Saving lives and livelihoods

• The current crisis is a different one

• Health crisis

• Synchronized disruption

• Restricted physical interactions

• India imposed a stringent lockdown and itsimpact was seen in contraction of growth

• Since June (withdrawal of lockdownrestrictions) there has been a V-shapedeconomic recovery taking place

Far sighted policy response for economic recovery• Imposed lockdown has affected the service sector

• The pandemic induced lockdown has led to local,regional and global supply disruptions which has hitthe economy leading to first order supply shock

• Because of lockdown it was difficult to estimate howdirect cash transfers would be used. In case of US

• Only 15% of recipients have used the transfers toincrease their spending

• 33% saved it

• Remaining 52% have used it to pay debt

• “Pushing the accelerator while the foot was firmly onthe brake”

• In the first two quarters• Govt ensured that the funds will available for

essential activities• Provide cushion for MSMEs and poorer sections of

the society• Debt moratorium was announced and then

extended• PM Garib Kalyan Yojana was announced for

ensuring food security, DBT to widows

• After this in the third quarter govt targeted atincreasing the investment by announcing AtmanirbharBharat 2.0 and 3.0

Far sighted policy response for economic recovery

Structural reforms• Govt under Atmanirbhar Bharat (ANB) has initiated structural reforms on

the supply side

• Reforms of govt have provided opportunities for growth in these along with job creation

• Agricultural reforms

• Labour reforms

• Changing the definition of MSMEs

• Coal mining

• PLI Scheme

• Privatization of non-strategic CPSEs

Looking forward

• The Indian economy is experiencing a V- shaped recovery in this period of global recession

• India is reaping the lockdown dividend with the brave and preventive measures adopted by the govt from the onset of pandemic

Does Growth lead to Debt Sustainability?

• With the pandemic, the governmentsaround the world have gone forexpansionary fiscal policy

• With such policy there are concernsattached

• Survey has concluded that in the contextof India growth leads to debt sustainabilityand not vice versa

Counter and Pro cyclical fiscal policy

Relevance of Counter Cyclical Fiscal Policy (CCFP)

• The GDP is calculated by Y=C+I+G+X-M

Relevance of Counter Cyclical Fiscal Policy (CCFP)• Studies done for 114 countries has

shown that• Following a pro cyclical fiscal policy will

lead to lower economic growth, highervolatility in the output and higherlevels of inflation

• Countercyclical fiscal policy acts as astabiliser by reducing output volatilityand keeps the growth rates on a steadypath

• Industries have grown faster ineconomies which have followedcountercyclical fiscal policy

Is public debt leading to crowding out in India

India’s debt structure

India’s debt structure

Policy Implications

• Hysteria about impact of covid and net loss of jobs should be avoided

• In order to ensure that the economy gets the benefit from the reforms implemented by the govt, there is a need of active fiscal policy

• During crisis well designed expansionary monetary policy will lead to positive outcomes

• Need for a fiscal rule

Does India’s Sovereign Credit Rating Reflect Its Fundamentals?

India’s Sovereign Credit Rating (SCR)

Does India’s SCR reflect its fundamentals

• India has been an outlier in terms of its sovereigncredit rating and its performance in many of thefundamental parameters which are considered to bevery important for the economy

• Annual GDP growth rate

• Political stability

• Current account balance

• Investor protection

• General govt gross debt

• CPI inflation

Does India’s SCR reflect its fundamentals• India’s willingness to pay can also be reflected

• Foreign currency denominated govt debt is just 4% of GDP

• 54% of the sovereign external debt is owed to multilaterals and IMF as of March 2020, which should not be affecting credit rating assessments

• Huge forex reserves have been built that can pay for the short term of private sector’s as well as entire India’s sovereign and non-sovereign external debt. The forex reserves stood at $584.24 bn as of mid January 2021 (greater than India’s total debt i.e. sovereign and non-sovereign)

Macroeconomic indicators as determinants of SCR changes

• No clear pattern between changes inGDP growth and SCR changes

• All sovereign credit rating upgrades haveoccurred in the years that havewitnessed lower fiscal deficit ascompared to the previous years

• Most upgrades have happened in yearsthat have witnessed higher or similarlevels of general govt debt (as apercentage of GDP)

Macroeconomic indicators as determinants of SCR changes

• Most upgrades are in the years thathave witnessed higher overall debt ascompared to previous years.

• Pattern between CPI, CAD and ratechanges are not clear.

• The average change in the annualperformance of these indicators (GDPgrowth rate, CPI, CAD etc) i.e. in theyear of rate changes was better thanor similar to the previous year; andfurther improved or remained similarin the year after the year of ratingchange.

Impact of SCR• Impact of SCR downgrade -

Summary

• Rating downgrades do notappear to have strongnegative correlation withSensex return, exchange ratein short, medium and longterm.

• Rating downgrades seem tohave a negative correlationwith the FPI (equity and debt)in the long term.

