So, it’s just a fact of life that when oil prices go up for an importing economy like India, you have to take other corrective action to make sure macro stability is maintained.
Remember, it does not follow that if oil prices go up, excise duties come down, because that presumes only one perspective, which is of the consumer. Governments can’t just look at that one angle. If you do that, revenues come down, deficit might go up, so you have to balance this consumers’ perspective with the government’s perspective. It’s a delicate art.
You had mentioned a miscalculation on when shale oil would kick in...
I think many people, including me, misjudged... I thought, and I said so in the last Survey as well, that one of the features of shale oil is that it has this accordion-like quality, that it comes back very quickly and goes out very quickly. Broadly, at about $45-50 a barrel, it is profitable. All of us thought $45, $50, $55, $60, but it hasn’t happened. Yesterday, the rig count went up again, so I think we need to see.
But the new confounding factor is Saudi Aramco. None of us thought that Aramco listing... and remember it is tied up in Saudi domestic politics. That we have the King and he wants to make Aramco a big success and it’s probably one of the world’s largest companies and one important ingredient to make it a success is high oil prices because then its valuation is much greater. So that has confounded... We had all thought that the listing would be some time early this year, but it will probably be later this year and that is going to complicate the oil market.
But it’s just 5%. Why do you think the Aramco public listing is going to have such an impact?
There are two things going on here. Saudi public finances are a mess, they have been eating into their reserves. So, they need to raise a lot of money to do this. And 5% of Aramco is a lot of money because it is one of the world’s biggest companies. Second, it is part of this politics of ‘I am a new guy, I am going to show the world how we run this and these are all valuable assets’. Remember, they allowed oil prices to fall because they said, ‘We will take the hit, but the Iranians are getting hurt even more’, but now I think it’s changed. Now even if the Iranians are benefiting from this, they are saying, ‘We have other domestic objectives that we need to satisfy’.
Given the low and falling oil prices in the first two years of this government, do you think it has done enough to take the benefits of that and apply them here?
I think that’s a question that keeps getting asked, and my response is that when oil prices came down, it was a bonanza, and all governments said, ‘How should I respond to it?’ It’s the flip side of what’s happening now. What the government decided was that some of it would be passed on to consumers, some would be used for higher public investment, and some would be used to cut the deficit. Now, these are all objectives that the government has, and different governments across time might make different choices in weighing these, but broadly it’s a very defensible choice.
It was a fairly reasonably considered choice. And remember, when you cut the deficit using part of that, you are also preparing for the future, that when it goes up in the other direction, then you have that cushion in order to flexibly manage it.
But the last point I will say is that one of the things the government is saying, in continuation of what the previous government said, is deregulate oil prices. Oil prices coming down was a good opportunity to deregulate. To be fair to the government, oil prices came down, and then they have gone up and down, and now they are going up again. During that phase, the government stuck to the policy of deregulation and I think that’s a long-term micro benefit that we have. That’s another reason why when you say ‘oil prices have gone up, I must cut excise’, it’s a little bit inconsistent with the spirit of deregulation. The whole point is that you pass it on and the consumer bears the ups and downs, within limits, of course. You don’t want to respond to every little change in oil prices.
The Survey pointed out that a lot of people are putting their savings into equity. Would you ask them to be extra cautious now?
I think, if you study the history of financial asset price increases, going back to the South Sea Bubble… I mean, we have to find something from the Ramayana and Mahabharata which is an analogue of the Dutch Tulip Bubble and the South Sea Bubble because I will again be accused of being mentally ‘un-Indian’ with the analogies I am giving ( laughs ).
But [when] asset prices go up too much, they come down again. One can never time this, one can never say this is a bubble, but I think my rule of thumb is that the more out of line in history they become, the greater the need for vigilance. So, I think all investors should be aware that this is not just going to go up and up. At some point it will come down, and I think certainly there is a role for broader financial education. Maybe heightened regulation as well. SEBI (the Securities and Exchange Board of India) has to be much more vigilant about regulating these markets.
Because at the end of the day — and that’s a point that is unusual about this — this time around, the person who will be affected will be the small saver, because he’s the one who has put his money there. And then politics will intervene. In politics you cannot afford to ignore when a small saver gets hurt. A politician will be forced to respond, and those responses then can end up introducing more distortions. And that’s why we need to be extra vigilant this time around.
You had indicated a pause in the government’s fiscal consolidation in the year ahead...
Let’s be careful here. I think for this year we know what the situation is. The government had made it clear what the borrowing will be. For the next year, how should we think of fiscal policy? As an economist watching the economic cycle, if growth is reviving and inflation and other things are happening, then this is the time for some serious fiscal consolidation. That’s what my advice would be. But it’s also an election year, which you can’t ignore. And here is the nuance I want to get across. An election year should not lead to populism because the overall macro situation... one has to be a bit watchful of it. Bond markets are worried, inflation is rising. So, fiscal populism would be really counterproductive.
