3YearsofModi: Macro economy is robust and stable, says Arvind Subramanian

A: In order to answer that question we just have to go back and contrast where we are today to where we were in late 2013. India almost had a full-blown crisis, investors were fleeing and the rupee was under pressure and generally the sense that the economy was on a downward spiral, so if you roll the tape three years hence, we are in a very different situation in terms of the overall macro economy. As you know very well, inflation is below 3 percent, the fiscal deficit central government has been coming down very steadily, reserves are very comfortable and there is a sense that the macro economy is robust, stable and not to forget that sound macroeconomics is the foundation on which everything else is built. So, that is a huge change and a huge achievement, number one. Over and above that, India is amongst the fastest growing countries in the world, so it is not just that we have stability that we have seen that we are seen as a country of tremendous opportunities and returns to investors.

All those outcomes are backed up by a number of policy achievements. I would say three or four big ones, I am not trying to be exhaustive here but first of all the sense that corruption, transparency in disposal of public assets, decisive decision making, that investors seem to have warmth to that especially in contrast with the past. I think the goods and services tax (GST) is an absolute game changing reform that has taken place. I think architecture of Jan Dhan-Aadhaar-Mobile (JAM) which is going to transform in many ways, the way in which the government interacts with citizens, direct benefit transfers all of that is fundamentally very transformational and of course on the foreign direct investment (FDI) front, we have opened up and that is reflected in the fact that India has got the highest FDI ever, USD 60-65 billion depending upon how you count and in addition there has been bankruptcy code, the Monetary Policy Committee (MPC) and all of that. So I think it is a very different economy today than it was three-and-a-half years ago.

Latha: Since you say very correctly that it is GST and Jan Dhan and getting more people into the formal economy. Would you say that the tax to gross domestic product (GDP) ratio is all set to increase?

A: I think it is going to increase in a number of ways. One, we are going to have the GST with all this invoice matching, better compliance. So the indirect tax to GDP ratio will go up on that score. Second, with the GST we are going to also see compliance gains on the income tax side because indirect tax data and direct tax returns; there is a certain matching that one can do using big data. Third, if the experience of last year 2016-17 that actually many more tax payers have entered the tax net because the environment has changed, some of it due to the signal from demonetisation then all of this could make tax receipts quite buoyant in India and increase the tax to GDP ratio. However, the caveat I would draw is that one should not try and do this assessments like every day or very soon. This is going to be a trend development and I do think that in the medium-term as a result of all these actions the tax to gross domestic product (GDP) ratio should raise significantly - indirect and direct taxes.

Q: Let me come to the first macro for which you gave an A to the National Democratic Party (NDA) government growth. As you said correctly that we are a standout performer especially in the current global scenario and yet in your article you have advised against a definite overestimation of growth that will come because of the revision in the Index of Industrial Production (IIP) series and the revision in the Wholesale Price Index (WPI) series. Are you worried about the growth?

A: I have a piece which tries to explain -- recently we have had revisions to the IIP and WPI data. What I am trying to set out in the piece is that to say that there are certain consequences of that for the GDP, actually the gross value added (GVA) data that will come out later. Let us be a bit cautious about the impact of these revisions on the estimates that will come out because there are some quirks in the way we do the GDP which should make us cautious about how we interpret that and my sense is that inflation is under control. I think it is well under control, the inflation outlook is very benign and the new IIP data especially seem to me to suggest that the economy could do with a lot of macro policy support.

Q: In your Mint article as well as in your VKRV Rao Memorial lecture, you are making a strong case for monetary easing. Do you think that the Reserve Bank of India (RBI) has been too tight too early?

A: We have a Monetary Policy Committee (MPC) that makes all these decisions. All I can say is that it seems to me that they have done a terrific job on bringing inflation under control, well beyond what the target requires. So, it is a great achievement.

The inflation outlook is actually relatively benign. If you look at the fact that the exchange rate has actually appreciated, oil price outlook is good, monsoons are good, moreover the goods and services tax (GST) for example, the incidence is going to come down, so if you put all of these things together, it seems to me that the inflation outlook is relatively benign and on top of that, if you look at how the economy is doing that it is perhaps not as strong as we want it to be and maybe not as strong relative to potential, then the implications follow from that analysis.

Q: There is no formal way in which the government meets the MPC members. We know that the Governor meets the Finance Minister ahead of the monetary policy. Do you think that institutional arrangement needs to be in place where there is an interaction? Government is a legitimate representative of interests. So, is that institutional mechanism needed where government speaks with the MPC members, external members included?

A: For one thing, the act itself provides for that government input, but I want to interpret that more broadly, not in a kind of legalistic sense. The spirit of my VKRV Rao Memorial lecture is that we should have more voices and opinions and informed and even from the point of view of the MPC, they would welcome and benefit from a wide range of views, including the views of the government on this. So, it just makes for more informed a decision making.

Q: Are you also surprised that there was unanimity in all the decisions that the MPC has taken so far. I think four of them now?

A: I think it is kind of surprising and interesting, isn't it. You would think that given how complex these things are, in fact there are different interpretations of the macro economy because the assessment that I offered just now benign inflation, possibilities for more i.e. larger output gaps - that's one interpretation. There are other interpretations as well and I would have expected that the range of views would get reflected and as I joked in the lecture that normally the criticism against economists is that you ask three economists, you get four views but here it seems to me that you ask many economists and you get one view and that is a bit surprising and it is very interesting maybe the data and the facts warrant that the convergence of opinion but in my view they probably don't. I think there is a kind of rich way of interpreting the data in multiple ways, I think.

Q: You touched on the rupee. We did have the April trade deficit numbers widen, USD 13 billion after about 30 months or so, imports rose by 39 percent year-on-year. Are you worrying that some Indian business is being captured by foreign companies?

