Privatisation will enable better governance, lead to more credit creation: Former CEA KV Subramanian

Do you expect inflation to ease going forward? How many rate hikes can we expect this fiscal year?

With inflation also, you have to take into account the global environment. If we use the average CPI inflation from 1960 to 2020 as the normal for India, let's say, 60-year average, compared to that, India's inflation prints in the recent couple of months is 4 percent higher. In contrast, if you take the United States and Europe, they are 400 percent higher than the historical average, with countries like Turkey having inflation close to 80-90 percent now, Argentina around 60 percent, Brazil also in double-digits.

These are peer economies. Yesterday, there was an article, which said that 100 other countries actually have higher inflation than India.

In other words, overall inflation itself has to be understood in the global scenario.

Now, with respect to the steps that have to be taken, I think it's important to understand what is the source of this inflation. Globally, the source of this inflation is that there was too much Keynesian demand priming. The United States printed money like there is no tomorrow. Europe did that to a lesser extent, but still did it, and many emerging economies just mimicked that. There were no supply side measures or very little supply side measures.

In contrast, India firstly spent far more prudently, and also implemented supply side measures. If only demand grows and supply shrinks, then obviously, inflation will be much higher. So, from a domestic policy perspective, there is very little that we can do on the global supply side factors because those are beyond our control.

Secondly, there is a difference between investment demand and consumption demand. And the elasticity of these demands to interest rate hikes is different. In India, unlike in the advanced economies, nobody borrows for food consumption or for going on a vacation. So, about 50 percent of the consumption basket is not affected by interest rate hikes. It's only consumption of durable goods like houses, cars, motorbikes, refrigerators, television sets, these are durable goods, these may be impacted by interest rate hikes, because people may borrow to actually buy these. So, among various items of consumption, it's only these durable goods that will get impacted by the interest rate hikes. In other words, demand for these will come down when there is an interest rate hike. As a result, the elasticity of consumption -- overall consumption to interest rate hikes -- will not be very large. In contrast, investment -- elasticity of investment to interest rate hikes -- will be very high, because almost all of investment uses borrowing (borrowed money).

So, when the interest rate is hiked, then consumption may not go down as much, but investment will go down far more.

The second thing that has to be kept in mind here in the context of interest rate hikes is that because of the way the banking sector functions in India, when there is a 100-basis-point increase in policy rate, banks transmit that as the rate on borrowing or to the borrowers almost entirely. But if there's 100-basis-point cut in the policy rate, that does not get transmitted fully into the lending rate; maybe 40 to 50 basis points actually get transmitted.

So, if you look at the full cycle -- which is 100 basis points increase and 100 basis points decrease -- then you may end up with banks having lending rates that are higher than at the start of the cycle. And that, in turn, also impacts investment. So, these are some of the key considerations that must be kept in mind. So, to summarise, elasticity of investment to interest rate hikes is much greater than that of elasticity of consumption to interest rate hikes, and interest rate hikes actually get passed on to the borrower far more than interest rate cuts by the central bank.

Are you concerned about the rupee hitting fresh record lows? Will this help our exports? Do you expect more measures from the RBI and the government?

From the 1990s onwards, on average, the rupee vis-à-vis the US dollar has depreciated by about 3 percent every year. During the period of the global financial crisis, the rupee depreciated almost 60 per cent. In contrast, during the COVID period, the rupee did not depreciate even the usual 3 percent. If you compare March 2020 to, sort of, March 2022 levels, or I think it's better to take December 2019 to December 2021 levels, just to avoid the impact of the Ukraine war, the depreciation was almost negligible.

What happens during uncertainty typically is that foreign investors usually take money out of emerging markets into safer havens. That's what’s called the flight to safety phenomenon. And that's partly why there is a depreciation.  In other words, during that two-year period, typically about 6 percent depreciation should have happened, even if it were a normal period.

Our inflation is about 4 percent higher than the historical average, while other countries are at 70, 80 percent, other emerging economies are at 70, 80 percent, and advanced economies themselves actually 400 per cent higher than historical averages. So, that's the second point.

And overall, …the fiscal policy has been reoriented to spending on infrastructure, which actually generates huge multipliers, growth should be better going forward as well.

Investors should not be clubbing India and other emerging countries together because the fundamentals are very different. Some of these measures should help, but overall my policy stance generally is that it's the volatility in the exchange rate that must be targeted, rather than any specific level. The level has to be market determined.

The government has announced an ambitious privatisation agenda, but progress has been quite slow. Do you expect things to pick up, because the government is also planning to introduce a privatisation Bill in the upcoming session of Parliament?

The slowdown happened because of the cascading effects of banking sector problems. Now, with the legislation that was enacted (as) part of the budget speech of 2021, the finance minister then had announced the creation of a ‘bad bank’, so that bad assets are removed and management bandwidth can actually be enabled for the creation of new credit.

And with the privatisation as well and legislative efforts being done, the privatisation Bill itself will help. Overall credit growth from 2004 to 2014 was in excess of 20 percent, and that was primarily because of a large amount of crony lending. In contrast, credit growth from 2014 to 2022 is about 9 percent. As these policy measures have been taken, like creation of the bad bank, creation of the public sector infrastructure, financing company in the public sector and privatisation of some of the public sector banks, credit growth should pick up. 

The disinvestment target for the IDBI Bank has not been met. So, do you think privatisation at this point will be a good idea or is there a lack of interest for such assets from the investors?

If people could time the markets well, then everybody would be a billionaire. There's a tonne of research in finance, financial economics that shows that timing markets is not very easy. There is actually no evidence that anybody has been successfully able to time the markets. And privatisation is actually a decision based on fundamentals. It's a decision based on the fact that privatisation will enable better governance, and thereby, lead to more credit creation as well.

Unemployment is rising as per latest the CMIE report. How big a worry is this and what more can be done at this point?

I think, that the evidence is very, very clear that CMIE actually is not the data to use for inferring for policymaking. The recent PLFS data has clearly shown that the unemployment situation has eased. And we've covered this in the Economic Survey as well that even pre-COVID, there was actually a significant improvement in the quality of jobs in the country. As per the Economic Survey 2019-20, there was a change in the nature of employment with number of casual labour coming down significantly and salaried workers increasing.

Let us clear the misinformation about the employment situation having deteriorated in the country before the pandemic. Regular wage/salaried employees increased by 41 million in 2019-20 vis-à-vis 2011-12. That’s an increase of about 46.9 percent; 82 percent of this increase was among females; self-employed increased by 36.5 million in 2019-20 vis-à-vis 2011-12. That was a growth of 14.9 percent.

Casual labour decreased by 15.5 million in 2019-20 vis-à-vis 2011-12 with decrease by 18.6 million in rural areas contributing the most. Formal employment itself increased by 20.6 million in 2019-20 vis-à-vis 2011-12. That's a growth of 53.8 percent. As formal employment, regular workers and self-employed workers actually get paid much better. And these kinds of jobs actually provide far more stability in earnings compared to casual labour or helpers in household enterprises. Clearly, the quality of employment increased significantly in 2019-20 vis-à-vis the 2011-12 scenario.