Fixing banking system crucial for GDP growth, says Montek Singh Ahluwalia

Q: Would you say that this is at least in the first five years largely good luck because the entire world grew from 2003 to 2008?

A: I have heard that argument but actually it is true that the entire world grew, but the acceleration of the world economy was much less than the acceleration of the Indian economy. If you take the period of growth, when I last looked at the numbers, the world economy may have grown about 0.7 percentage point faster, the Indian economy grew more than 2.6 percentage point faster. So it was a period of global boom, but I think the Indian growth recovery was much beyond global boom.

Q: The first five years clearly were excellent years of growth, but the second half, the second set of five years, from 2008-2009 to 2013-2014, while many of the years we have something like 7 percent growth, it falls to about 5.5 percent in 2012-2013 and in 2013-2014 to 6.4 percent GDP. Do you think that the second five year term of the UPA was guilty of artificially boosting growth through higher fiscal deficits, higher bank lending and not recognizing the writing on the wall that was coming to us from the global growth story?

A: Let me put it differently. There is no question that UPA-I showed a growth rate of 8.9 percent or something like that. Against that, the UPA-II, the growth rate was 7.4 percent. The UPA-II was also the period when you had the Eurozone crisis. So, just as we say that the global boom helped a little bit in the earlier years, the Eurozone crisis would have had a negative effect in the second period.

Even so, the growth rate in these new numbers in the second period i.e. UPA-II, it is a growth rate of 7.4 percent. The present regime, we do not have the numbers for the current year, but everybody has been using, even the official side have been using numbers like 7.3 percent. If you end up with 7.3 percent in the current year, then the NDA government’s record in five years will be 7.2 percent. So, in that sense, even UPA-II will be better than NDA-II.

The other thing, you mentioned the last couple of years, you forgot to mention or rather you did mention but you did not highlight, the growth went down to 5.6 percent, but then it started to recover. The thing is when you have a long boom, there is a tendency after a long boom to have a slowdown and then the slowdown is usually used to correct some of the excesses that might have occurred during the boom like some of this excess lending stuff. Raghuram Rajan had rung the bell in 2014 that there is the real problem. So I think if that had been corrected earlier, we would have less difficulty now than we do.

Q: I take your point that even after the dip in 2012-2013 growth rate picks up in 2013-2014 and 2014-2015. However, the other figures that have come from the real sector and we did not need the real sector report to tell us that, 2008-2009, fiscal deficit – it is a bad year, it is a year of the great financial crisis, fiscal deficit jumps from 2.5 percent in the previous year to 6 percent. 6.5 percent the next year – 2009-2010 not a crisis year. 4.8 percent in 2010-2011, not a crisis year. 2011-2012 7 percent GDP growth, 5.9 percent fiscal deficit, not a crisis year. This is unforgivably high deficits.

A: First, the deficit going up in 2008-2009 was a conscious reaction to the threat of a global recession. You can argue whether we should have done it or not done it, but believe me at that time, when the whole world was petering on the brink of a recession, when the heads of government of 20 countries had got together in October or something to create the G20 at the summit level where everybody was saying we need fiscal stimulus and monetary stimulus. It would have been madness not to have a stimulus. So talking mindlessly about the high deficit without recognizing that the high deficit is in response to a truly exceptional situation does not accept.

Now secondly, you say the next year was not a crisis year. 2008-2009 if you look at the global position, the growth rate in 2008-2009 was negative. When you get a crisis in September, Lehman Brothers collapses, the spread of contagion, the choking off of credit, the appreciation that you got a serious problem took a couple of months. So the idea that 2009-2010 was not a crisis, I do not buy that. It was a crisis. You can argue, legitimately I think, that maybe we should have scaled off the fiscal stimulus a little faster than we did.

Q: Much faster, isn’t it?

A: You can argue that.

Q: 5.9 percent in 2011-2012 that comes on the back of previous year growth of 10.8 percent and 2011-2012 itself it is a 7 percent GDP, I mean 5.9 is pretty unpardonable isn’t it?

A: What happens to a fiscal deficit in any given time is essentially a judgement that the finance ministry has to make. In that particular case what really happened was there was a decline in revenues. You can have two different views, that is when you are getting off the high deficit regime, how fast do you do it? I agree, even the government then did try to get off it. What you are saying is they should have done it faster. On the whole, I agree with that. But you are now talking about the last two years. So, when you are looking at the performance of a government which has been there for 10 year and to my mind, yes the last two years there were problems.

