Raghuram Rajan: ‘I’m Worried By the Extent of Economic Catastrophe India is Facing’

This is the transcript of the second part of the interview former Reserve Bank of India Raghuram Rajan gave Karan Thapar for The Wire on the economic challenges created by the COVID-19 pandemic and what the government needs to do to overcome them. 

The first part of the transcript has been published here.

Karan Thapar: I want very much to talk about four or five of the top reforms the government has announced during this crisis and ask you whether there are substantive and meaningful or whether they’re just red herrings but I’ll do that after the commercial break. Let me end this part by saying, I think you’ve indicated three areas where you have concerns about the government’s response for the poor, the migrants and the vulnerable for MSMEs and for big industry. If all of that has been announced up to Sunday is all that happens, what do you think will be the shape and look of the Indian economy one year from now?

Raghuram Rajan: It will be heavily constrained. It will be, you know, perhaps a shadow of its former self. Now, there will be room for expansion, as some of the entities today essentially sort of die. But that expansion will take time. It will typically be the larger firms which gain market share. And it could be at the expense of the smaller entities that don’t get help. Now, we’ve talked a lot about areas that need work. One area we haven’t talked about is the financial sector,  that too needs work, and that needed work before the coronavirus crisis – after the crisis it will need significantly more work.

KT: You are, in fact, an expert on the financial sector in particular. Quickly then, make up and remedy my lapse by telling us what do you think the government should do about the financial sector?

RR: Well, we’ve got so many moratoria. We postponed payments. This that, a lot of this will turn into NPAs. We already talk about the MSMEs, NPAs. There is a lot of bad debt around and a lot of that bad debt is owed to the banking system. Typically, the private banks this time around have been better at managing risk than the public sector banks. So there will be a lot of bad debt showing up at the doors of the public sector banks.

And that means that, one, you have to bring it down through a process of restructuring, etc, two, you have to recapitalise the public sector banks to a significant extent. But three, you have to stop the hole in the leaky bucket. You have to focus on governance improvements in the public sector banks. Let me give you one example. In the MSME lending, the RBI pointed out in 2018 that the bad public sector banks – the banks that were put under restriction by the RBI – prompt corrective action, the only place they could lend was to the MSMEs because they couldn’t make big loans. That was one of the constraints that was imposed by the RBI. They still found ways to make losses! In the first year of the MSME loans that they made, four percent of the loans turned into NPAs. That suggests the poor quality of management we have. We absolutely have to stop the leaky bucket.

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Need for agricultural reforms

KT: Dr. Rajan, let’s take a break at that point. As I said, when I come back, I want to talk to you briefly about the reforms, structural reforms in particular that the government has announced and ask you whether these are meaningful and substantive, or whether they amount to red herrings.

Let’s now come to the structural reforms the government has announced during this crisis. And as you mentioned yourself, in part one, perhaps the most significant are three, to deal with agriculture, amending the Essential Commodities Act and agricultural marketing and facilitating contract farming. But government has said that they believe that these three reforms are the agricultural equivalent of ending the license-permit Raj. Would you accept that these are as significant as that?

RR: I would. I think these are important reforms. But let’s, it’s important that they be carried out to the full extent of the intent. And unfortunately, sometimes in carrying out reforms, they get hijacked by the bureaucracy. You know, the Essential Commodities Act, for example, prevents commodities from being stored in a big way, and that prevents – that forces the farmer sometimes to sell out in a hurry and get low prices simply because nobody wants to store those commodities.

So this will be very important for the farmer. The problem, however, is there are always clauses buried in any reform, which then subvert the whole reform – the sting of the scorpion, as one bureaucrat told me, you know, everything is negotiated, and then finally, there’s one clause which subverts. In the Essential Commodities Act it will be what are the circumstances in which the Act can be brought back. And typically that means certain price rises. Well, if if that becomes too easy, if, you know, onions move around all the time, if we can invoke the Essential Commodities Act again when the price moves by a certain amount, we’ve subverted the intent of the reform. So it has to be much harder to bring it back. There has there have to be exceptional circumstances, a pandemic or something like that. Otherwise, we should let market forces do what they do and allow imports to happen or exports will happen, as the case may be, rather than intervening to manage those prices.

KT: Now Dr. Rajan the second significant reform is the decision to open up all sectors of the economy to the private sector whilst restricting the public sector to a still undefined strategic area. And associated with this is a significant amount of privatisation. I assume none of this is going to make any impact until the economy’s back on its feet. But how important a message does this send for the medium and long term?

RR: Again, I think this is an important step. I think it is important that we execute. I think, Ashok Gulati, who has been associated with the government on various committees, said 50 percent of the announcements on agriculture had actually been carried through. And that’s a low hit rate. We need to execute what we announced and quickly. We’ve talked privatisation for so long. Every budget has a huge privatisation number, and eventually we achieved some fraction of it, and often largely by selling one public sector to another public sector. That’s that’s not privatisation. And I hope this announcement indicates a willingness to have essentially mixed sectors not dominated by the public sector, but having some public sector presence in some areas. I think that’s fully appropriate for the country. We don’t need to privatise everything, but we certainly need to start getting government out of a number of entities.