A: This is something that is interesting what is happening, both exports and imports have gone up and you need to do this carefully on the export side, you need to take out oil because oil exports tend to be volatile as well depending upon the prices but export volumes have risen quite substantially over three quarters and that is very good news.

On the import side it is very interesting. A couple of things are going on. One, there is a huge surge in gold imports as well which one should take away but even taking away from that imports rose quite sharply. I think there is a kind of positive and a less positive side to that. I think the positive thing is that it shows that maybe domestic demand is coming back again which is what is leading to higher imports and that is a good sign, that is a sign that the economy is perking up but on the other hand a part of the increase in imports could be due to deteriorating competitiveness and that is something that we should be watchful about. I think our exports as well as our import competing sectors, their performance is sensitive to the exchange rate and so we have to be very watchful of that.

Q: If you were in the MPC, what would your repo rate be today?

A: Hypothetical should remain hypothetical. All I can provide to the best of my ability is my assessment of the macro economy which I have laid out to you. I think we live hypothetical as they are.

Q: You spoke correctly that there should be an institutional arrangement whereby the MPC members, all of them, external and RBI members are exposed to all kinds of view. Is the government formally pushing it and asking for an audience with the MPC members at a formal or informal level?

A: These are matches that are being discussed and you will find out soon. There are ways of interacting which all of us are open to and let us see how these things evolve, but the principle that there should be more input from all sides including government inputs into decision making is widely accepted.

Q: Your view of the global environment. The Fed has made it clear that is going to contract its balance sheet in extremely calibrated manner, taking the market into confidence. Would you say that global worries from Fed rate hikes and Fed balance sheet contraction should not really worry our policy making?

A: I think first of all the fact of the Fed rate increases and slowly winding down their balance sheet. I think that has been or at least should have been priced in because that has been known now for some time. I do not think there are any surprises there as far as I can see. The interesting thing for me is that remember late last year December even January, we thought that a combination of Fed rate increases plus possibly a huge fiscal package in the United States would increase interest rates and strengthen the dollar and therefore capital would flow out of emerging markets including India - that was the worry but notice that certainly in March-April and May, there have been flows coming back to India, the dollar has weakened not strengthened. So there has been some recalibration of market's perception of what is happening in the United States. I think the Fed stuff has been priced in. What is a bit more uncertain is US fiscal policy and Budget policy going forward. The more the sense that we are going to get a big package perhaps with a big fiscal deficits, I think that will increase US interest rates and strengthen the dollar but otherwise regardless of all those things which of course have an impact on India, I think given that our economy is quite robust macro economically, given that the monsoons are expected to be good, given that the reforms are continuing, given that growth prospects are still good, I think that investors are going to looking quite favourably at India and especially even in relative terms now, relative to other emerging markets or China even India does look reasonably good.

Q: China just got a downgrade from one of the rating agencies. The market shrugged it off because they thought it was the rating agency that was behind the curve but should we expect some nasty shocks from the global environment, from our eastern neighbour?

A: I think that the Chinese authorities have a very good record of macroeconomic management. They are much better aware of their problems than any of us are and the world is relying on the fact that all countries face challenges. In China the challenge particularly of rising debt and credit - that's their number one challenge. In some way if India has a twin balance sheet problem; I think China has a twin balance sheet problem in spades but they are well aware of it. I think they are taking actions and at some point there is vulnerability which they will have to work through but for the sake of the world economy and for the sake of India as well we should hope that China weathers this and navigates macroeconomic policy in the way they always have.

Q: Coming back to the Indian situation and the twin balance sheet problem you pointed. Would you worry that this big bad debt problem now - about Rs 8-9 trillion - is getting out of hand. Can this jack growth?

A: We know that the twin balance sheet challenge has already been affecting our growth, credit growth, private investment overall growth and the government have been ceased of this problem and have taken some very serious action in the form of the ordinance passed recently. I think the government is taking all steps possible and we have taken this big action and now we have to see how it is going to pan out in the months ahead. If we get progress on this based on this then we are beginning to make a dent in that problem. So let us see how it works out.

Q: Are you expecting from the RBI?

A: I think now the RBI is empowered to deal with this problem and I can see that they have started taking action. So now the proof of the pudding is going to be in actually seeing some big resolutions in the immediate months ahead. I think that will be the test of whether we are making progress on the twin balance sheet challenge or not.

Q: Resolutions, we are told will have to come with haircuts because so much of the debt is unsustainable. Do you think that any which way the capitalising bill has to go up? Is the government aware and ready to do that?

A: For long I have been of the view that when you look at the twin balance sheet challenge, I think we focus maybe a little bit too much on the bank balance sheet rather than on the corporate balance sheet side. I think that in some ways one is not just a mirror of the other but derives from the other. The banking thing derives from the corporate situation. So if we can make a progress on the resolution, I think that will also help the banking side of it. Of course banks have to be recapitalised and so on but we cannot make these actions focus exclusively on recapitalisation because resolution has to happen - that is where the real challenge is. Once that happens, we can look at the other parts of this twin balance sheet challenge but resolution now is a key to see that we can make progress on that.

Q: Your own record over the last three years has been a spectacular especially with your economic survey. I think the best I have read in recent years, in fact in recent decades. As you look at the next two years, what are one or two steps that you want seen implemented in India?

A: Thanks for the compliment. I have always been nervous about listening one-two things as if there is a laundry list. I think that the process of reform is ongoing, continues, steady without serious reversals.

In the economic survey in chapter two, we kind of spell out what the matter challenges for the economy are. In the short run I would love to see the twin balance sheet challenge behind us. I would love to see private credit and private investment picking up and once we get that dynamism from exports, from overall growth, I also think that we will start making a lot of progress on all the employment challenges that we face and keep plugging away.