Recapitalising banks only sure way to revival

India’s economic outlook begs a strange prognosis currently. While most global institutions are sanguine about the country’s economic acceleration in the medium and long term, pessimism abounds at home. The reasons are not far to seek: a number of world organisations have cut their short-term growth forecast for the Indian economy in the past few weeks.

The International Monetary Fund (IMF) and the World Bank have slashed their annual growth estimates for India; the Asian Development Bank and the Organisation for Economic Cooperation and Development (OECD), too, have done so. A few days ago, the rating agency Fitch, too, cut the growth projections. Domestically, the Reserve Bank of India has brought down its forecast as well. The government itself is yet to do so. It is expected that when the second quarter (July-September) GDP estimates come out on November 30, the official projections, too, will be lowered.

The immediate reason for all of them to cut their estimates has been the disruption caused by two big blows delivered by the government in quick succession – demonetisation and the GST. These reforms, badly handled by the Narendra Modi government, have slowed the process of India’s factories producing goods and exporters exporting goods and services.

Small and medium businesses have been feeling the pinch more than the large ones because they operate with small working capital, of which cash is the major component. These reforms are bound to cause pain for some time. The aftermath of the two reforms was not strange or unexpected. What is strange is the government’s knee-jerk reaction. There are murmurs of a stimulus package for the economy in the coming days, although there is no official confirmation yet.

A careful analysis of macroeconomic factors reveals that the weakness in the Indian economy is due to different factors that have been persistent for a few years now. For example, exports have stagnated since the last three years; industrial production has been volatile in the absence of a concrete manufacturing policy; tough rules and labour laws are chocking businesses for ages; infrastructure projects have been facing delays, raising the spectre of cost overruns; and Indian banks are laden with debt and non-performing assets.

None of these can be cured through a stimulus. Economists have, in fact, said that a stimulus will negate all the reforms that have been done so far in the last year or so. Right from the just-revived Prime Minister’s Economic Advisory Council (PMEAC) to the RBI, the IMF, the World Bank and the ADB, all have rejected the idea of a stimulus and urged the government to stay on the path of fiscal prudence.

The farm loan waivers announced by states have already started to put pressure on their fiscal status, which had already been weakened by the revival package for state-owned electricity distribution companies under the UDAY programme. They borrowed generously from the market to implement the scheme and ran into deficits. The RBI recently sounded an alarm, saying that the combined fiscal deficit of the Centre and the states has topped 6%. This gives the Centre little room for fiscal recklessness.

There is pressure on the government to bring in more reforms in land and labour laws and to improve the ease of doing business. But a big question is whether the government can do any of these when it is so close to election year. In the past, Prime Minister Narendra Modi has appeared undeterred by criticism, especially from within political circles, and has often said he will unleash tougher reforms going forward. He has even said he’s not afraid of losing elections. But will he carry through with these programmes now?

Although a little late in the day, he has revived the PM’s economic advisory council, and given the body one month to come up with solutions to the slowdown in growth and job losses. Does he have the political capital and is he still willing to take the risks to put into action their recommendations?

Meanwhile, businesses will continue to cry hoarse for a reduction in interest rates by the RBI. But that will be of no avail since the banks are not in a position to transmit the rate cuts. Instead, public sector banks need capital to boost their balance sheets. If they are strengthened through recapitalisation, they can enhance lending to businesses. That will kickstart investment and give life to stalled infrastructure projects worth thousands of crores of rupees. That, in turn, will create more jobs and boost the economy in the next 6-12 months, analysts say. Will this hopeful scenario come to pass?