In the previous instalment of this article, we had ended by saying,
No doubt the Government will come forward with another stimulus package shortly, but it is hesitating and dragging its feet. Why? We address this question below.
The second stimulus package has since been announced on May 12. While it talks of a sum of 10 per cent of GDP, it turns out to be virtually devoid of expenditure by the Government. At best there are some schemes for extending credit to different sections, which will be of little use in addressing the unprecedented depression we are now witnessing.
In order to understand the Government’s policy, let us look at three questions:
(i) Why does the Government fear increasing its expenditure even in the face of an unprecedented crisis?
(ii) What is the Government’s alternative growth strategy, since it has ruled out any significant increase in spending?
(iii) What accounts for the political confidence of the Government in embarking on a policy which has caused such upheaval and may spark mass unrest?
The Indian government’s policy of restraining expenditure is broadly in line with other underdeveloped countries worldwide. No doubt, there are some special features of the Indian government’s response, which bear the stamp of India’s present rulers: sweeping autocratic edicts, indifference to mass misery, monumental mismanagement, widespread coercion and a single-minded focus on ‘event management’ (summarised in the footnote[1]). These features greatly intensified, even multiplied, the misery and despair experienced by millions.
However, more fundamentally, the extraordinary tight-fistedness of the Government’s policy is not on account of the specific traits of India’s rulers. Rather, it flows from the Government’s anxiety to conciliate and woo foreign financial investors, who are opposed in general to increased government spending by Third World countries. This reality is bluntly stated by the most authoritative sources, as we see below.
Clear division
Before proceeding, we need to remember that global finance makes a clear division: there is a handful of powerful countries that dominate the world economy; and there are weak economies, like India’s, which account for the bulk of the world’s population. (The latter countries are no doubt rich sources of cheap sweated labour and precious resources, but through a long historical process that wealth has been devalued, and continues to be further devalued.) In the world of global finance, no one pays attention to the breathless claims that India is a rising power and imminent developed country. They simply see it as a poor and weak country, a source of rich pickings in good times, but one that can be dumped in bad times.
The currencies of powerful countries, ‘hard currencies’ (or ‘reserve currencies’), are accepted as payment between countries, i.e., world money. The leading currency is still the US dollar. The US can thus unilaterally expand the supply of dollars and make payments to others in its own currency, but in the present world order India cannot do the same
India’s rulers have long adopted a development path which hitches India’s economy to inflows of foreign capital, and this has deepened over the years. According to conventional accounting, India’s net foreign liabilities were $427 billion by December 2019. Capital that has flowed in can also flow out, particularly in the case of purely financial investments (in the stockmarket and the debt market), which are not tied down in physical assets here. If foreign financial investors decided to rapidly withdraw their investments, the stockmarket would crash (as it has done in the past), and the exchange rate of the rupee would plummet.
As a result, it is foreign investors who hold the whip hand, and can shape the policies of the Indian government. Foreign investors’ interests are ably represented by ‘credit ratings agencies’ – Moody’s, Standard and Poor, and Fitch Ratings. These agencies rate the ability of an entity to service its debts, and the chances that it will default. They assign borrowers grades, not unlike the grades schoolmasters give children in school, such as ‘AAA’ or ‘BBB+’ and so on. Not only companies, but sovereign countries too are rated in this fashion. Their access to overseas credit, and the interest rate at which they borrow, depend on the ratings assigned by these three agencies. Indeed, if a country is ‘downgraded’, not only will it find it harder to borrow, but foreign investors may withdraw their investments in the country to one extent or the other.
A “junk” rating means that there is a high chance of the borrower defaulting, and accordingly the interest rate is higher on these borrowings. Fitch and Standard & Poor both rate India one grade above a junk rating, while Moody’s Investors Service more generously rates it two grades above junk. Accordingly, a ratings downgrade would have large consequences for the present set-up of India’s economy, which is addicted to inflows of capital.
Clear warning
The present chief economic advisor to the Government has warned that countries with a credit rating similar to India’s have given small stimulus packages, and India would have to do similarly. Indeed, Fitch Ratings has already raised the alarm regarding India’s fiscal deficit in the wake of Covid-19: “The country has limited fiscal space to respond to the challenges posed by the health crisis… Further deterioration in the fiscal outlook as a result of lower growth or fiscal easing could pressure the sovereign rating in light of the limited fiscal headroom India had when it entered this crisis.”
Government officials involved in preparing the Government’s Covid-19 economic package told the news agency Reuters quite bluntly: “We have to be cautious as downgrades have started happening for some countries and rating agencies treat developed nations and emerging markets very differently…. We have already done 0.8 per cent of GDP, we might have space for another 1.5 per cent-2 per cent GDP.” (emphasis added) This statement fits very closely the actual expenditures now being announced by the Government, contrary to the grander and vaguer pronouncements about “10 per cent of GDP”.
