by Romar Correa, retired RBI professor, Bombay University*

After the Reserve Bank of India (RBI) lowered its repo rate last week, the question remains whether such cuts will turbo-charge the economy. The central bank reduced the rate by 40 basis points to 4%, its third reduction since March 24 when the country was locked down to limit the spread of the coronavirus. Analysts forecast that the lock down, coupled with the global economic recession, will result in India’s economy contracting by at least 5% in the current fiscal year. This drop, of over 8% from the previous year, will be the first annual decline in GDP since 1979.

Boosting liquidity to pump prime the economy

The RBI’s goal, by enabling commercial banks to charge very low interest rates, is to make it increasingly attractive for businesses and consumers to borrow and spend money. This, the central bank hopes, will spark a quick, sharp rebound in the economy. The RBI governor will continue to cut rates. He seems oblivious of the experience of his compatriots in Japan and Western Europe who have traversed the zero lower-bound to the policy rate to no avail. Gloom is pervasive. Banks are flush with liquidity but there are no takers.

In time-honoured fashion in India, the commercial banks will borrow funds from the RBI and invest in riskless government paper, pocketing the difference to boost their profits. There is the separate matter that the managements at the big banks, which are mostly government-owned, will easily give in to pressure from the government and the RBI and rapidly boost their lending. In that case, due diligence is given the go by and collateral requirements are weakened. What else, other than yet another increase in non-performing assets (NPA,) can we expect in the future?   

The dimming of animal spirits

The classical economists taught that the heart of the economic dynamic is the accumulation of capital. The core maladjustment that can occur in an economy, in that case, is the evaporation of the propensity to invest on the part of the business class. John Maynard Keynes made much of the dimming of the “animal spirits” of entrepreneurs and the futility of reductions in the market rate of interest to ameliorate that mood. India is in the trough of this circumstance.

Mood and sentiment are essential to induce foreign investors as well. For instance, the much-touted expectation of the Prime Minister of India of billions of dollars flowing in from American and Chinese companies for the purpose of infrastructure building is likely to come to nought.  Infrastructure investments are massive and indivisible and the input flows stretch out over years. Positive present values cannot be calculated when payoffs ensuing even a few years hence cannot be assured.

A boot on their rears

Meanwhile another source of dollar funding is reducing to a trickle, causing nervousness over India’s balance of payments. In fiscal year 2020, Indian migrant workers, especially in the Persian Gulf, sent home $83 billion to support their families.

However, the economies of the Persian Gulf at present are seeing a steep drop in revenues because of the collapse in crude oil prices, since global demand has been hit by the post-COVID-19 downturn. As a result, states like Kerala are experiencing a mass reverse exodus of workers. With sharply reduced remittances from workers abroad, India’s current account deficit, which was about $27 billion in 2019, will be much higher in 2020.

In the miraculous event of a turnaround and a resuscitation of production, business executives in the Persian Gulf countries would rather (re)employ workers whose heads are not filled with ideological rubbish. The viciousness of some Hindutva workers in those countries only hastens the landing of the boot to their rears.

Rising budget deficits

On May 12, the Indian government announced yet another stimulus package, this time of about $140 billion. The various stimulus measures announced since March total about $265 billion, or 10% of the country’s GDP. They involve money being spent by the government and the RBI with the goal of building a “self-reliant India.”

The sharp rise in government spending, and a drop in its tax revenues due to the weak economy, will worsen the country’s budget deficit. In fiscal year ended March 2020, the deficit was over 3% of its $2.6 trillion GDP. This year, the combined deficit of the central and state governments is estimated to climb to around 12% of GDP. This will push the country’s accumulated budget deficit to over 80% of GDP.

For its part, the RBI is effectively printing money to fund the stimulus packages. Currently the money printing and the rising fiscal deficits are being ignored by financial markets, perhaps because trillions of dollars are being similarly created by central banks and governments around the world. Inflation in India is subdued, under 5%, given the collapse in demand and a 25% unemployment rate, according to current data from the CMIE.

