Lecture Delivered at the Institute of Public Policy on 16th May 2020 by Dr. Rathin Roy
The Institute of Public Policy organised its second lecture in the ongoing series of Webinars through which we try to understand the present pandemic from various thematic lenses. The lecture was titled “Political Economy of the Contemporary Indian Situation” and was delivered by well-known economist Dr. Rathin Roy.
Dr. Rathin Roy, an expert in public finance, has formerly served on the Prime Minister’s Economic Advisory Council, and presently serves as the Director of National Institute of Public Finance and Policy, Delhi.
In his lecture, Dr. Rathin Roy gave the participants a comprehensive picture of the Indian economy against the backdrop of the COVID-19 pandemic. He conceptualised the economic crisis in terms of the absence of ‘interaction’, forming the very basis of the Indian economic system. Thereby, the lockdown imposed a domino effect on production and consumption cycles, leading to the inability of firms to hire, which in turn causes a steep decline in national income and GDP growth. Owing to this, the destruction of capital and national economic wealth country gathers momentum. In particular, the service sector has taken a hit as services in India necessarily require either interpersonal interaction or mobility, both of which are on hold for now.
The government must protect national income by temporarily putting income in the hands of the people so as to drive consumption and restart economic activity in sectors that pose the least health risk.
The above economic crisis has caused pessimism in annual growth forecasts with some economists even predicting a contraction in the economy. However, Dr. Roy is relatively optimistic predicting a growth ranging from 0-2 percent, provided certain financial actions are carried out. He advises that this must be looked at as a “war-like” situation, where the objective is to minimize losses arising out of displacement.
The government must protect national income by temporarily putting income in the hands of the people so as to drive consumption and restart economic activity in sectors that pose the least health risk. Thus, the underlying idea is to increasingly transfer the control consolidated by the Ministry of Home Affairs at the beginning of the lockdown, to the Finance Ministry, which is now tasked with bringing the country out of economic shock as lockdown lifts.
The Role of State Apparatus
Based on the experience of Japan, Canada, and the UK, Dr. Roy suggests two possibilities of economic protection. First, the government could announce industry-wise protection of a certain percentage of wages and capital, by mobilizing public resources. However, given the weak structure of the Indian state (polity), the government may not effectively be able to ensure that the benefits transfer results in the intended outcomes (protection of consumption and hence, demand). For instance, to protect wages, it may transfer incomes, but whether this cash will actually be spent or merely fuel inflationary tendencies is not certain. The second option is to provide individual firms a certain percentage of protection. For this to work, the firm must transfer this protection down its supply chain which requires tight contracting and enforcement, which again is a difficulty given the nature of the state. Perhaps giving too much consideration to these possibilities, the government failed to come forward with any significant support or protection to the industry.
…to provide individual firms a certain percentage of protection. For this to work, the firm must transfer this protection down their supply chain which requires tight contracting and enforcement…
Hits and Misses
So far, in the actions taken by various governments there have been a few hits and misses. The hits have been:
- The state governments have managed to protect agriculture. This has been helped by the low rural transmission of the virus. Hence, the Rabi harvest took place as planned and Kharif sowing is expected to proceed as normal.
- Industrial production at a limited scale has been permitted and exports are being allowed, which should protect the manufacturing sector from the scourge of this economic downturn by up to 60%.
However, on two fronts the government has failed:
- Communication to the people, entailing an official estimate of where the economy is expected to stand post the crisis in terms of macroeconomic indicators like growth, inflation, and deficits.
- The failure of the Centre is devolving funds to the States, who are at the forefront of this health crisis. The major expenditure on healthcare and administration is being borne by states who are finding themselves increasingly cash strapped.
Lending, Not Spending
In decoding the relief package, Dr. Roy explained that most big-ticket allocations are on a credit basis, i.e., money is being lent by the government, not spent. The onus is on the people to borrow money and raise demand in the economy. Thus, this can be construed as a loose monetary policy rather than a fiscal stimulus. This can also be seen as a debt financing path out of the crisis.
With regards to expectations, Dr. Roy stressed that the situation is still not as bad as is being predicted because of two factors. Firstly, agriculture has been salvaged and thus, rural non-farm employment such as demand for informal services will be protected. For example, informal transport which comprises about 65% of total transport will contribute to income in rural India. Further, the expectation that Kharif sowing will be mostly unaffected and normal will largely control food inflation.