Labour reform must be negotiated, not imposed

KT: Now the third set of major reforms that seem to be on the anvil are huge, if not dramatic, relaxations of labor reforms undertaken by three BJP ruled states, UP, Madhya Pradesh and Gujarat and they cover a whole range of things from hours of work, sanitary and health regulation, hire and fire and union rights. Do you see this as something that will spur investment or do you see it as a rather disturbing disregard for well established union rights?

RR: Well, I think that it is important to negotiate the process of labour reform with all parties, including labour. I think what we need to do is realise the constraints that the old laws impose both on business as well as on labour, and understand there is a win-win alternative for both, where you protect workers better in some situations, especially the contract workers, give them severance pay for years of service they’ve done, improve their working conditions, but allow for some flexibility. If the firm actually is going under because it has too many workers, it should be able to lay off a number of workers, paying appropriate severance, while keeping the rest in a job rather than taking everybody down. So this kind of negotiation is very important. I understand there’s an Industrial Relations Act in parliament and maybe it doesn’t go as far as some industrialists want, maybe it goes further than some labour want. But we need to negotiate this process. The worry is, if you just in a stroke of the pen, do away with labour protections, then what is the worker going to do if the worker is totally unprotected by the laws they will take to the streets to protect themselves. That is in no one’s interests either. Where you have strikes, violence, gheraos in an attempt to re-establish worker rights. So my sense is this is something that needs to be done in a deliberate way. We should do it as fast as we can, but we should take all parties with us.

Finally, as I understand it, these labor law dispensations are for three years. Who’s going to invest knowing that at the end of three years, it may all change again? This leads to a larger point. What business wants is certainty. We keep talking, we want FDI and we keep changing the rules all the time on FDI. But sometimes for good reason, sometimes to favour parties who complain about big foreign investors. Nobody really wants to invest in a big way if they don’t have certainty because they’re putting in money for 10, 15 years. And if they can’t even believe that the laws will stay what they are for next year or two, they have really a more moderate incentive. So my sense is, we need to clarify what this will look like for time to come rather than keep changing it. And certainly, three year limits are not particularly encouraging for investors.

Federalism means Centre should nudge states, not micromanage them

KT: Now, on Sunday, the finance minister identified three sectors which she believed to be growth sectors in the future. These are coal and mineral mining and defence production. And there’s no doubt that in all three, she’s taken substantive measures to open them up. But you know better than me that mining both coal and mineral is an area where the states have rights in terms of licenses and terms of granting permission. Is there a danger here, that if using coal and mining as growth and laying down central laws to determine its future, she’s trespassing on centre state relations and perhaps sending out the message of centralisation and diminishing federalism?

RR: Well, look, I think the Centre has to be very careful of intruding on the states as well as the federalism that has been enshrined in the constitution. That doesn’t mean it can’t play an enabling role, it can’t create model laws, it can’t nudge states towards those, but also through creating interstate competition it can encourage reluctant states to actually up their game and join in, especially for things like mining. I mean, investors are going to look to which is the state that is most welcoming and go there.

So I think the Centre can play an enabling role. But I think the issue you raise more broadly of Centre- state relationships, I think it is something that is extremely important. I think in a country of our size, decentralisation typically is a constant necessity. It’s something that every finance commission has recognised. And we need to continue on this path going forward rather than go towards more centralisation. Centre creates the framework, creates the enabling infrastructure and gives the nudges. But the states essentially, on many of these things, decide

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KT: In fact Dr. Rajan I’m holding up your new book. Here it is in my hands. The audience can see it. It’s called The Third Pillar and this issue that we’re discussing of centralisation and diminishing federalism is one of your key concerns. One of the things that everyone knows is that the fight against the virus, as much as the recovery from the lockdown, is something where the states will be in the frontline. And yet the Centre refused initially to give them an increase on their borrowing limits. And eventually, when it did so on Sunday, it’s attached four conditions. Do you believe that this is the wrong way of ensuring things like portability of rations or better handling of power distribution companies, that attaching the two together and making conditions only increases the centralisation, diminishes federalism and puts the backs up of state.

RR: So I think it is reasonable for the centre to worry about runaway deficits in states which is why those limits on states have been imposed. But to micromanage the state approach to a particular activity presumes that the Centre knows better. And to some extent, in the you know, constitutionally we believe the states on some issues are the prime mover and their freedom to act should not be constrained by the Centre.

So I think the Centre has a legitimate interest in seeing that there isn’t over borrowing. But how that is spent, to my mind, is something which is primarily the decision of the states. And apart from nudges, I think micromanaging that is something that limits the states and infringes on their rights.