Wishy washy stimulus packages

The scripts of ‘stimulus’ exercises get more and more wishy-washy. In their stead, we are regularly slipped dose after dose of the Mickey Finn of privatisation. What have auctions of mining rights got to do with anything other than, in the contempt for environmental clearances, hastening the path of the country to ecological catastrophe? Most significantly here, in its obdurate devotion to the fiction of a market economy, the Indian regime is in disconnect with the best opinion everywhere that markets have not evolved independent of state support and their functioning must be circumscribed by the organs of the state.                

Depressions are often the aftermath of wars and the description of the pandemic calling for responses on a war footing is apposite. The first line of attack in the Commander-in-Chief of the Armed Forces ordering and requisitioning all available modes of transport to ferry stranded migrant laborers in India, back to their homes, has been missed. That would have called for a government with humanity.

Macroeconomics and equilibrium

The economic situation in India raises questions about the relevance of a model of macroeconomics. In the academic world, macroeconomics is a subject where primary attention is paid to the so-called closed economy which usually malfunctions and because of which the state in the form of the government and the central bank must intervene and attempt to restore equilibrium. The open economy is introduced at the end and is less than a third of the course. The model now comprises of the ‘home’ country and the ‘foreign’ country.  

It is fruitful to look at an economy as a set of interrelated balance sheets. The elements can be arranged in a box by the principle of double-entry bookkeeping so that they sum to zero. A positive item somewhere cancels out as a negative item somewhere else. For instance, consumption is a negative item in my balance sheet and a positive item in the balance sheet of the firm selling me the consumption good. The wage bill is a positive item for workers. As an item of cost, it is a negative item in the balance sheet of the firm.

A distinction is made between stocks and flows, the latter being changes in stocks. Wealth, my house, my car, is a stock. Income, typically from work, is a flow. The stock of NPAs is a negative item in the balance sheets of banks which cancels out with the identical item but with a different sign in the balance sheets of firms. The flow of fresh borrowing and lending, on the other hand, our prime concern today is accounted for separately.

Monetization of deficits

Economists view financial flows between central banks and governments as joined by balance-sheet arithmetic. A flow of bills and bonds issued is a negative item in the balance sheet of the government. It may be absorbed by private financial institutions or citizens in the country or abroad and also held by the central bank as a positive item. ‘Monetization of the deficit’ is a pejorative expression not only in India and its avoidance has even been enshrined in laws in some countries. The reason is the suzerainty of a particular model over the profession and practitioners which ordains central bank autonomy from the government-run treasury. Central bankers are hired to obsess only on the inflation rate. At the moment, the inflation target is down and out and economists, including the chairman of the Federal Reserve Bank in the U.S., are not shrinking from using the D words, deflation and depression as they look to the future.      

In short, the standard macro model is in tatters. After decades of neglect, models of monetary-fiscal coordination will take time, similar to a COVID-19 vaccine, to come to market. In the meantime, academics and policy makers are uttering ‘monetization of the deficit’ with trembling lips.                 

Expenses and taxes

Corresponding to the inflation criterion of the central bank, the government’s treasury is expected to balance its budget eventually. Here, the expression of abuse was ‘fiscal deficits,’ arising from a government’s inability to balance its budget by matching expenditures with income. At root, the brouhaha generated by the term is based on the fundamental fallacy of thinking of the government as an individual. The term needs to be broken up into its two constituent parts, expenditure and income, namely taxes. Only government expenditure is salient at any point of time. The government must give ‘whatever it takes’ to pull an economy out of a recession. Keynes associated government expenditure with public works.

Taxes will flow when they will as economies bounce back. It is wrong, as we do for ourselves, to think of them as the wherewithal to finance government expenditure. Indirect taxes are regressive. The Goods and Services Tax in India is an indirect tax. Leaving aside the messiness of its implementation, the theorem is vindicated in the effect it has had on small business. The progressive income tax, wealth and capital gains taxes are back in the running as contenders for rigorous tax policy in many countries except in India.  

For a macroeconomist, the distinction between rural and urban employment guarantee schemes drops. Considering the rapid response time called for, cash disbursement is the order of business but I would rather they were an advance on a wage fund as part of a Plan. A major component would be the employment of the Phoenix that has risen from the ashes of neglect in the form of the health-care worker. The only accounts that lift the spirits and make them soar, in the current lockdown, are the heroic and heartrending tales of their valour, well beyond the call of duty.         

 *Romar Correa retired as the Reserve Bank of India Professor of Monetary Economics, Bombay University.

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