Policy Implications

• Policy should be guided by the considerationsof growth and development

• These ratings do affect the FPI flows

• Amend to reflect the ability and willingnessof the countries to pay their debt

• Developing countries must come together toaddress this bias of credit rating agencies andprevent exacerbation of crisis in future

• The pro-cyclicality nature of credit ratings andits potential adverse impact on theeconomies, especially the low rateddeveloping economies must be addressed

Inequality and Growth: Conflict or Convergence• Inequality and growth

• Significant reduction in poverty incountries such as India and China isin conflict with this notion

• Generally the policy objectives haveinherent trade-offs, but the policythat suits the specific economiccontext of the day is critical

Inequality and Growth in India• In case of India unlike in advanced economies,

inequality and economic growth both have the same relationships with the socio-economic indicators

• The survey highlights that unlike the advanced economies, in India the economic growth has a far higher impact on poverty alleviation than inequality

• Therefore India should focus on economic growth to lift the poor out of poverty by expanding the overall pie

Relative impact of economic growth and inequality on poverty

• States with greater income or high percapita NSDP experienced low rates ofpoverty and vice versa

• However such strong relationship isabsent between inequality and poverty

• World Bank has noted that India wasable to achieve sustained decline in thepoverty during 1970s - 1990s

Enabling decision making under uncertainty• The real issue hindering the

effectiveness seems to be theundue delays, rent seeking,complex regulations and qualityof regulation

• As per the report published byWorld Justice Project - ‘WorldRule of Law Index’ - in 2020, India• Ranks 45 out of 128 countries

under ‘Due Process isrespected in administrativeproceedings’ (proxy forfollowing due process)

EODB REPORT 2020

Unnecessary regulation in India• Voluntary closure of a company takes

about 1570m days (i.e. 4.3 years)

• Out of this 1035 days are forclearances by Income Tax, ProvidentFund, GST departments and intaking back security funds fromvarious departments

• In contrast to this it takes about

• 12 months - Singapore

• 12 to 24 months - Germany

• 15 months - UK

OVEREGULATION & DISCRETION• Analysis regarding ‘granting

construction permits’ shows thatmore regulations have led to higherdiscretion in implementing them.The same is applicable even in caseof providing an operating license fora facility. Both of them are a proofthat with higher number ofregulations the discretion alsoincreases

• In another analysis it has been seenthat countries with stringent labourlaws are less likely to enforce them

Problem of regulatory default

• Shifting to non-banking financial intermediaries frombanking sector.

• Public Procurement and L1 principle.

• Listing of CPSEs.

• Tax disputes in India.

Way forward

• More transparency in decision makingprocess.

• Need for efficient legal systems.

• Administrative process and reforms.

• Need of Transparency Act .

• More powers and accountability for theboards.

Regulatory Forbearance• Pandemic has increased the distress in

the economies around the world andIndia is no exception to this.

• The emergency measures such asforbearance prevent the spill over ofthe failures in the financial sector tothe real sector, thereby avoids thedeepening in the crisis.

• However this forbearance must beused as a emergency medicine and notas a staple diet.

The original sin - seven year forbearance • The forbearance has had desired

short term economic effects

• GDP growth recovered from 3.1%in FY09 to 8.5% within two years.

• There was a marked improvementin other parameters as well suchas IIP, exports, etc.

• Growth in total revenue of thelisted firms increased from 4.88%in the crisis year to 20% in 2011.

• Growth in bank credit had fallento 16.9% in FY10 recovered to21.5% in FY11.

The original sin - seven year forbearance • During the Global Financial Crisis

(GFC) the policy worked well butas the banks got the wind ofcontinuation in the policy,various types of distortion’scrept in

• The number of restructuredloans increased from 0.74% inFY08 to 6.94% in FY15

• The gross NPAs of the bankingsector increased modestlyfrom 2.2% in FY08 to 4.3% inFY15

Adverse impact of forbearance• Undercapitalisation of banks.

• Lending to zombie firms.

• Loans increased from 5% (FY08) to27% (FY15).

• Evergreening of loans.

• Failed to boost investment.

• The Gross Capital Formation (GCF)fell from 34.7% in 2008 to 28.7% in2015.

• Misuse of the funds by the incumbentmanagement.

• Performance of the firms deteriorated.

Bank clean-up without adequate capitalisation

• RBI mandated AQR in 2015

• This clean-up is different in twoways compared to the one donein developed countries

• It was done not in a year ofcrisis

• There was no forcedrecapitalisation nor capitalbackstop provided by RBI

Issues with AQR• Underestimation of NPAs

• PSBs added NPAs worth ₹ 5.6 lakhCr between FY16 to FY19

• All the ways of evergreening were notcovered

• Underestimation of required capital

• Banks were unable to raise equitycapital from the market

• With banks reducing their lendingactivities, their loans to investmentsand capital expenditures have alsocome down. Post AQR, the stalledprojects have increased

Implications for the current forbearance regime

•Withdrawal of such measures.

• Clean up bank balance sheets.

• Based on the capitalrequirements, the clean upmust be accompanied withcapital infusion.

• Improve the quality ofgovernance in the banks.

• Strengthen the legalinfrastructure for recovery.