The last three governors of India’s central bank (the Reserve Bank of India) have recently weighed in with their views. All three explicitly draw the line between the developed world and countries like India. In London’s Financial Times, ex-governor D. Subbarao sternly warns that India must restrict itself to a fixed amount of additional borrowing and plan to reverse the action once the crisis blows over:
Global markets are much less forgiving of unconventional policies by emerging market central banks. Rich countries can afford to throw the kitchen sink at the crisis [i.e., do whatever it takes] because they have the firepower and they issue debt in currencies that others crave…. emerging markets don’t have that luxury.
Ex-governor Urjit Patel warns similarly that
Hardly any emerging market economy (EME), with the possible exception of China, can match what developed countries like the US, UK and Germany, for instance, have announced. These countries have basically set out, at least in the short run, to offset, through generous direct government entitlements to large sections of the population and extraordinary central bank activism, the adverse demand shock following the primary negative supply shock of the pandemic. Countries that can issue reserve currencies have much more elbow room. EMEs, like India, obviously don’t have this luxury. (emphasis added)
What would happen if India tried to imitate the developed countries, and took substantial measures to cushion its population from shock? Foreign investors, he warns, would get “spooked”:
[I]f the fiscal and monetary responses are overdone, the likelihood of non-trivial consequences for macroeconomic stability increases…. Foreign portfolio investment in Indian equity and bonds is about US$ 300 billion. US$ 15 billion exited last month, and that is not a surprise…. . Our macroeconomic management should not be the driver to spook investors…
In a crisis, he points out, “there is a flight to safety, essentially investment in US government bonds, with home country bias also coming into play when global risks flare up. The exorbitant privilege of the US dollar not only endures, it is reinforced during crisis.”
While Raghuram Rajan spares a few more words for “spending on the needy”, he too is blunt about the limits:
Unlike the United States or Europe, which can spend 10 per cent more of GDP without fear of a ratings downgrade, we already entered this crisis with a huge fiscal deficit, and will have to spend yet more. A ratings downgrade coupled with a loss of investor confidence could lead to a plummeting exchange rate and a dramatic increase in long term interest rates in this environment, and substantial losses for our financial institutions.
Rajan proposes to give foreign investors a guarantee that any immediate increase in spending will be followed by a reduction in spending, enforced by an “independent fiscal council”. In other words, he suggests that future fiscal control be taken out of the hands of the government of the day, and put in the hands of an ‘independent’ body effectively taking its cues from foreign investors.[2]
Note that the former governors do not estimate the size of stimulus on the basis of the projected loss of GDP, and the need for Government spending in that light. They simply, and quite frankly, say that only such-and-such amount will be allowed by the credit rating agencies. In this way, they make it quite explicit that domestic economic policy is not essentially framed domestically, but abroad, without any involvement of the Indian people.
Imminent danger
The three governors cannot be faulted for saying that foreign investors may punish India for expanding its Government spending by withdrawing their capital, and that there would be a crisis as a result, given the present nature of the Indian economy. We may differ with the prescription that flows from their analysis, but not with their contention that India’s situation is perilous.
Foreign investors have already withdrawn $83 billion from what are termed “emerging” markets globally since the beginning of the crisis, the largest capital outflow ever recorded; they withdrew $16 billion from India’s “emerging” equity and debt markets in March alone – the highest ever for a single month, and the highest for any country that month.
At first glance, it seems that India should have nothing to fear from a flight of foreign investors, since it has huge foreign exchange reserves: $479.6 billion as on April 17, 2020. However, these reserves are not as impressive as they look, since they have been built not through current account surpluses (i.e., not by earning more foreign exchange than we spend), but by increasing the sum we owe foreigners – foreign debt and foreign investments. These liabilities impose a drain on the country in ‘normal’ times, yet at times of crisis do not necessarily protect the country from ruin. (One study indeed termed the foreign exchange reserves not a “shield of comfort”, but an “albatross” around the neck of India.) As we describe in an Endnote, India’s foreign exchange reserves can be rapidly depleted in case of a grave crisis. Of course, such crises are exceedingly rare, but when they take place, they can have devastating consequences if our rulers render us defenceless.
The growth model: Relying on aggressive ‘reforms’ and privatisation to arouse the animal spirits of private investors
As we have seen above, the reason for the Government’s refusal to spend is that it is keenly aware of the power of foreign investors. It tailors domestic economic policy to that reality. (There is an alternative to this surrender, as we shall see later in this article, but that alternative is ruled out in the present set-up.)
