Government spending, Arthur Laffer observed, is taxation, and said that he had “never heard a poor person spending himself into prosperity ”. The distilled insight, though, has not dented the gusto of governments to spend their way out of crises—and often fund their way into power. Ostensibly the ideal is small government and efficient outcomes. In reality, governments believe size and spend matters and the veneer of a ‘balanced budget’ unravels in the columns of deficit and debt.
A week after the November 19 meeting of the RBI board, to define the contours of rights and entitlement between the central bank and the government, commentary continues to update the score on whether the government wrested the points or the RBI held its ground. The fact that a policy debate is seen as a war is a testimony to the trust deficit.
The crux of the matter is who will cough up the cost of clearing the swamp in the financial sector to prevent a systemic crisis. Last week, the Board and RBI agreed to delay the implementation of Basel III norms so banks could lend. The fact is, despite the forbearance, barely five of the public sector banks meet the stipulated capital adequacy ratio..
The government wants to enable liquidity so that non-bank finance companies do not go belly-up. It must also recapitalise public sector banks. Theoretically, the government could expand borrowings to fund recapitalisation, but that would trigger a cascade of consequences, widen the fiscal fault line and wreck the fragile fiscal deficit ratio. The mandarins of the Ministry of Finance would like the RBI to part with some of its reserves.
Technically, much of the “surplus” with RBI is the result of rupee revaluation of dollar and gold reserves. It has been argued that to make available rupee resources to the government, the RBI will need to offload a part of its reserves—securities, gold or dollars. And this, former governors of RBI have averred, would be akin to “creating or printing money”.
The standoff, though, is not irreparable or at a dead end. A decade back the government of India, the Planning Commission and the RBI debated a proposal to leverage the foreign exchange reserves to fund infrastructure. The government had then wanted the resources to be made available in rupees. The RBI was ready to backstop the funding, but it would have to be abroad and in dollars. Eventually the idea was shelved for another day.
The option could be revived along with the cautionary markers on risks and returns. Foreign currency reserves are invested in a diversified portfolio—for instance. US Treasury Department data shows India has invested $144 billion in US Treasury Bonds. The idea is a part of the dollar reserves could be used as seed capital to set up a sovereign fund—say, India Fund. The government could either play solo or invite the BRICS Bank and/or other funds such as ADIA and investors to participate.
The capital raised could be leveraged in dollars to fund bank recapitalisation and infrastructure, the caveat being that the funds be invested to fund productive assets and not helicopter populism. Indeed, the ‘India Development Fund’ could eventually own public sector assets and stakes in infrastructure projects. The gains from the upside of growth could be offloaded and returns reinvested in emerging priorities.
The option merits due consideration—perhaps at the next meeting of the RBI Board. The government could dredge the documentation of the time and seek expert advice from experienced minds. The moot point is to take the discussion beyond the stated positions, to examine alternative ideas. The narrative of stasis despite known problems and known solutions is a poor reflection on the $2.8-trillion economy which is expected to be among the top three in the world.
On November 16, 2017, rating agency Moody’s “upgraded the government of India’s local and foreign currency issuer ratings to Baa2 from Baa3 and changed the outlook on the rating to stable from positive”. The rating agency cautioned: “Much remains to be done. Challenges with implementation of the GST, ongoing weakness of private sector investment, the slow progress with resolution of banking sector asset quality issues, and lack of progress with land and labour reforms at the national level highlight still material government effectiveness issues.”
Over 372 days later, data on the macro factors of the economy virtually validates the concern expressed then and is reflected in the stress in the financial and real sectors of the economy. On November 8, 2018 a Moody’s commentary said, “The greatest downside risk to India’s growth prospects stems from concerns about its financial sector,” and prophesied a slowdown in credit growth.
On Friday, a foreign institutional investor at a round table asked in wonderment why bad loans continued to rise despite the moniker of the fastest growing economy. The question is also validated by the continuing stress in the three sectors which employ the bulk of the workforce – small and medium enterprises, construction and exports. The answer lies in the divorce of political attention and policy action. Far too frequently India’s political economy is left stranded between intent and implementation.