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India grows despite inter-government woes

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Shaktikanta Das, the new Reserve Bank of India (RBI) Governor, gestures as he attends a news conference in Mumbai, India, 12 December 2018 (Photo: Reuters/Danish Siddiqui).

In Brief

All indications are that the Indian economy is poised to do well in 2019. Outgoing International Monetary Fund (IMF) Chief Economist Maurice Obstfeld praised India in late 2018 for four years of robust economic growth.

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According to the IMF, the Indian economy is expected to grow at 7.3 per cent in 2018–19, accelerating to 7.5 per cent in 2019–20. Provided the Indian government undertakes reforms to the labour market and foreign direct investment, growth rates are likely to further strengthen. Inflation is expected to remain well within the target zone set by the Reserve Bank of India’s (RBI) Monetary Policy Committee.

Gross saving is expected to rise from 28.8 per cent of GDP in 2017–18 to 30.0 per cent in 2019–20. Gross investment is expected to rise from 30.6 per cent to 32.2 per cent over the same period. This indicates that key drivers of growth will accelerate even as deep structural reforms aimed at improving the country’s investment climate, such as the implementation of the goods and services tax, continue to cause some uncertainty.

Torrid debates around economic policy between the RBI and the central government culminated in the resignation of RBI governor Urjit Patel in December 2018 for personal reasons. The background for these debates was the steady accumulation of non-performing assets (NPAs) — assets that have not yielded returns for at least 90 days — by commercial banks and particularly public sector banks.

The genesis of India’s NPA problem lies in efforts to stimulate lending in the aftermath of the credit squeeze following the global financial crisis. The problem was then compounded, particularly during the previous United Progressive Alliance regime, by a large number of arbitrary decisions on loan advancement without sufficient oversight, corporate corruption, poor governance and slow project timelines due to policy paralysis.

Specific sectors, such as infrastructure, experienced downturns after borrowers defaulted on large loans and fled the country. At the time of the 2018–19 budget the NPA crisis had become so serious that Prime Minister Narendra Modi himself took charge of formulating the policy antidote.

NPAs are now being tackled by a tightening of prudential norms and the recapitalisation of some banks (particularly government-owned banks). India’s new Insolvency and Bankruptcy Code allows Indian companies to go legally broke for the first time. Remedial measures including the sale of insolvent companies’ assets are also now permitted. This should go some way in addressing banks’ balance sheet concerns.

The bankruptcy code is already helping to shift the power balance between creditors and debtors and to improve corporate discipline. This is being complemented by efforts to improve corporate governance in public sector banks.

As expected, stronger oversight of bank lending practices is leading to some slowdown in credit growth. The Indian government finds this unpalatable in view of the upcoming parliamentary elections in early 2019. Of particular concern is the slowdown in credit growth for the micro, small and medium enterprises that provide a large proportion of formal sector employment in India. With the employment record of the Modi government likely to become an important election issue, improving credit flow is crucial.

The RBI opposes government pressure to go soft on lending standards, citing adherence to strict prudential norms and the guarantee of central bank independence. The government in turn argues that the RBI needs to be held more accountable.

The appeal to the RBI to be more accountable has spread to other areas of central bank responsibility. The government claims that the foreign exchange reserves of the RBI are ‘excessive’ and that some of these reserves should be passed on to the public exchequer.

Clearly the temptation for the government to use some of these funds to boost public expenditure before the elections is strong. The fiscal deficits of the national and some state governments could be ameliorated through this cash flow.

By the end of November 2018 several of these issues seemed to have been addressed. The RBI agreed to improve credit flow and the government supported the RBI’s new lending norms. They both agreed to establish a committee to look into an ‘appropriate’ level of foreign exchange reserves. The December 2018 meeting of the Monetary Policy Committee projected a united picture with respect to monetary policy. A few days later, governor Patel unexpectedly resigned.

The new RBI governor Shaktikanta Das — himself a veteran of the Ministry of Finance and current member of the 15th Finance Commission — will have his work cut out for him to pursue the terms of the agreement struck between the Indian government and the RBI in November.

With this as the background, maintaining financial stability in 2019 may be challenging.

Raghbendra Jha is Professor of Economics in the Arndt-Corden Department of Economics, Crawford School of Public Policy, The Australian National University. You can follow him on Twitter at @jha_raghbendra

This article is part of an EAF special feature series on 2018 in review and the year ahead.

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