Emerging economic challenges

Post-Covid Recovery

Now that most economies of the world have returned to positive growth after the Covid-induced recession, several challenges and opportunities are emerging for India and the world.

The immediate one is how to vaccinate the majority of the population before the virus mutates enough to render the currently available vaccines largely ineffective. At the same time, in the coming days, the vaccines need to be modified to cope with the mutated variants and new drugs developed to treat Covid patients better. Hopefully, after the mad global race to come up with vaccines has subsided, more effort and resources would be devoted by the drug companies to find effective treatments for the disease. All these open up huge opportunities for Indian pharmaceutical companies to be major suppliers of low-cost vaccines and drugs to the world.

Many countries, including India, have been running fiscal deficits, much above the customary levels, to mitigate the impacts of Covid. The deficits have been largely financed by money creation, leading to bubbles in the asset markets (shares, gold, real estate) all over the world. The rewinding of this liquidity glut has to happen soon. With the resulting downward correction in asset prices, investors in the asset markets would then be poorer. This, in turn, would induce them to cut back on their consumption and investment expenditures, which would dampen the process of economic recovery.

According to the IMF, even by the end of 2021, most economies of the world would still be operating below their pre-Covid levels of output. In these circumstances, managing the adverse impacts of reversing excessively loose fiscal and monetary policies would be a big challenge, particularly for emerging economies like India.

The ongoing global recovery will likely cause a rise in commodity prices, including the price of petro-products. For an oil import-dependent country like India, there will be predictable consequences, like a hike in inflation and worsening of the trade deficit. ‘Inflation-targeted’ monetary policy would imply a pause in policy interest rate reduction, if not a hike in interest rates. Given that the domestic prices of petrol and diesel have already reached record high levels, despite international oil prices being much below the peaks attained in 2013-14, both the central and state governments would have to go for some cuts in taxes on petrol and diesel in the coming months. Correspondingly, they will have to cut expenditures and/or raise revenue from other sources, including disinvestment of PSUs. Taking recourse to disinvestment proceeds is not a sustainable solution as the space for raising revenue from this source will shrink over time. The long-term solution lies in accelerating the pace of switching from fossil fuels to renewable energy sources, including the use of electric and hybrid cars.

The prevailing near-zero nominal interest rates in the developed world and negative real interest rate in India (repo rate below the inflation rate) has provided India a window to borrow funds at low cost to bridge its huge infrastructure deficit. India should seize this opportunity before the situation reverses. The advantage of spending on ‘hard’ (power, transport, storage, telecommunication) and ‘soft’ infrastructure (health, sanitation, education, skill formation), as opposed to consumption expenditure, is that infrastructure spending has dual benefits. On top of increasing demand through the multiplier mechanism, it removes crucial supply-side bottlenecks. Thus, it helps boost GDP growth and employment in both the short and long run.

Would the resulting rise in public debt be sustainable? It would be, if the future rate of return from the projects is higher than the interest rate at which funds are being borrowed. Hence, a proper selection of projects based on expert cost-benefit analysis and efficient project management and monitoring are crucial. It is a matter of big concern that the ratio of interest payments to tax and other revenue receipts of the central government has been steadily rising in India -- from 10% in 1950-51 to 36% in the pre-Covid year 2019-20 and to 44% in 2020-21. This alarming trend implies that an increasing fraction of government revenue is being used up to pay interest on past debt and less and less is available for maintenance and development expenditures.

The steady rise in NPAs of banks and NBFCs is another important constraint on credit growth and private investment expenditure. Privatisation of a couple of public sector banks, along with the creation of a ‘bad bank’, is being offered as a solution to these problems. It is difficult to be optimistic about this new policy package as several private sector banks in India are also suffering from bad loans advanced to favoured parties as quid pro quo by the top management of the banks. Big willful loan defaulters have been allowed by the powers that be to abscond and evade the jurisdiction of Indian courts. Eventually, for PSBs, the outstanding debts are routinely “written off” and the government recapitalises the banks using taxpayers’ money. In the case of bankrupt private sector banks, shareholders and depositors suffer the loss. Mere privatisation will not do the job. Unless the existing information, regulation and enforcement systems are synchronised and tightened, we cannot expect any significant improvements. Care should also be taken to ensure that PSB shares are sold publicly through the open market, instead of selecting favoured business houses as ‘strategic investors’ to give them back-door access to depositors’ money.

Finally, the impact of climate change cannot be ignored any more. The increasing severity and frequency of floods, wild fires, earthquakes, droughts, extremely hot and cold waves are now realities in all parts of the globe, including India. The recent Uttarakhand disaster must make us rethink carefully about the future course of many ongoing projects such as building thermal plants and tunnels in the Himalayan areas with highly fragile ecosystems. We just cannot afford to go back to business as usual.

(The writer is a former professor of Economics, IIM-Calcutta and Cornell University, USA)