New Delhi: Arvind Subramanian, having aided the government’s policy making as chief economic adviser since October 2014, is returning to academics later this month. Subramanian turned the annual economic survey, a budget document, into a widely read, in-depth commentary on the Indian economy and guided key policies including banking reforms and the goods and services tax (GST). The economist believes the structural reforms introduced in recent years have placed the Indian economy on a stronger footing to deal with external challenges. Edited excerpts from an interview:
There two external threats that India is facing —rising oil prices and a strong dollar. How equipped is India to withstand these risks?
The strong dollar could lead to capital outflows from emerging markets. You have a rising dollar, you have trade skirmishes which could become full-blown wars. But I think what is dangerous and what may happen this time is that trade wars become currency wars. So if the dollar is appreciating, the Chinese currency is depreciating and so are all Asian currencies. What can we do about it? How resilient are we? If oil prices rise and other currencies depreciate, the rupee depreciating has to be part of the adjustment mechanism. To say that rupee should not depreciate when all these shocks are happening is just bad economics.
So the only question is that we should prevent disruptive adjustments. We should have gradual non-disruptive adjustments for which we are very well equipped.
We have a stable macro-policy, growth is coming back and we have foreign exchange reserves to cushion this disruption.
Second, one should not make matters worse. The government is trying hard to maintain fiscal discipline and maintain macro-economic stability.
On oil, the government deserves a lot of credit for sticking to deregulation, for not doing anything unduly populist and for showing that if oil prices go up, we will absorb it.
So India is well-placed to absorb these shocks?
Yes.
Is the rupee undervalued or overvalued?
Since January 2014, India’s real exchange rate, until the recent episode, had appreciated by 20%. So what has happened in the last few months is a desirable correction in the exchange rate. As long as it is gradual, the rupee depreciation is not that undesirable.
Should we be apprehensive about further depreciation?
It has to be gradual and it has to be commensurate with the adverse shock we face. Oil prices have gone up by 25% relative to last year. For India, part of the adjustment has to be through the rupee. If the import bill and current account go up, how do you restore that? Partly by a currency depreciation.
What about its impact on fisc and inflation?
It will be there. If oil price goes up, there will be adverse consequences. Inflation will go up. Depreciating rupee will get the big competitiveness impact but you will also have higher inflation which the monetary policy authorities will take into account when they do monetary policy.
But politically it is a hot potato...
Politically, I think large sudden disruptive changes are hot potato, not gradual changes. After all, the rupee moved from trading at 40 against the dollar to 69.
Are you sticking to your growth projections of 7-7.5% for FY19?
Yes.
But with higher interest rates, what side of the range could the growth be?
Relative to that projection, oil prices are higher and financial conditions are tighter. The projection already had factored in oil prices of $60-65. They are now higher. We will have to calibrate that. So to that extent, there will be a small 0.1, 0.2 percentage point impact on growth.
Where is the impetus to growth going to come from?
Capital formation has revived. National accounts show that real investment has been rising. Economic activity is picking up. Credit growth has also picked up. Government also contributed a lot to the growth.
What is the extent till which the twin balance sheet problem been addressed?
Going back to my 5Rs: Recognition—wee have done a good job although there may be more toxic assets. Resolution—we have made very good progress on the resolution side. We have hit upon a legal framework that allows resolution. Recapitalization—we have made a start. It is on reforms and regulation we have to do much more. I do think that further recapitalization will have to be linked to reforms. Broadly the reforms have to be narrow banking by the less viable ones, much more majority private sector ownership.
On resolution, we need to constantly keep tabs on whether we are overburdening this framework. Can this be the only game in town for resolution? We need to keep thinking on this carefully.
We have had two resolutions from the first list of 12 large cases of bad loans. Next two batches are lined up. Two per year is a very good start but it has to be much faster.
What is your view on the proposed LIC-IDBI Bank deal ?
My hypothesis is that India is affected by stigmatized capitalism, where there is not enough trust in the private sector or in the ability of the state to regulate the private sector. It is making it much more difficult to give the private sector a bigger role. It is easier to give a public or a quasi-public entity a bigger role rather than getting more private sector participation. IDBI has large amounts of real estate and land holdings and getting their correct valuation is a long-drawn process.
The fourth quarter results of banks show that most of the capital infused by the government has been wiped away by losses. Isn’t there a need to give additional capital to banks? Does government have the fiscal bandwidth for this?
I think we will need to give more. I have to work through the numbers. I have some ideas on how and from where money can come. Over the next few weeks let us see if I can talk about this.