In these circumstances, the Government knows that demand is going to remain depressed, and as a result private investment would be low. Where will growth come from then? Evidently, the Government’s plans for stimulating growth are focussed on arousing the ‘animal spirits’ of private capital, by carrying out what are nowadays called ‘reforms’. That is, the corporate sector is promised higher returns by reduction of wages, subsidising land, and subsidising loans. This the real content of the Prime Minister’s special package of May 12:
In order to prove the resolve of a self-reliant India, Land, Labor, Liquidity and Laws all have been emphasized in this package.
Of course, the costs of this stimulation of the animal spirits of private capital will be borne by workers, who are to be more severely exploited and even physically endangered; peasants, whose lands are to be forcibly acquired; and all working people, as bank capital is concentrated further in the corporate sector.
The chief economic advisor spells out the growth model: “Land and labour are really factor market reforms because these are factor inputs that really affect the cost of doing business and you have seen a lot of changes on these recently at state level. Uttar Pradesh, Madhya Pradesh and Gujarat have announced fundamental labour reforms and other states are also in line to follow up…. Karnataka had just gone ahead and changed the regulation on acquisition of land for business. Land can now be directly bought from farmers in the state and other states will also imbibe the model.” The old land reform law in Karnataka prevented direct acquisition of land by private business, in order to protect peasants from force and fraud. The scrapping of this protection has been immediately welcomed by big business.
Similarly, the Finance Minister’s announcement of ‘reforms’ for agriculture were not addressed to the peasantry, but to the corporate sector, to enable it to penetrate agriculture more freely. There is not a word about public procurement at remunerative prices, which is what the peasantry have been demanding. Instead the Finance Minister has presented a plan for capitalists – processors, aggregators, large retailers, exporters – to procure directly from the peasants.
As we finalise this article comes the latest instalment of Sitharaman’s five-day marathon presentation of the economic package. The latest instalment contains no word of Government expenditure; as such it does not even pretend to stimulate demand. It is composed solely of the unbridled privatisation of everything – coal, minerals, defence production (where ‘self-reliance’ is to be achieved by raising the limit of foreign investment from 49 per cent to 74 per cent), civil aviation, power distribution, atomic energy and space.
The refusal of the rulers to spend, and the aggressive ‘reforms’ they are now embarking on, may kindle unrest and resistance by sections of the people. What then gives them the confidence to proceed on their present course?
Evidently, they have assured themselves that their physical force and ideological hegemony over the people are sufficient for them to sail through the crisis. In this, the recently exacerbated communal divisions, which always existed but have taken particularly disturbing forms in the last six years, play an important role.
The rulers do not require the support of a majority of the people to exercise effective control; it is sufficient that they have the support of a sizeable, vocal, and assertive social bloc. When properly mobilised, for example through demonstrations of support such as thali-beating and lamp-lighting, this bloc can convey a sense of overwhelming strength and instil fear in weak and disorganised opponents of their policies. The prevailing atmosphere of panic and isolation can set the stage for more ominous political changes. The rulers have tested the waters over the past few weeks, and they foresee no real obstacles to their plans.
However, in a situation of great upheaval and misery, the rulers’ confidence may be ill-judged. Conscious sections may emerge as an organised opposition to the current drive of the Government. Starting precisely from the experience of the Covid-19 crisis, they may demand a roll-back of privatisation, the nationalisation of different services addressed to people’s needs, and the addressing of a range of basic needs. If these spark a broader response among the people, developments may take a very different turn.
Unanswered question
What we have discussed above is the reasons for the rulers’ refusal to spend, and their confidence that they can sustain their rule despite an unprecedented economic crisis. The frame, as we saw, is set by the opposition of foreign investors to Government spending. The question remains: why do foreign investors oppose Government spending?
On this question the RBI governors and the present and past chief economic advisors are silent. Sometimes silences are more revealing than what is said. We turn to this question next.
[To be continued]
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ENDNOTE to Section IV
India’s Foreign Exchange Reserves: No Protection from a Sudden Flight of Foreign Capital
On the face of it, India’s foreign exchange reserves are comfortable. Indeed, in the last four months, the reserves have even risen by $35.4 billion. At present, they amount to about a normal year’s imports.
However, the danger to the foreign exchange reserves comes not from import requirements, but from capital movements – a rapid withdrawal of foreign investments and deposits.
Let us look at a few facts regarding India’s foreign exchange reserves. The latest detailed data we have are for the end of 2019.
(i) At the end of December 2019, India’s foreign exchange reserves were $459.9 billion. However, at $563.9 billion, India’s external debt was more than $100 billion larger than its reserves.
(ii) The RBI calculates a figure called ‘short term external debt by residual maturity’. This refers to external debts which are falling due within 12 months (i.e., including some debts which were long term debts when they were taken, but are falling due within a year). This figure comes to $238.3 billion at end-December 2019.
