Times Network’s white paper on the state of the economy shows there is indication that green shoots are emerging but still challenging times lie ahead for the economy. How do you see India’s revival mission?
It is heartening that the recovery has come sooner than we expected and the downturn is also less deep than we feared. As recently as even six months ago, we were worried that the contraction of the economy might be 10% or even 15%. Now we are told that the economy is going to contract by 8% this year. That is bad but relative to 15% it is still comforting. Next year, we understand that there is going to be a rebound. Estimates of next year’s growth range from about 11% of RBI and the government to 13.5-14% of some of the investment banks and analysts. But here, the important thing is that even if there is going to be a V-shaped rebound, at the end of FY22, we are still going to be worse off relative to the pre-pandemic growth path.
Look at the growth profile over the last five years. Four years ago, we were growing at 8%, three years ago at 7%, two years ago at 6%, last year at 4%. This year, we are contracting by 8%. Next year even if we grow by 13-14% and have that V-shaped rebound, the output is going to be lower than what it would have been without the pandemic. So we got to be aware of that.
Do you think some drastic steps are needed to bring the economy back to that pre-Covid level?
I would say steps are required to bring the economy to the pre-Covid level. There certainly would be a permanent loss of output compared to the pre-Covid growth trajectory but our endeavour should be to catch up with the trend line as soon as possible and put the economy in a high growth trajectory. Certainly a lot of things need to be done. I would not call them drastic but those are things that are already known. Some of them are mentioned in the Times Network’s very white paper that you refer to. I think the government needs to implement the steps very systematically and energetically. It is already doing some of that.
Specifically, at least four recommendations have been mentioned in this white paper. One of them is empowering low skilled manufacturing. Do you think India is doing enough to seize the opportunity in manufacturing?
You spoke about manufacturing and then low skilled manufacturing. First let us focus on manufacturing. It is key to India’s economic growth and India’s economic prospects. A country’s progress starts off with a high share of agriculture in GDP but as they move up the ladder, the share of agriculture goes down and the share of industrial manufacturing goes up. After some time, the share of manufacturing goes down and the share of services goes up.
The development history tells us that the progression is from agriculture to manufacturing to services. India defined the paradigm. Our share of agriculture in GDP had come down but it is not manufacturing that went up, it is services that went up. Now we realise that we need to focus on manufacturing if we want to get on to a high growth trajectory, if we want to generate jobs. Agriculture is not going to create jobs. In fact, agriculture is going to throw out tens of millions of people if productivity goes up.
We cannot have job growth in services. The services sector cannot create high value jobs. So, we need to focus on the manufacturing sector. In a country like Vietnam, the share of manufacturing in GDP had doubled between 2000 and 2020. For India it went up barely from 2% to about 15% to 17% and the share of manufacturing in jobs had remained fairly stagnant so for jobs for economic growth we need to focus on manufacturing.
On the second part of your question about low-skill manufacturers. If agricultural productivity goes up, it is going to create jobs for those people and they are unskilled. So it is very important that the focus on unskilled manufacturing stays at least for the next 10 years. There is an enormous potential both in the domestic market as well as the export market for unskilled manufacturers.
Paul Krugman in a lecture at Ashoka University a couple of weeks ago said exactly this. There is still scope for low skilled manufacturer but the important thing is that even as we focus on low skill manufacturing for the next decade, we need to simultaneously focus on improving the skill endowment so that we do not get locked into a low skill profile. So, for the next 10 years, focus on low skilled manufacturers but at the same time focus on improving the skill endowments so that we can move up the value chain.
The second recommendation is that we need to boost the domestic consumption of durables. A lot of steps were taken by the government during the last six months when the unlocking phase started. Do you think they have given us the desired results? Also, what is your opinion on the state of consumption of durables?
There are two parts to that question. The first part is on the government’s fiscal stimulus. Over the last one year since the pandemic broke out in India, the government made some payments and expanded the MNREGA to provide livelihood support. That was more in the nature of providing support for consumption of non-durables. Millions of people have seen their incomes go down, their savings go down, their purchasing power go down. The effort and endeavour of the government was to make sure that they have enough to live by and that their livelihoods are protected and that helped the consumption of durables.
Consumption of non-durables is more a medium term effort. It is very important that as we come out of the pandemic and try to put the economy on a high growth trajectory, our prospects depend on producing non-durables and ensuring that incomes to low income people go up so that they consume non-durables. So two things are important. We must encourage production of non-durables so the production cost of investment adds to growth and jobs are generated, that incomes of the low income group people go up. These are people whose personal propensity to consume is high and they use the money, they use the high incomes to consume durables. It is a good proposition, it is something to work on both from the production and consumption side.