Look we said that ourselves that there were problems, but take a government as a whole is a pretty damn good record. As a matter of fact except for China during that period for that whole period, India was a fastest growing economy. In the immediate aftermath of the crisis, let me tell you that the IMF has done a report on India in the year 2009. The IMF had said that look you have slowed down in 2008-2009, we are projecting that you will slow down further in 2008-2009. Actually, we recovered. So, the question is would it had been better to slow down further or would it had been better to make sure that you can put the economy back on a recovery path.

All said and done I don’t disagree with the view that fiscal deficit should have been brought down faster. But to go on and on about the fiscal deficit without verifying it. By looking at the exceptional circumstances in which it increases is not in my view a very sensible way of doing it.

Q: Sagacity lies in knowing when an extraordinary situation is confronting the country and the UPA was a government of many intellectuals, many internationally renowned economists such as yourselves so I wouldn’t quite forgive not being able to see the writing on the wall for 3-4 years in a row.

A: What do you mean 3-4 years? Where is the 3-4 years?

Q: Yes, I read out the fiscal deficit numbers to you 5 years in a row.

A: Don’t talk about the fiscal deficit numbers. Look at the objective global situation. The objective global situation is that in 2009-2010 you have got negative growth. In 2010-2011 the economy picked up a little; by then we are reducing the deficit. 2011-2012 you got a Eurozone fight. Quite frankly, I don’t actually disagree that we should have got off this fiscal stimulus a little bit but to say that 4 years, of a whole lot of economist list, is everything I mean hindsight is a wonderful thing, but please put all these things in context.

Q: I agree with you hindsight is a wonderful thing but on several years the gross value added (GVA) is higher than the gross domestic product (GDP) indicating that subsidies were very high and indirect tax collections were low. Now that also is a responsible isn’t it? Your GVA is higher than the GDP in at least three or four years?

A: Let me explain first was, GVA is a real measure of production and income. GDP at market prices is a different concept altogether. So, when you say subsidies it is true, this was really the problem of the fiscal deficit also. We didn’t raise petroleum prices. I was saying at that time that we should. It is not easy to do. Now the political system in our country does not make it easy to raise petroleum prices. But as a result, we had sort of a hidden deficit which was met by issuing oil bonds. Since I recommended it then, I will certainly say it now we should have raised petroleum prices.

Q: You were handicapped by the fact that the government depended on the CPM and Mamata Banerjee’s support and she wouldn’t allow you to raise.

A: I don’t want to point fingers at anyone. Because you know while some people are very loud the truth is no politician wants to raise petroleum prices. We did start raising petroleum prices which was a big change.

Q: I agree that it was a very statesman like in 2013-2014 in the face of general elections to start raising prices, I give you credit for that. But now can you accept responsibility for something else. Because of this four or five years of continuous 6.6, 6 percent, 5.9-4.8 percent fiscal deficit you left the country behind with double-digit inflation continuously for 4 or 5 years, is not that the UPA’s fault?

A: I mean look inflation definitely did become too high all through. I think any government when they look at the period would look at what was the strength and what were the weaknesses and there is no question that inflation did become a problem. The part of the problem frankly is that our political class doesn’t understand that if you don’t jack-up petroleum prices and you run a hidden fiscal deficit the general level of prices go up. So we need a huge educational effort amongst the political class generally. I don’t mean anyone party, generally. There isn’t a good appreciation of that. Every government will find that difficult.

Q: To be fair both the UPA and the NDA have accepted the MPC, it started off in the UPA regime and got legislative form under NDA, so perhaps a responsibility of low and step-stable inflation has been accepted. But coming to another point that probably allowed the UPA to enjoy or give the country a 10 percent growth in 2011-12 and generally in a 7.4 percent growth in your second terms. That was also because of what is very clear now - reckless bank lending. Should not that also have been a responsibility of both Mint Street and the government?

A: There is no question, if you look at the history of any boom - a boom easily consists of a genuine upswing, then somewhat exaggerated, irrational exuberance, every fellow thinks he can go in and invest, bankers also become a little loose, and they feel whatever happens here you can lend and projects will work and then you get a hit on the head, things start to slow down and some of that is quite normal.