Apart from debt, India also has other external liabilities – in particular, foreign investment, both direct investment (FDI) and foreign portfolio investment (FPI). While FDI is meant to be longer-term and cannot be repatriated quickly, FPI can be withdrawn instantly. The RBI reports that by end-December 2019, FPIs had invested $148.9 billion in shares, and $117.8 billion in debt instruments. Even though this greatly understates the liability,[3] the sum comes to $266.7 billion.
Adding the above two figures – short term debt by residual maturity ($238.3 billion) and liabilities to FPIs ($266.7 billion) – we get a sum of $505 billion at end-December 2019, i.e., $45.1 billion more than the foreign exchange reserves. This indicates that, if fresh foreign loans and investment are not forthcoming, the seemingly large foreign exchange reserves can vanish over the course of the coming year.
(iii) More relevant, however, is the sum that can be withdrawn very rapidly from the country. It is this that presents a more imminent danger. This applies to two types of NRI deposits, namely, NR(E)RA and FCNR(B), totaling $116.9 billion, and FPI investment, at $266.7 billion. The sum comes to $383.6 billion. That means that foreign investors and depositors could at short notice withdraw a sum amounting to more than 83 per cent of the foreign reserves.
Exchange Reserves
Some point out correctly that this is very unlikely to happen, since it has not happened for nearly three decades.[4] However, the present situation is an unprecedented crisis, and nothing can be ruled out. In an earlier foreign exchange crisis, in 1990-91, NRI deposits were withdrawn very rapidly from the country.[5]
As for the share market, it is true that, as foreign investors sell shares, share prices would fall, and the rupee’s value would fall, thus reducing what those investors would get in hand; and so there would seem to be a sort of self-correcting mechanism preventing a flight of FPI investments. But we know from experience worldwide that in a situation of crisis, foreign investors might fear losing all, move as a herd, and accept drastically reduced prices in order to cut their losses.[6]
In sum, under extraordinary circumstances, the foreign exchange reserves are not protected from rapid draw-down. Periodic panics serve as reminders of this fact. Irrespective of whether or not a dramatic collapse actually occurs, the consciousness of this possibility conditions the Government’s responses, and ensures that it toes the line drawn by the credit rating agencies and the IMF. And it will not contemplate an alternative course, namely, blocking foreign capital movements, for reasons we will discuss later.
[1] According to a recent report, the Government delayed action on early warnings from its own top medical advisors to begin preparation for a coming Covid-19 pandemic. It imposed a sudden, sweeping virtual curfew on a nation of 1.3 billion with four hours’ notice. It did this despite specific advice in February 2020 from its advisors to refrain from a sweeping lockdown, and to instead opt for “community and civil-society led self-quarantine and self-monitoring.” The first announcement of lockdown was for 21 days, on the stated ground that this period was “extremely critical to break the infection chain of Coronavirus”; but before it expired, the lockdown was extended to 54 days. Millions of migrant workers were stranded without livelihoods or food. When they set out on foot for their villages they faced severe police action, with the Home Ministry issuing orders to restrict movement; the Haryana police ordered the fleeing workers to be jailed in stadiums and similar facilities. The press reported an appalling paucity of relief for desperate workers and their families stranded either in the cities or on the way. In the rural areas, food supply chains were disrupted without any planning. There were widespread complaints of the absence of protective gear or testing kits for frontline workers; the Government appears to have placed orders extremely late. And finally, two weeks into the lockdown, the Government’s scientist advisors reportedly complained that this period was not being used effectively for setting up the necessary public health teams and infrastructure to tackle the inevitable surge of cases when the lockdown was lifted.
[2] This is in line with what he as RBI governor did to the Government’s control of monetary policy, by handing it over to a Monetary Policy Committee.
[3] The RBI’s figure for FPI investment in shares understates the liability by putting it at ‘historical values’, i.e. it is the sum of the figures that were invested over the years. Now, the current market value of the shares bought with those figures is now multiples of the original figures. The total market value of the Indian share market at end-December 2019 was $2.15 trillion, of which FPIs owned about one-fifth, or about $427 billion. That is almost three times the figure of $148.9 billion given by the RBI.
[4] Official presentations argue that various measures – external debt/GDP, debt service ratio, number of months of imports covered by the reserves, and comparison with peer countries – show that India is
[5] Nirmal K. Chandra, “India’s Foreign Exchange Reserves: A Shield of Comfort or an Albatross?”, Economic and Political Weekly, April 5, 2008.
[6] Meanwhile, the Government may try to prop up the share market by instructing its public sector financial firms to buy shares, thus in effect reducing the losses of fleeing foreign investors as the latter dump shares. Indeed that is what happened in March 2020.
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