In the white paper there is also a mention specifically of Taiwan and how it dealt with the impact of 2008 economic recession. This pandemic gave us a technical recession. We seem to be slowly coming out of it but of course challenges are continuing. Can a voucher system work in a country like India like in Taiwan?
I am not very familiar with the Taiwan voucher system but if what Taiwan did was to give voucher to people which was specifically tailored for the production or for the consumption of durables, perhaps yes. But instead of government deciding for people what they should buy, I think it is better to give them the freedom and flexibility to decide what they want to consume.
Obviously, the first thing people want is livelihood and they want to consume food and clothing and shelter, they want to spend on that. As their incomes go up and as they generate and store some savings, they want to buy more durable goods. I am not sure if in a large economy like this given our poverty levels and our income levels, a voucher system is either necessary or sufficient. I would think that giving people higher incomes, more secure jobs and making them feel more secure about their future is sufficient for them to shift from buying non-durables to durables. They will certainly do that.
The centre had come out with the LTC voucher scheme. Do you think that was a bad idea because you are forcing people to buy a certain kind of product?
Well the LTC voucher was a different proposition altogether. You must look at it in the context of the time. The government employees had the benefit of LTC, the government wanted to stimulate the economy and stimulate consumption, therefore converting the LTC benefit into vouchers was a very innovative scheme at that time. But you cannot extrapolate what was good during the time of lockdown for a very limited section of stakeholders to the large economy at a time when there is no lockdown and no restriction on mobility. I am not sure a voucher system is the most optimal thing to do.
What do you think about the current rate cycle that we are seeing? Where do you see them heading from here and any thoughts on the inflation targeting mechanism?
This is a dilemma that the Reserve Bank confronts even in benign times. One wants to give low interest rates for borrowers in order to encourage investment. But on the other hand, you want to give high interest rates to savers to encourage savings. So where do you manage this trade off tension between the requirements of investors and the demands of the savers? That is the dilemma for all central banks. It is a dilemma for the Reserve Bank of India as well.
Coming to the context of the economic crisis triggered by the pandemic, the Reserve Bank has resorted to extraordinary easing of liquidity conditions and came out with some innovative schemes led by targeted LTROs etc. The motivation was to stimulate credit but that has not really happened because of the risk aversion in the economy for all the problems that we are familiar with. Banks are not yet willing to lend, they are risk averse. Corporates are not willing to borrow as they too are risk averse. So going forward, the Reserve Bank will certainly have to raise interest rates to manage inflation. But they will have to do it non-disruptively. It is going to be a challenge for the Reserve Bank and they have done it very well so far. I am sure that they are going to navigate the way forward very intelligently as they have done all this while.
And on inflation?
The Reserve Bank has been trying to manage the tension between support and growth and maintain combating inflation. Over the last six months, we saw growth recovering but it is still very low and the economy is still in contraction.
Paradoxically, inflation had gone above the Reserve Bank’s tolerance level of 6%. That was a very difficult challenge for the Reserve Bank but they decided to look through this inflation because they saw this as a transient phenomena and decided to maintain an easy monetary policy stance in order to support recovery which I believe was appropriate. But inflation pressures are still strong, core inflation momentum is still high and sooner rather than later, the Reserve Bank will have to get down to this task of managing inflation. For that they will have to start withdrawing liquidity and raising interest rates over a period of time in a very calibrated and non-disruptive manner.
It is very important to prepare the market for it so that there are no hiccups on the way forward. That is one of the lessons learnt from the global financial crisis, not just by the Reserve Bank of India but all the central banks around the world.
The last suggestion that is mentioned in the white paper is about strengthening public investments with a special focus on the healthcare sector. Your thoughts?
Strengthening public investment and focussing on health and education is like motherhood and apple pie. You have to do it. Increasing investment is a recipe for growth. It helps potential growth rate go up and increases the production base and improves productivity. We need public investments by way of infrastructure to crowding private investment and to expand the production base.
We need investment in education and health to improve the productivity of that investment. So the recipe for growth is expansion of the production base and improving productivity. Expanding spending on infrastructure, health and education is important and India’s spending on health and education as a proportion of GDP is low compared not just to rich countries but even compared to other emerging economies. What is important is not only to spend more but ensure that the productivity of that spending is high. Take Sri Lanka for example. They spend less than us as a proportion of GDP on education and health but their educational and health outcomes are better than us, So increase in spending is important but focus is more important.