In that sense, when we appointed Raghuram Rajan in 2013, he did a terrific job. He highlighted this issue and by 2014 it was very clear that this was the problem. Now I am not blaming anyone government or not but the truth of the matter is we are just talking about tips of some of these problems through the IBC etc, which are good initiatives but there is lot of blame that you can throw around everywhere when it comes to the failure to handle the banking crisis.

Q: It is a rather severe one and it is getting into the taxpayers pocket, so blame will not stop anytime soon, especially when large corporates default on their loans. But now as you look at the past ten years, especially the second term of the UPA, what are your lessons as an economist? Wear your economist hat and not a UPA hat or NDA hat - as an economist are wrong in aspiring or trying to get double-digit growth because the potential output appears to be more around 7 percent?

A: I don't think any government formally ever targeted 10 percent growth. When we were preparing the 11 plan, we had actually said let us try to go for 9 percent growth and at that time, we already had two years of above 9 percent growth and there was enthusiasm that maybe we may get 10 percent.

But looking at the savings and investment numbers etc, my judgment was that that is not terrible, so we should be reasonable. Since then the world has changed, the global situation has changed, I think today most people think that India probably can grow at 7 plus percent unless you make a big mistake and most people think if we really get our act together, we could do better.

Q: But what is that act together? What kind of reforms does that entail?

A: I think there two separate issues there. One is the macro, we need a much better understanding that what is a sensible macroeconomic policy and to some extent that is happening. Because today there is a realisation that the fiscal deficit has to be watched, the monetary policy committee (MPC) will look at the interest rates. I think the next step really is fixing the banks. Right now to my mind that is the single most important thing to get done.

Q: What would you say is the mantra in terms of numbers, what is good behaviour in terms of numbers? Should we be very strict about 3-3.5 percent fiscal deficit, 5 percent inflation, 2-2.5 percent current account and most importantly not more than 14-15 percent credit growth, is that how we should look at it, what would be your big numbers that future government should watch out for?

A: I am not looking at these numbers on a daily basis. However if you just kind of trigger broad thought, I would certainly say that we ought to be targeting 8 percent growth, I think that is something we can do.

You can always say, why not 9 percent but I would say let us get to 8 percent plus.

Q: I thought percent is what created the mischief?

A: We targeted 9 percent but give us credit, we targeted 9 percent at a time when for three years the economy grew at 9.5 percent. However, we recognise that this is an unsustainable boom. I don't know what the target is because we stopped having targets. The Niti Aayog could be doing it too but they have said different things. At one stage they talked about 8-10 percent, then they said 8 percent plus, so I don't know what they are targeting. However, we should be clear that the policies they are putting forth are based on a certain path.

As far as the current account deficit is concerned about guess is that a little above 2 percent is quite sustainable, we can finance it through long-term flows. For a very short time if it went above 2 percent, maybe it can be financed but anything more than that becomes a serious problem. Right now it looks as if it is more than that and that is clearly a problem.

I think the simplistic approach is cut down expenditure. The danger with cut down in expenditure is that you will cut down things like health and education and all the rest of it and you won't cut down untargeted subsidies. Today, for example, the total fertiliser subsidy, most agricultural economists will tell you that if you get rid of the fertiliser subsidy and convert it into investment in agriculture the country will be hugely better off but is there a single politician willing to say that in parliament? No.

There are huge problems with agriculture that we need to address. We keep talking about credit but then what we do is loan waivers.

Q: The king of all loan waivers happened in 2008.

A: Let me say, I wasn't in favour of it by the way. You are right it happened then but that is not the first loan waiver. Unfortunately every 5 or 6 years we seem to have had them. Now what is really bad in the present situation is, fortunately, the central government isn't announcing loan waivers but the state governments are happily announcing loan waivers. Question is can they afford to pay for it? If they are not going to pay for it, is the central government going to bail them out? If they are going to pay for it, what are they going to cut? No chief minister feels under any compulsion to answer this question. I am not referring to chief ministers of any one party. In fact, the way the system is going, I am sure most political advisors are advising chief ministers that you announce loan waivers and somehow or the other it will be taken care off.

The rest of the world gets the impression that the states are going to drive us nuts, there will be no credibility. The only test of fiscal credibility is if you let some states go bankrupt, in other words, if you don't bail them out but are we ready to do that?