Notes from India’s great slowdown presentation by Arvind Subramanian at ORF
High growth in India in past is primarily associated with trade and not consumption.
The current economic slowdown is due to both structural and cyclical issues and both are related to stresses in financial systems.
Long term Decline
India has not recovered from the global financial crisis of 2008. There is a long term decline in dis-aggregated economic indicators since the financial crisis.
Temporary boom
Short term boom in 2017 and 18 is associated with the collapse of oil prices as well as off balance sheet expenditures like Food Corporation of India (FCI), National Highway authority of India (NHAI) and railways. These expenditures boosted demand and therefore the short term economy growth but simultaneously increased the overall budget deficit not recorded in official statistics.
First Twin balance sheet problem.
(Public sector) Banks cannot lend because of the non performing assets (NPA) problems.
(Infrastructure) Corporations have difficulties with making more investments due to high interest and tax payments.
Second Twin Balance Sheet problem
Non-Bank Financial Corporations (NBFC) lent mostly to real estate companies. Real estate companies could not sell real estate inventory due to lack of demand. NBFCs continued to finance unsold inventories ensuring that the house prices would not fall with surplus real estate inventory. This created a big credit bubble with real estate companies not being able to service the debt.
Final Collapse
Final collapse in 2018 was triggered by the collapse of infrastructure leasing and financial services (ILFS). Non-bank financial corporations funding was cut off by the mutual funds after the collapse of ILFS, thus bursting the credit bubble.
Solutions to boost the growth.
Both fiscal and monetary stimulus will not help because both transmission mechanisms are under stress.
Income tax or GST cuts are not good solutions for current problems.
Solutions are broken into five Rs for the financial system.
1. Recognition of the problem Prompt and honest recognition of NPAs 2. Resolution Bankruptcy resolution takes 400 days instead of 270 days planned originally.
Bankrupty laws are more suitable for market based economic cases with no government intervention. Infrastructure cases like power plants require government intervention in ensuring future asset value.
3. Recapitalisation. Bad bank is necessary to remove NPAs from the bank books and enable their ability to lend.
4. Regulation of financial systems
5. Reforms. Recapitalization must be combined with reforms in banking sector.
We should not be complacent with short term good news in the economy because we have structural problems in financial systems and they will not be resolved quickly. Exogenous factors like the global economy indicate hard times going forward.
Data quality issues (side comments)
Dis-aggregated numbers below the headline macroeconomic indicators (i.e. GDP numbers) show a bleaker picture then what is presented at the aggregate level.
Clarity in the GDP growth numbers, changes (upward or downward) in poverty, unemployment, fiscal deficit, non performing assets growth rates