Secondly, as discussed, we should be able to save manufacturing at around 60-70%, while services will take a serious hit except IT, which could add 0.5% to GDP growth. Hence, a halving of GDP growth is the basic estimate and the range can be expected from 0-2%. However, if we fail to reach these targets then it is likely that we will witness negative growth.
How to come out of the vortex?
Dr. Roy suggested that while the situation seems grim there are several ways in which the economy can be turned around. He further qualified these suggestions from being more preferable to less preferable. According to Dr. Roy, the options before the government in decreasing preference would be: (a)Ways and Mean Advances available with the RBI (b) release of Consol type Pandemic Bonds and (c) printing money.
Ways and Means Advances
One of the key policy measures suggested by Dr. Roy was utilising the Reserve Bank of India’s (RBI) Ways and Means Advances (WMA) facility (Damodaran and Iqbal 2020). The WMA is a provision that allows the RBI to lend money to the Centre and the State governments for a temporary period. The rate of interest for the loans is equal to the repo rate. The Centre and States are allowed to borrow beyond their prescribed limits at higher interest rates. WMA provides a much-needed infusion of funds into the coffers of the Centre and the State governments who find themselves short of funds while being at the frontline of the pandemic mitigation efforts. The RBI has recently increased the WMA limits of states by 60% which is a positive development. However, Dr. Roy believes that WMA can be put to more effective use by including the unspent money belonging to the Government in various bank accounts.
Consol type Pandemic Bond
Another policy suggestion that the government can take up is issuing a consol type pandemic bond. Consol bonds, first issued by the British government in the 18th century, are a type of perpetual bond (Smith 2019). Perpetual here would imply they have no fixed maturity period. The principal paid for the bond is never repaid. Instead, a fixed interest is paid annually to the holder of the consol bond. A consol bond has been compared by many to be akin to investing in a stock that pays a fixed dividend annually.
Consol bonds are an attractive option for governments to raise funds as it gives them an opportunity to amass large funds without any corresponding obligation to return the principal amount. This is important for a country like India where many have raised strong concerns of managing the fiscal deficit in light of relief packages and subsidies being announced to boost the economy. The government can choose to recall the consol bonds anytime it has the principal amount thus giving more flexibility as opposed to conventional government bonds and treasury bills.
They can also prove attractive for investors since they are assured of a steady return as long as they hold onto the bond. Thus, acting like a win-win model for the government and the investors.
However, there is the concern that a rise in interest rates can erode the value of the consol bond making it unattractive for bondholders. Data from the Bank of England for a 70-year period beginning from 1950 reveals that yield of consol bonds has gone from a high of 15.78% in August 1974 to a low of 1.52% in September 2016, thus indicating the swings in bond yield that can take place (The Fred Blog 2016).
As a last resort Dr. Roy proposed that money should be printed to increase the money supply. The increase in money supply is likely to bolster the demand for goods and services in the economy. This can help contribute to economic recovery. However, the reason that it is the last resort is that the measure is fraught with downsides that impact macroeconomic indicators. Such a measure is likely to be inflationary and it can also lead to the widening of the fiscal deficit.
The lecture ended on a somber note in which Dr. Roy suggested that in all the talk about an economic turnaround and reforms, one must not forget the human suffering of the ones who are walking hundreds of miles in despair and the fear of bleak future. It is for all to come together and create a path of recovery that not only helps in building a better economy but also a fairly equitable one.
(Neel Karnik is a student of the Masters in Public Policy program. A graduate in electrical engineering, his areas of interest are Internet and social media, energy, agriculture, international relations, and policy evaluation. He can be reached at firstname.lastname@example.org)
(Priyanka Sahasrabudhe is a student of Public Policy at the National Law School of India University, Bangalore. She is interested in exploring the intersection of economic policy with societal inequalities in India. She can be reached at email@example.com)
Damodaran, Harish, and Nushaiba Iqbal. 2020. The Indian Express. April 19. Accessed May 18, 2020. https://indianexpress.com/article/explained/reserve-bank-of-india-rbi-ways-and-means-advances-wma-repo-rate-coronavirus-covid-19-6367396/.
Smith, Lisa. 2019. Investopedia. June 25. Accessed May 18, 2020. https://www.investopedia.com/articles/investing/082313/perpetual-bonds-overview.asp.
The Fred Blog. 2016. The Fred Blog – Economic Research. July 21. Accessed May 18, 2020. https://fredblog.stlouisfed.org/2016/07/consols-the-never-ending-bonds/.