Reforms matter, but India today needs economic stimulus more

KT: My last question, Dr. Rajan, you’ve been chief economic adviser after that you were governor of the RBI. You know, and understand not just the Indian economy, but also the sort of political constraints that hold up politicians taking reforms. You’ve seen it from the inside. On the principle that one should never waste a crisis, are there measures that you believe Indian politicians should implement for the good of the economy or perhaps weren’t they to do so for understandable political reasons? Now, this crisis gives them a chance to do it. Are there such measures in your mind?

RR: Well, there are, I think, easing the factor markets, labour, land, in a negotiated way, labour, land and finance would be would be very important. easing doing business would be very important. But I think that the government has its hands full even dealing with this crisis. So I would be perfectly happy if we managed this crisis well.

And, you know, we talked about a lot of things. But, one of the things we didn’t talk about this, that apart from  repel the virus, offer relief, repair the economy. We haven’t talked about recovery. And this is where we need, we will need some amount of stimulus to get the economy back on the road. And we need to start planning that. What kind of stimulus will be most appropriate?Are we going to have more infrastructure buildout? If so, how do we make that possible, so that right from day one,  when the economy starts opening up, we can build more roads, build more ports. That is something which is a no brainer in India. It is a way to re-energise the economy. How do we get the construction sector up and running? How do we get the builders who have deep problems back on track? These are things we should be thinking about now.

Even if we manage this crisis well, I think it will be par for the course. Let’s, you know, we should be thinking about reforms. I think India is overdue for a new set of reforms. Some of what has been announced will help. We need far more. But I also think we need to deal with this crisis. This is, in a sense, a nation threatening crisis. We need to tackle it now.

KT: You are leaving us on a tantalising note that we need to do more to ensure recovery, particularly in terms, as you pointed out, of the construction sector and infrastructure. Is this simply a question of more money directed at them in some sort of bailout manner? Or is it also specific schemes that need to be set up and carefully though through?

RR: We have a lot of black holes. We can’t pour more money down those black holes. We poured enough. We need to first stop the holes. We need to be clever about where we put money. We need to be clever about the form in which we put money. And often these entities that we need to put money in are already heavily indebted. We need to find ways to restructure that debt. A lot needs to be done. But if we do that, we can get the economy back on track. And remember, we’re not just repairing the problems of the coronavirus,  we’re repairing three or four years of drift in which we have gotten into a bad situation even before the virus. We need to do all that it takes to set the economy back on track. This requires the entire focus of the government.

KT: Now there’s a paradox in what you said, and I want to point it out before I end, that we’re not just repairing the damage of the coronavirus, we’re repairing the 3-4 years of drift. The problem is that drift happened under this government. And yet the repairing of the drift has to be done by the government. Do you believe they are capable of correcting the drift they allowed to happen, because they don’t even begin to believe they’ve allowed the economy to drift. They don’t even accept that.

RR: Well, they need to accept the data. They need to first make sure the data are truly presented as they are rather than, you know, data that doesn’t reflect reality. We need to get the data out. We need to understand where we truly are. And we need to do what it takes to set this economy back on track. That requires enormous work. There are lots of capable people in India. They need to be brought in to help the government. It can’t all be done by the prime minister’s office. It needs to bring a greater group of people. There are perfectly capable finance ministers, even from the BJP, who would be happy to provide the advice, bring more people in, understand the problems, set more people to work on them, and perhaps we will come through this crisis a lot stronger.

‘Don’t look at politics… We need all hands on deck’

KT: You’re saying go get the advice of people like P. Chidambaram and Yashwant Sinha, get the advice of people, even if they’re political opponents, because they are capable,  it can’t all be done by the PMO.

RR: This is a national emergency. Don’t start looking at who’s on the other side of the political aisle. We’re all in it together and therefore get their opinions. They are smart, sensible people who’ve been through something like this before.

KT: In which case, and this is definitely my last question, do you have a sense of confidence that this government can actually take the steps needed for recovery? There is so much that they need to do to first correct that attitude – correct is the euphemism –  alter or completely change that attitude. Will they do it? Politicians often in a crisis, become stubborn. Sometimes they become innovative and sometimes they become stubborn. You have any feeling that this is a government prepared to do almost a U-turn to help enable the recovery?

RR: I don’t know. I hope. I hope the leadership sees that this is necessary. I also believe that if we don’t do what is necessary going forward circumstances would force us to do it because it can get very ugly very quickly given the forces that are that we are up against.

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KT: When you say it will get very ugly very quickly, you’re suggesting that you’re very, very worried about the future of the country.

RR: I am very worried about the extent of the catastrophe we are facing. And this requires all hands on deck. We need to be working very hard to get out of this. And it is important we recognise the magnitude of the problem sooner rather than later.

KT: Dr. Rajan, thank you very much for this interview. Thank you for making time in such a full measure to explain and educate. Take care. Stay safe.

RR: Thank you.

Transcript prepared by Kabir Varadarajan Arora