This is part two of the first of IPC’s series of ‘big think’ interviews, with Abhijit Sen. The idea behind the series is that experts present crucial policy issues and solutions, in the simplest way possible, for laypeople to understand. In this part, Sen, economist and former member of India’s planning and finance commissions, shines a light on the economic measures necessary to get India out of the medical and economic crisis that is COVID-19.
What the economic package to get India out of the COVID-19 crisis should be is a contentious question, and answers to the same often seem difficult to decipher. However, in part two of our interview with him, economist Abhijit Sen breaks down the ideal package that will be needed to pave our way out of this crisis. He also addresses questions pertaining to deregulation, oligopolies and saving individual sectors.
He lays out his recommendations in the context of the Atmanirbhar Bharat Abhiyan economic package that Finance Minister Nirmala Sitharaman has announced in five tranches, and independently of this context as well.
For reference, here are the five tranches of the package:
And here is Part 1 of Abhijit Sen’s Big Think interview.
The Stimulus and A Summing Up of Part 1
‘Stimulus’ comes in when you start opening up the economy - when you start ending the lockdown - when you need demand and the economy can be expected to respond to that demand. Now we’ve reached that point to some extent.
At this point, the government expects that there is pent up demand and that will be sufficient to start some of the activity on its own. But in many places that’s not going to be the case. We will need an economic stimulus of some type. It should be graduated, but it would have to be fairly large.
To summarise what I’ve said before this (see Part 1 of this interview), on the economic side we needed a much larger package in terms of PDS, and food, as well as cash, to be given almost universally to everybody: simply to guarantee lives and livelihoods. Also, to keep MSME units from just folding up, we needed a moratorium from banks and for this you needed banks to be guaranteed.
If this happened banks would have continued to keep businesses on their account books - even deferred interest payments - for a certain amount of time, till the economy comes back into function and these MSMEs start making money. However many of these things haven’t really happened. They need to happen and this needs to be a continuing process.
This will probably involve fairly large expenditure in itself. For food and cash, I would say two more months is the minimum this is going to require. And also similarly, for the MSMEs, a certain amount of ability for them to continue paying wages and a deferment of their interest payments, and repayments, so that they don’t go underground. Only if this is guaranteed will they be able to run once the economy starts working again. There is therefore scope for rethinking the methods of implementation of what has already been announced and to some extent begun.
‘We will need an economic stimulus of some type. It should be graduated, but it would have to be fairly large.’
The other thing I had said was that most of this would have to be done by the states. Much of what is being done for the MSMEs will also have to be executed by both the states and the centre. Because the states are actually deciding what opens up, what doesn’t, and which sort of activities would start at which points, and the extent of lockdown: how much it’s concentrated, to where, and for how long. And the centre would have to be involved to provide the bank guarantees because this would have to be done through the banking system.
The Stimulus: Questions of When, How and Why
I think the media and a lot of economists are confusing the stimulus as something that had to have been given by now or as something which has to be given in full, immediately. What had to be done and has to be ensured even now is to keep people and enterprises going. Which does not mean the government should make them start running, but that it should keep them living. The objective is not to create demand but to ensure sustainability.
In the next stage, you’ll require a large fiscal boost if the economy isn’t responding, and I don’t expect it to. Because essentially you’re working in a very bad world where export demand is bound to be less and, in any case, business sentiments are hardly great enough to drive large investments given our past, before COVID-19, where in any case the rate of growth was coming down.
That’s where the stimulus part comes in and it shouldn’t be a knee jerk reaction. It should be thought out properly - consultations with industry, consultations with the states - and in a manner which I have not quite seen in terms of the measures which the government has so far announced.
‘I think the media and a lot of economists are confusing the stimulus as something that had to have been given by now or as something which has to be given in full, immediately. What had to be done and has to be ensured even now is to keep people and enterprises going.’
The stimulus comes in because we are living in a fanciful world where there is this expectation of a V-shaped jump from things. Now unfortunately that’s optimism squared, or maybe even cubed. Yes there will be a certain pent up demand: for eg. in the case of liquor people will go out in a big way. That’s a different thing altogether. But for most economic activity to begin or start running, an investment climate has to exist where people are convinced that we are now out of the woods and we have a bright future, and everybody must think, “I’ve got to beat the other guy because when the markets grow I want a bigger share of that market.”
So, the objective there should be to first start the investing cycle and then keep it going. Now in this there is some place for the supply side measures that (Nirmala) Sitharaman announced, which have been lauded as reforms. These include the various liberalisation measures, for eg., regarding airspace, defence industries, coal mining and, of course, agricultural markets. That is a ‘1991 moment’ kind of a thing. There is some place for that.
The Stimulus, the Stop-Gos and the Question of Where
But the important thing would be to maintain, when things start opening up, a certain degree of graduation. You know that you’re not going to be able to go from COVID being pretty high priority on your list to COVID being 0 on your list. So you must be prepared for stop-gos.
