Globally, central bank governors are extra careful not to venture into the delicate subject of fiscal policy in public. But fiscal dominance and its ill-effects can impede not only monetary policy but all functions of central banking. And it's this aspect that central bankers, not just in India but globally, should discuss and debate in an open and transparent manner, Dr Viral Acharya, former Deputy Governor, RBI tells The New Indian Express in an interview.
Excerpts:
What are the key challenges the Indian economy is facing?
The first and foremost has to be the virus curve. While there are early signs of stability in key hotspots, new hotspots are emerging elsewhere.
One key thing the Covid-19 outlook has illustrated clearly is that the economy requires interdependence and we can't have one isolated pocket functioning. What's concerning is that the Indian curve continues to rise and flattening it without extreme consequences is critical.
Second, is fiscal stability. The foremost challenge for policy right now is creating fiscal space to accommodate expenditures necessary to support growth in Covid and post-Covid phase. The fiscal is very stretched, it has been stretched for a while and hasn't been adequately discussed as openly as one would like. I think that's because we are in a situation where we are unable to decisively take on certain critical expenditure in areas that might be necessary.
Figuring out a way to undertake these necessary expenditures, while at the same time maintaining debt sustainability and giving credibility to markets and rating agencies that we can actually stick to medium-term targets is an important challenge that should be solved right now. We cannot go on a path of expenditures without actually addressing debt sustainability.
Third, on a slightly longer horizon, is the issue of financial stability. As RBI's Financial Stability Report (FSR) recently has shown, gross NPAs are likely to go up to 15 per cent. This is not going to be easy to deal with and there's only one way out in my view. Given the present state of the equity markets, where domestic and foreign flows are actually good, banks, NBFCs should to go the market and raise capital. Public-sector banks can either get a direct approval from the government or (it will be) even better, if they are allowed to divest stakes or perhaps re-privatisation of some of these banks may have to be considered.
Several predictions are being made on GDP contraction. What in your view is reasonable? Will it be in double digits?
Some analysts, who have tracked growth seem to suggest that it's likely to be in the range of 5-10 per cent based on simple, realistic calculations basically on the back of 4-6 months of economic activity. It's true that rural activity and farming are doing well, but they relatively constitute a small portion of the total output unlike services. From a financial and macro-economic standpoint, what matters are not the average parts, but some stress scenario where we might end up. You have to have an economy that's resilient and I think the stress scenarios are more likely than what might ordinarily be, because Covid isn't just affecting India but rest of the global economy.
Covid has also accelerated certain difficult trends that were already emerging in the global economy. How the trade war and how geopolitical tensions plays out and what shape they will take and if they lead to a dramatic reformation of supply chains is unclear.
On the one hand, it's an opportunity for India, but given our imports, it could also be a potential cost. I'd say, not only will growth contract 5-10 per cent, it's highly likely to contract, but importantly, we have to entertain that there's a fair bit of uncertainty around that. I'd prefer the economy chose a path of resilience by undertaking core structural reforms so that while we are grappling with banking sector and fiscal space, we are simultaneously rebuilding external sector and investor confidence.
Can you identify two or three steps that need to be taken?
RBI's FSR needs to be taken extremely seriously. These reports over a period of time have been shown to be prescient about the upcoming stresses and partly because it's an objective look at the economy. The fact that for the first time they are projecting a potential NPA ratio of 12.5-15 per cent suggests that we do need to take capitalisation of the financial sector seriously.These estimates are used as a bank-level metric to determine capital needs and even applies to NBFCs.
Second, has to be fiscal. Even if expenditures are not expanded, debt-to-GDP ratio is likely to rise simply because tax collections are coming down. There's a revenue hit on the fisc even without expanding expenditures. Now we can quickly do calculations, say over three or five years on different protracted growth paths what sort of debt-to-GDP numbers are likely to arise. We need to do these scenario analysis to ask ourselves at what time the debt sustainability analysis is pointing towards reaching 90 per cent plus.