The economic cycle says you should consolidate aggressively, but the fact of politics you can’t ignore, so the question then becomes, ‘Should you consolidate aggressively or more steadily?’
But the actual wording says a “pause in general government fiscal consolidation relative to 2016-17 cannot be ruled out.” Is that what you are recommending or is it a fact?
Yes, that’s for 2017-18. Already the size of the market borrowings has been announced. We are at the end of the year, there’s nothing you can do about it. It’s just a given now. There is no prescriptive content to this at all because we are almost at the end of the year.
How is the bank recapitalisation package going to be handled with regard to the fiscal deficit? Will it be above the line, thus affecting the deficit, or below the line?
Indian government accounting practice says that it should be above the line. But my view has been very clear that in this case it does not affect the macroeconomic situation because in a sense you are shuffling money from one balance sheet to another balance sheet. It’s just a capital transaction. And that’s how the international accounting practice is. As part of the FRBM (Fiscal Responsibility and Budget Management), the committee recommended we should move to international accounting practices on this. I think in India’s case, both disinvestment and things like this are above the line. Both should be below the line, because they are all asset transactions.
[At the moment], it will affect the numbers, but I think it is a meaningless number. The headline number will be what it is because we have a certain accounting practice, and we follow it.
Several steps have been taken to fix the structural issues in private investment, but what about the cyclical nature of private investment?
I have almost forgotten that there is a cycle in private investment because it has been down for so long! I think that first let’s just get private investment up again. We see the first signs. In the last two quarters, I think, you see the first recovery in overall investment and I think some of it is also in private investment. I think for private investment to come back strongly, we need to grow to utilise the existing capacity, it’s still quite low.
And second is that the whole twin balance sheet issue will have to be addressed. Corporates will have to start spending again, and the resolutions could be very important for them. Banks will have to start lending, cleaning up debt. So, a combination of growth to eat up existing capacity plus cleaning up the balance sheets is what will make private investment grow.
If you want this cycle not to repeat itself again, some of the unviable banks have to be credibly shrunk and [former] Governor of Reserve Bank Y.V. Reddy had good ideas on that. The second thing is that we have to have more private sector majority participation. One of my favourite phrases in the Survey is that we have gone from crony socialism to stigmatised capitalism. How is that relevant in the banking system?
I think that stigmatised capitalism, part of the contribution to that Zeitgeist, was public lending to private firms, cronyism and all of the shenanigans that went on under the previous government. What that means is that public to private lending has become toxic. You can’t exit from it because people think you’re favouring them... allegations of ‘suit-boot ki sarkar’, and quite rightly so. After all, this Zeitgeist of stigmatised capitalism is there for a good reason.
And so, going forward, one lesson is that we never want to repeat this experience of public to private lending. That means that maybe there should be fewer public lenders and more private lenders.
You had predicted double-digit growth in your first Survey. What are some specific reasons that halted the idea that double-digit growth was achievable in the next few years?
I think I had underestimated the impact of this overhang from the twin balance sheet problem. I actually think that if we could move beyond that, with GST (goods and services tax) now in place and the stability that has come, provided the external environment cooperates, I think we can get back to 8% or even 8%-plus. I don’t think that’s out of our reach at all.
It’s taken us longer because of all the interim stuff that has happened. I think, to be fair to everyone, the twin balance sheet problem should have been addressed earlier. But stigmatised capitalism has meant that it has taken longer. It’s taken longer, so the problem has become more protracted and therefore I think that getting out of it will be a little bit slower.
Remember, we have never reached consistent double-digit growth, even in the boom period. For double-digit growth, the world economy has to cooperate. So, you do all you can in terms of reforms, and if you have a reasonably buoyant world economy, then you can be at 10%.
Is there anything being done in the Finance Ministry to ensure the tax department does not appeal so much, which is what the Survey has pointed out is a leading cause for delayed settlement of cases?
I think they are going to be spending some effort on that now.
Now that the government has repeatedly said that it is not going to let public sector banks fail, what future do you see for the bail-in clause in the Financial Resolution and Deposit Insurance Bill?
I think depositors in government banks are protected. I think that’s what everyone should take away from this. It’s only others for whom this bail-in clause will apply. So, depositors, there should be absolutely no doubt that they will be protected. It’s true all over the world. Everyone has deposit insurance, with limits. I think that small savers, depositors, should not have any doubts about their savings. The bail-in applies to other lenders to banks, wholesale lenders to banks, and so on. But that is a contingency I am not even willing to think about that this stage.