But the stop and the go, as I said before too, shouldn’t be national. They shouldn’t even be at the state or the city level, but they should be local. I think this is a pattern we are following correctly. It should be containment zones of various kinds.
But it still means stop-gos, and stop-gos mean that there is that uncertainty businesses face, so they are not going to actually jump into full production, especially if they think that a stop might come. They’re not going to make those investments till then.
Now, where there is a possibility of the investments being more in the ‘go mode’, you should actually start giving impetus there. What that requires is again a selective view of what the post COVID-19 situation will be like, and building up on what we’ve seen so far.
‘Where there is a possibility of the investments being more in the go mode, you should actually start giving impetus there.’
What we’ve seen so far is that the rural sector has been less affected by COVID than the urban sector. So there is more activity in the rural areas which are more likely to be in the green zones. And that’s where you should be signaling your investment. I don’t think this has quite happened, because most announcements so far are really in the central sphere and involve central agencies like NABARD (National Bank for Agriculture and Rural Development). However, the rural sector does not comprise just agriculture but also other sectors like construction and MSMEs. Also, for things to actually work out it is the states rather than the centre which should be playing the deciding role. This is important even where the centre is about to take some moves in this direction (for example, the opening up of agricultural markets). We have seen in the past that such things don’t work if the centre and states don’t come together.
The Stimulus, the Centre and the States
The responsibility for the actual operation of anything is going to be on the states. Especially when it comes to the rural sector, but in the urban areas too, where, for instance, the corporate sector deals directly with the corporations. But unfortunately over time there has come about this idea that we can bypass the state and give things directly into the bank accounts of people. That’s a wrong way of going about things. You see, operating through this crisis is not just a question of policy. You’ve got to go out and build institutions, get messages through, involve people. That needs grassroots activity, and the centre doesn’t have that sort of capability.
Now the states, as I said before (in Part 1), are meeting their expenses by front-loading the amount they can borrow for the whole year. The problem will be that around six months down, they’ll have spent what they have. And then the lack of states’ expenditures might actually lead to a demand crisis. This will be when money will be needed to flow from the centre to the states. This will be later but the centre will require that sort of money then to get the states to be able to continue making some investment for a stimulus.
Also, unlike the centre the states have strict budget constraints. The centre can actually cross its FRBM limit (limit for spending set under the Fiscal Responsibility and Budget Management Act) and can even print money. The states cannot cross their FRBM limits without central permission, and they certainly cannot print money. But they have to pay their employees, keep running health, education and many other essentials. And now they have to deal with other expenditures. And two months of lockdown have meant a gaping hole in their revenues.
This should have been and remains an objective. The relaxation (and that too with conditionalities) of state FRBMs, which was announced, is welcome but almost certainly not enough.
‘Unfortunately over time there has come about this idea that we can bypass the state and give things directly into the bank accounts of people. That’s a wrong way of going about things.’
We can infuse demand, to some extent, by depending on the reform side of things where we urge the private sector to get into production. But that again, as I said, is a question of not only which areas are open but also which areas are likely to be those where there are less risks involved. Involvement of the states will be important in deciding that as well.
The Policy for Banks: Guarantees, Payment and Recapitalization
When it comes to getting the investment cycle going, I think the critical thing will be how we treat banks. In the economic measures announced by the Finance Minister - as well as by the Prime Minister - a lot of emphasis was laid on liquidity. And liquidity will be important. And this is where the centre’s role is critical.
Liquidity is something which is going to come about, essentially, by the balancing act that the RBI and the banks can do together, and the willingness of the banks to lend. And in this, as I had also said earlier, a fair amount of government guarantees will be necessary for the banks and the bank managers to take the risks that are involved. These guarantees will have to come from the central government.
Let me digress a little to explain bank guarantees. They could mean two things. One, that the central government, over time, will have to give out money to the banks, especially private banks. Simply pay off the fact that they are not collecting interest even while they are paying interest. They’re making losses at the moment and may continue to do so and the central government may have to simply write off some of these bank losses. Or, second, the government could have to - again, over time - undertake recapitalization of (infuse capital into) the banks.
‘A fair amount of government guarantees will be necessary for the banks and the bank managers to take the risks that are involved. These guarantees will have to come from the central government.’
This is something the centre will have to do. If the economy does well, if it picks up and the growth rate is pretty high, then it might not cost too much if this expenditure can be spread out over some five or six years.
But, on the other hand, if the economy doesn't pick up relatively quickly there might be a fiscal cost to the central government later this year as well as next year.
Therefore, with guarantees in place, the centre should be prepared for the downside and the matter of monetizing the centre’s deficit should largely be in respecting the guarantees given to banks and would of course have to be done in close coordination with the Reserve Bank.