The only way to maintain those high debt-to-GDP ratios is to be on a phenomenal growth path, but whether we like it or not, we are not on high growth. The government wants to spend and clearly, doesn't want to face debt sustainability concerns in the market. This means, politics and economics are aligned right now. This is a golden opportunity to restructure our institutions on fiscal reform path. Not just transparency, above the line, below the line, inside the balance sheet, outside the balance sheet, but transparent fiscal accounting.
Second, adherence to FRBM (Fiscal Responsibility and Budget Management Act) norms. We truly need a bipratisan, indepedent fiscal council as advocated in the 14th Finance Commission, which Dr (YV) Reddy (Chairman) talked about. Unfortunately, those two pages in the 14th Commission have largely been ignored. The FRBM targets are without institutional mechanism helping adherence.
Finally, India benefited tremendously from the disinvestment programmes undertaken implicity during 1991 reforms and liberalisation of some sectors that was like a backdoor entry to disinvestment of public sector. There were also massive disinvestments during 1998-2002, which was the golden era.
I think this is the moment when the golden era can be created again because politics and economics are aligned to undertake substantial disinvestments. I would push it to reduce government stakes in banks and insurance firms. We can look at the South East Asian crisis, which forced countries to incur 50-70 per cent of the GDP costs to mop up financial cycles and the only way to reduce the burden was to allow foreign entry into the financial sector. We don't need to wait for that scenario. We can do much better to do disinvements at healthy prices we have in the markets right now.
Which are the vested interests that are standing in the way? Is it that we are worried more about the stock market than the Indian economy?
Vested interest is what I'm trying to highlight throughout my book (Quest for Restoring Financial Stability) and especially in the memorial lecture (given in October 2018). Government horizons can become very short at times and that's when they don't want to follow rules. They want to use discretion actually to extend credit quickly, to be able to borrow even if that means some amount of short term risks. Sometimes there isn't a moment for reforms neither from existing governments nor from the other side.
If I could give an analogy, no party in the US wants to get rid of Fannie May and Freddie Mac, which provide subsidized housing. Because, for one party it provides subsidized housing for second homes and the other for the very poor. At times, we need public opinion and debate, galvinsed towards what is right for the economy in the long run.
In fact, I view my book as an attempt to raise debate on these issues in public so that we can decide collectively. We need an open and transparent debate about the fiscal situation and why we need institutional reforms. Because, on their own, each government wants discretion to do what it wants.
Do you mean to suggest that those at the RBI aren't entitled to do this and therefore need a public debate?
In my view, RBI, or any central bank has to factor in fiscal as a macro-economic pre-condition. There should be an open debate. Nevertheless, central bankers do think twice when talking about fiscal because that's seen as over-stretching their mandate. But if the fiscal isn't in shape, there's pressure on all central bank policies. This is the summary of my book, on what I thought was the real problem.
Fiscal dominance is putting pressure on all policies of central bank and at the point of time when financial stability could be endangered, because the mandate of the central banks is to protect depositors, protect inflation credibility, protect external sector, I think the central bank must raise its voice. I did write a speech on this which was released only the day before my departure. It wasn't released as something the central bank supported, but as my independent view.
In my view, central bankers should speak. I did speak, I did raise these debates internally, and I did write a speech about it. All central bankers, not just in India, need to raise questions about the fiscal path.
But why do we hear voices only from ex-governors?
I haven't been a Governor. I shouldn't hazard a guess, but I fully understand the pressure because there's a big difference between being on the 19th floor and being on the 18th floor of RBI. Nevertheless, my issue is to do with democratic accountability. Central bankers who have conviction on this front do stand up, which I referred to in a footnote in my book about Paul Volcker, who explicitly stood up
against the monetisation of the Reagan-era expansion. There was no institutional framework at that time but he explicitly resisted fiscal pressures pushing him to keep interest rates low in order to reduce government's rollover costs on debt. But he refused to sacrifice the gains having arrested inflation from double-digit levels and in the end, he prevailed, putting macro-economic stability ahead of the immediate pressures coming from the fisc.
Are exits the only way out if no compromises are reached?