Do you think some of the state-run companies have outlived their utility? There are no takers for companies like Air India.
The more I see what is going on, the more I am convinced that the private sector will have a dynamic role in new sectors and in making a fresh entry, rather than in (acquiring) existing public assets. Going forward, we will have to grow the private sector through fresh entry and have the public sector shrink organically.
GST has logged one year. What did we get right and what did we get wrong?
GST is really a major reform in so many ways. After nine months, revenue performance has surpassed my wildest expectations. Overall revenue has been very buoyant at a time when (economic) growth decelerated and GST rates were slashed. We have got about 11.9% revenue growth and a tax buoyancy of 1.2 despite these headwinds. At the end of nine months, the compensation requirement has been very small. This means that the five-year compensation guarantee given to states is probably not necessary at all because we almost got there in the first year of implementation itself. We are seeing an expansion in tax base of net consuming and revenue poor states, as we wanted and expected, with one or two exceptions. Poorer states have gained, but not at the expense of anyone.
There are challenges too. The rate structure needs further rationalization, export refunding still needs to be cleaned up and I still think we have the agenda of bringing in land, real estate and petroleum into GST.
Maybe, we could have valued simplicity more upfront. We corrected it mid-course. Some more simplification is underway. As long as we get there over time, I will be happy.
What is the realistic time for GST rates and slabs to get further rationalized?
The 28% slab has already been trimmed quite dramatically. As long as we have steady momentum in terms of the remaining reforms, I am hopeful that in two-three years, it should happen.
Don’t you think imposing cesses such as the one proposed on sugar can distort the GST architecture?
We have to value simplicity and at the same time be pragmatic. All we need to ensure is that whatever is done is done for the right reason, is kept in check and has a sunset clause to make sure that it goes away after a period of time.
What is your inflation target?
I think there is no reason to second guess the RBI’s (Reserve Bank of India’s) inflation target. I don’t have an independent projection.
A lot of structural reforms have been carried out during your tenure, whether it is GST or subsidy reforms. Is plumbing in the Indian economy—to quote (Infosys co-founder) Nandan Nilekani—much better today?
For sure. Among the major achievement of the government is creating the financial technology and biometric architecture for better public provision for essential private goods and services such as toilets, bank accounts, social security, cooking gas, housing and power. There is a lot of progress though more needs to be done in some cases —for example household electrification and increasing the refill rate in the Ujjwala scheme.
What is the Subramanian legacy?
There are three to four things that a chief economic adviser should aspire to do. One, giving inputs to policymaking. There, my report on the GST had a big impact on forging political consensus and serving as a benchmark for comparison. In the very first budget, we diagnosed the twin balance sheet challenge and gave primacy to public investment. The moderate MSP hikes, pulses report, power sector reforms. Second, generating new ideas —whether it is universal basic income, 4Cs problem or 5Rs of banking. Third, elevating the standard and quality of macro-economic discourse. Then, expanding state capacity in its narrow sense.
It is going to be 10 years of Lehmann. Debt levels are doubling. Is the world vulnerable to another meltdown?
There is a scenario where we talked about in the 2015-16 survey that the next possible global shock could emanate from China. Chinese debt has risen very rapidly and authorities are now looking at deleverage and bring it down. It is this combination of something happening in China and its currency depreciating that creates a possibility of a global shock as it can have ripple effects on all other emerging economies. It can be a negative shock for the emerging market economies as their competitiveness will fall. India per se doesn’t have very high levels of foreign currency denominated debt.
There is a growing clamour within the government for double digit growth.
Part of these are aspirations. Part of these are aspirations for a medium term. In order to get double digit growth, reforms have to continue and the world economy has to cooperate.
What is a sustainable rate of growth?
It depends on international conditions.
Where do you see inflation given the increase in MSP for kharif crops?
We have to wait and see. A lot will depend also on how this is implemented. There are two scenarios—market prices are either at or above the MSP or below the MSP. If we are in the latter situation, then the more effective you are in procurement--because after all, procurement is a major challenge--the more the benefit to the farmer. Whether the scheme is about procurement or price deficiency, if you are very effective, then prices will be higher and the benefits to the farmer will also be higher.
In direct tax, do you see further scope for widening the base?
I do not want to pre-judge what the committee on direct tax code has in mind. We are just beginning to see the benefits of higher compliance in tax base. What we see the world over is tax rates coming down, but given that we are a poor country, our direct tax system has to be highly progressive. We need low rates to attract investments but the objectives have to be traded off.