Spending for Food, Basic Cash and Medical Expenses as a Percentage of GDP
I think, for the two months beginning from when the lockdown began in March, we should have spent about 2% of GDP to provide for food, some basic cash and medical expenses for people as well as supported states in their effort to have done so. In fact, I think we have achieved much less than what most Indians expected their governments to be able to do.
For example, a larger spending in the last two months would have prevented migrants from rushing back to their home states, spreading the disease even more. It would have lessened the length of the lockout. That could’ve been considered an investment in shortening the period of the lockdown.
This is becoming less and less of an option now, but it’s still an option. Because there are still migrants who are in the urban areas but may be thinking of going back to where they’ve come from. For example, one reads that people who have lived in Dharavi for a very long time are now trying to get out of it. Because they're scared. Now if you can actually say that the medical expenses, to an extent, will be looked after, and they’ll get their incomes and food, then they need not start rushing back. So if you want to control the movements to an extent, you’ve got to give people that. Much of the water might’ve flowed under the bridge already, but some of it still remains.
In this context it should be noted that judging from the finance minister’s economic announcements there was only about 1% of GDP for this. And, in fact, the net fiscal cost to the central government would probably have been a mere zero because the government has gained an almost similar amount from the dropping oil prices and non-payment of dearness allowance to its employees.
A large part of 1% could be immediately released to the states and packaged in a manner which both signals continuity in the government’s intention and a commitment to centre-state cooperation.
‘I think, for the two months beginning from when the lockdown began in March, we should have spent about 2% of GDP to provide for food, some basic cash and medical expenses for people as well as supported states in their effort to have done so.’
This expenditure will also be worth it because, among the expenditures required, especially on the side of the states, is better public health. Because people will have to be tested, not just for COVID-19, but for a lot of the other non COVID-19 diseases totally ignored. For eg. diseases like tuberculosis which are equal to or even larger than COVID-19 in terms of mortality. The diagnosis and treatment of such diseases are going to come back into focus the moment doctors are able to direct their attention towards them. To keep all of that going, you need that policy where you say, “We’re collectively going to look after you.”
Total Value of the Package as a Percentage of GDP
As for the economic package, including but also over and above this, how much should it cost? It’s very difficult to say but I think the number Modiji (Prime Minister Narendra Modi) mentioned was not a bad number: 10% of GDP.
But that 10% of GDP will be less than several other countries are going to spend and, also, a big difference between their spending and our spending will be that most of them will be spending it out of their budgets. We are trying to do it, for a great part, through loans.
‘A big difference between the spending of other countries and our spending will be that most of them will be spending it out of their budgets. We are trying to do it, for a great part, through loans.’
Portion of the Package that goes to States: 4% of GDP
For example all that has so far been announced for the states is a conditional relaxation in their fiscal deficit of 2% of GDP. This too is a loan. As I have mentioned before, this should not only be less conditional, but also 1% of GDP should be given immediately for the problems which have accumulated in the past month. In addition, a further 1% of GDP would probably need to be given to the states for them to participate meaningfully in any stimulus to revive the economy as it opens up. Thus 2% in extra fiscal deficit, 1% for the past and an extra 1% for the states in their infrastructure projects comes to 4%. That will make up Rs 8 lakh crores out of the Rs 20 lakh crores package.
How the central government will account for the 2% ‘fiscal’ component to the states (which is not a loan), I’m not so sure. Maybe by ensuring that the states receive the full GST compensation recommended by the 14th Finance Commission and promised to the states when they accepted the original GST package. This requires that the states be guaranteed a minimum increase in their GST revenues, irrespective of actual outcomes, with the balance being picked up by the centre. Over the last year the centre has been backtracking on this and that is not a good idea at all.
Thus 2% in extra fiscal deficit, 1% for the past and an extra 1% for the states in their infrastructure projects comes to 4%. That will make up Rs 8 lakh crores out of the Rs 20 lakh crores package.
Loans for Liquidity, involving RBI and the Banks: 5% of GDP
In addition to things which have to be done by the states, the package needs to have many elements which depend upon bank lending.
This would mean, as I have explained before, that the government has to guarantee the banks. Otherwise the banks won’t lend, in which case many of these announcements will remain on paper only.
So that direction of spending which is through the banks would require those guarantees for the moratoriums, and then paying or adding equity to the banks (recapitalization)— all of which will eventually require fiscal expenditure.
So, out of a fair amount of that 10% of GDP for the package I would say about 5% will be of this nature. But, as I have said, all of this expenditure may not need to happen right now. Payment to and recapitalization of banks, dealing with the bank losses, especially where the public sector banks are concerned, the central government can kick these things down the road a little, but only so long as the banks don’t go under.
But to make the banks actually run, you will need all of this. Without that nothing is going to happen. So you’ve got to actually promise that this is going to happen. It does not necessarily mean that all of that will be spent immediately, but you’ve got to make provisions for it.