My sense is on certain issues there can be no compromise. We know that the pressures from the bureaucracy and government are in their own vested short-term interests. Central banks are run by public servants and we have a legal constitutional mandate, which we take seriously. If we are asked to protect depositors, or banks, or the external sector, if I'm tasked for interest-rate decisions by maintaining my target inflation levels, that's my legal mandate. And I'm accountable to the Parliament if it's not met.
I don't think saying no to government or bureaucracy or not being able to reach a compromise means that we aren't flexible. That's not the right implication. I think what happens in the short-term is every compromise we make today becomes a starting point for re-negotiations tomorrow. Then we know that the pressures are unrelenting and at some point we have to draw a line. Public servant is a servant of the public, not a servant of the bureaucrat or of the government. The objective is to serve the people of India and we have to make calculations given the legal mandate of RBI to decide what is the right decision..
But there is a limit to what fisc can do in the medium-term, isn't there?
We do have FRBM targets, but you need an institutional mechanism to prevent slippages. That mechanism was advocated in the 14th Finance Commission to have an independent fiscal council for transparent accounting, approval of budgets before they are announced. If the budget is saying we are meeting based on extraordinary growth assumptions, clearly that's not a reasonable budget to start with and needs to be vetted by an independent council.
Second, 1998-2002 saw significant government revenue through disinvestments. Even now we can generate revenue other than taxes because government owns several assets. Unfortunately, disinvestment has become a cosmetic thing with one arm buying another. Utlimately, that one arm is borrowing to pay for the acqusition and dividends and so public sector borrowing requirement isn't coming down. We need genuine disinvestment. Instead of raising debt in the markets, we need equity, which is a powerful tool. In fact, former Niti Aayog Chairman noted that the disinvestment ministry often falls short of targets.
Lastly, one reason why the fiscal scenario is crucial to India is because it's affecting financial stability. The reason why adequate capital never gets into the public sector balance sheets is because the fisc is always stressed. We need to look at alternative solutions. Something ought to do to ensure that fiscal isn't spilling over to all aspects of the economy.
What measures would you suggest in the next 6-12 months?
We need to undertake institutional reforms, create short-term extra fiscal space to borrow more as tax collections and revenue are coming down. Expenditure has to be on infrastructure, may be it requires creation of SEZs or Delhi-Mumbai industrial corridors...some thinking has to be done on supply chains and how do we actually create business and market-friendly practices to set up plants and create high quality jobs. A combination of fiscal reorientation, strengthening infrastructure, health and education and institutional reforms on fiscal credibility is the right combination.
What were your thoughts on invoking Section-7?
I'm fairly dispassionate about these things. I understand that governments have their own pressures, they come from a variety of short-term pressures. If you are invoking Section 7 because there were disagreements and you think the central bank seems sort of resisting, there has to be a public debate about it. If you think it's in public interest, you need to articulate it.
On the one hand, we have been saying our PSBs are in a mess because we had excess lending and on the other hand, in the midst of a clean up, there are pressures to relax prudential norms. As public servants, and given our understanding of the legal mandate of the RBI, the only option left for us on the table was to actually have a public debate. I'm glad we did it and I'll do it all over again if I have an opportunity to do so. I think voice and dissent are very important parts of a country for right decision making. If we don't discuss/debate these issues, we will not make progress.
If there was voice and dissent, could demonetisation have been averted?
It's a googly and outside the offstump...and I am not going to play it...There has to be public debate about these decisions. In fact, in the Preface chapter I recommend that when the central bank takes
extraordinary actions, they should be backed by publicly disclosed reports explaining why are we deviating from standard norms..
For instance, if a regulatory forbearance is proposed, we need to ask why are we doing this? What do we expect the intended consequences are and what are the likely unintended consequences if we adopt.
Those have to be laid out in a transparent manner for everyone to see because the very process of being precise, of being asked to write public document that's going to be vetted by everyone will make you think twice, thrice, four times of taking an extraordinary decision. That would be a healthy discipline. I understand, we have to act fast, but we also have to act right and both these things should be given equal importance.