‘Payment to and recapitalization of banks, dealing with the bank losses, especially where the public sector banks are concerned, the central government can kick these things down the road a little, but only so long as the banks don’t go under.’
Money to be Spent by the Central Government on its Own: 1% of GDP
What the central government spends on its own, that is without the intervention of either the states or the bank, would be in the sort of areas that Nitin Gadkari (Minister of Road Transport & Highways and Micro, Small & Medium Enterprises) talks about: some large investment projects for instance.
Those take time to start, but if there’s a shelf for projects, and we do have a certain shelf for projects, then those can be kickstarted pretty quickly. Many of them are in rural areas, so that you can involve the population in the rural areas, but the demand effect of these projects - the income they would generate and the transmission of this money - would permeate across the economy, in urban as well as rural areas, throughout the country. As a result, you might be able to get around some of the problems posed by the lockdown (such as there being no demand in certain areas because there is no money flowing in currently).
“(Large central investment projects) take time to start, but if there’s a shelf for projects, and we do have a certain shelf for projects, then those can be kickstarted pretty quickly.”
These projects can be executed in phases. Some can begin pretty soon. Most of them, in fact, will be what has already been announced in previous budgets. So one need not do too much new thinking on that, because there will be a shelf of projects to execute, and then these can be stepped up.
Overall I think the total ‘fiscal’ amount which has to be spent - not in the form of loans - will have to be at least 5% of GDP, taking into account transfers to the states. If things get stretched out even more, if we can’t deal with COVID-19 in the next two months, as I am thinking and hoping, then the amounts will be much much larger.
IPC: In the context of the current economic climate, the incentives given to the private sector, especially the bigger players, and the state of MSMEs, is there a fear of oligopolies arising?
See, obviously there is. Take Jio for example. We are heading towards, I hope, at least three companies in the telecom sector, and if it becomes two then we are dead in that area. But it's not just in that area, it's in many other areas as well.
If the MSMEs drop out, and if the MSMEs have to be replaced by large businesses, we are going to get an oligopoly of a different kind. We’re not going to have the sort of vibrant economy - not particularly rich, but vibrant nonetheless - that we have had so far. Here you will actually have a cutthroat battle between big guys, and that’s not necessarily something which is going to lead to better outcomes.
‘If the MSMEs drop out, and if the MSMEs have to be replaced by large businesses, we are going to get an oligopoly of a different kind.’
IPC: In terms of the deregulation that is taking place, is there anything one needs to be watchful about?
There has also been in the package talk about freeing up factors like land and labour. And UP, for example, has gone furthest in terms of suspending labour laws and removing regulations of all kinds in the marketing of agricultural produce.
Some of this is necessary, but much of it can become a bad idea if it's done too quickly and without consultation. If a government doesn’t have too much time for consultation, it should try and stick to deregulating in areas where consultation has taken place already. Or it should get stakeholders on board - trade unions, farmers, states - before deregulation and execute this in places where there is enthusiasm instead of deregulating where there is opposition.
‘(A government) should get stakeholders on board - trade unions, farmers, states - before deregulation and execute this in places where there is enthusiasm instead of deregulating where there is opposition.’
IPC: There has been impetus given by the Government to NBFCs. One isn’t clear on the details. But how would you explain the rationale behind it?
NBFCs become important because banks aren’t lending. So NBFCs become the conduit: the banks lend to NBFCs, who do the onward lending. Now whether that is the model that you want to continue with, or the banks themselves can do that after enough government guarantee, is something that I think the Reserve Bank and the banks and central and state governments can get together, make an assessment, and figure out.
Some of the NBFCs will have to be saved like everything else. But when it comes to saving enterprises, there are other sectors to consider too. For example, the entire airline industry. Very large parts of our tourism infrastructure. How much of these need government intervention is something which will have to be thrashed out. But these are institutions which are large enough so that between banks and them they can actually last out for 3 to 4 months or so. I don’t think they’re going to crash.
‘When it comes to saving enterprises, there are other sectors to consider too. For example, the entire airline industry. Very large parts of our tourism infrastructure. How much of these need government intervention is something which will have to be thrashed out.’
These are big sectors and a lot of demand will come from these sectors. But, nonetheless, I’m not getting into discussing these because I think these issues are of the second order of magnitude.
Abhijit Sen has spearheaded public policy design and implementation in India as a member of Finance and Planning Commissions as well as head of various high level commissions and committees. He has also taught economics at Jawaharlal Nehru University and been an adviser and consultant with various international organisations such as the United Nations Development Programme (UNDP), the International Labour Organisation (ILO) and Organisation for Economic Cooperation and Development (OECD). He is a recipient of the Padma Bhushan for his service in public affairs. You can read more about him here.
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