India Is Just Another Vanilla Emerging Market Economy, Says JPMorgan’s Jahangir Aziz
A pushback against trade is the key driver of global distress and India is also facing it, said JPMorgan’s Jahangir Aziz.
The “game” of basing growth story on globalisation is over for emerging market economies, including India, according to JPMorgan’s Jahangir Aziz, who said that with limited global headwinds, the Indian economy is struggling to find a new driver of growth.
“We refuse to accept the fact that we (India) are just another vanilla emerging market economy that grew on the back of globalisation,” Aziz, who is the head of emerging markets economic research at the investment bank, told BloombergQuint in an interview. He said the “game is over” for emerging market economies that were “addicted to globalisation”—a model that served them well for the past 15 years.
India, like other emerging market economies, is now struggling to change its growth driver, he said. A pushback against trade is the key driver of global distress and India is also facing it, he said.
“That uncertainty has driven down significantly business sentiment and that has been the one key driver of global woes and India is just a part of that,” he said. “We need to recognize that.”
The Myth Of Domestic Demand
India believes that there is always demand in the economy but that’s not true, according to Aziz.
“In India we have been believing this for last 50 years and we continue to believe that, all our woes on growth are essentially supply-side issue, because there is always demand. Unfortunately that is not the case,” he said. In the current scenario demand side issue have been “much more dominant” in driving down growth as opposed to supply-side issue, he said.
That weakness in demand has reflected in households across India cut spending bringing down growth in the economy to its weakest pace in over six years. Sales of cars and utility vehicles have already slumped to their lowest in over two decades.
Domestic consumption doesn’t imply that it’s driven by domestic conditions, he said, adding, “that too is driven by external demand”. “To argue that there’s a separate independent domestic driver of growth, which is either consumption or investment that is independent of what is happening globally, is a bit of a stretch.”
The Policy Prescription
According to Aziz, interest rate cuts and a reduction in the cost of funding is “the right way to go,” for the Indian economy, which has been facing an economic slowdown for the past few quarters.
But the cuts have failed to trickle down to the economy. “We had almost 135 basis points rate cuts and hardly any of that has been passed on”, he said. “So, there is clearly also supply-side issue that’s halting transmission.”
Aziz continues to argue that the Indian financial system needs de-clogging — something JPMorgan has been saying since 2014-15. Unlike others, he is not opposed to the Reserve Bank of India intervening to take over bad loans of banks and non-banks. “ Reserve Bank of India, just like many other central banks, can take over the bad loans onto its balance sheet and then negotiate with corporates as part of the bankruptcy codes,” Aziz said.
On the fiscal side, according to Aziz, the government has used the available space incorrectly. “We had the space and we used that space to cut down corporate taxes, that’s the supply side solution,” said Aziz, while arguing that expecting corporate tax cuts to eventually aid demand via investment or lower prices is a long shot.
“The usual way of boosting consumption is you cut indirect taxes and you make it time bound,” said Aziz. This typically prompts households to accelerate spending and the economy gets a demand boost.
Watch the conversation here:
Here are the edited excerpts from the interview:
What have you made of the last couple of quarters of data and what it tells us about the underlying state of the Indian economy?
Growth has been relentlessly slowing, particularly if you take away agriculture and if you take away the government part of it. So, if you look at non-government, non-agricultural GDP, which is some sort of a proxy for private sector GDP, I think, we peaked somewhere in the December quarter of 2015 at somewhere around 9-9.5 percent. Since then there has been a relentless slowdown.
Clearly demonetisation and the quarters following it made it even worse. There was a pick-up after that but that trend has been there since early 2016. We can blame demonetisation, GST, we can blame the liquidity crunch facing the NBFC sector, all of the non-performing loan problems and all of those are true. I am not saying that those are not the issues that we should be looking at.
But we really need to go back and ask the question, why did the slide start somewhere in the end of 2015 and has been relentless since then?
So, then you are pointing to the fact that there is a buildup of an aggregate demand problem in the economy? Like you said various aspects have played into it, perhaps the rural sector, non-food inflation, demonetisation, GST and what it did to the informal sector. Is that the basic issue?
There are both supply-side and demand-side issues as in every other economy. Right now, the demand side issue has been much more dominant in driving down growth in India as opposed to supply-side issue.
In India, we have been believing this for the last 50 years and we continue to believe that all our woes on growth are essentially supply-side issues because there is always demand. Unfortunately, that is not the case.
We refuse to accept the fact that we are just another vanilla emerging market economy that grew on the back of globalisation, that grew on the back of the relentless increase in trade that we saw in mid-2000. And as global trade floundered and as globalisation stagnated, there is growth there but very low growth compared to what it used to be in the past. We have failed to recognise that it has been a key driver of both investment, corporate investment as well as growth.
I think that on the demand side, external demand has been a very big driver of the slowdown. But since we are not willing to accept that India is an open economy we continue to believe that there is always demand for Indian goods as long as we can produce them. And so we focus completely on supply side issues. Even now, the solutions which the government is providing essentially are supply-side solutions and, therefore, we are getting not only the diagnosis role wrong, we are getting all the solutions wrong.
So, you basically agree with the analysis that there is a structural demand problem but you differ on the reason for that problem.
We can quibble about whether something is structural or cyclical. For an emerging market economy, it is almost impossible to figure out what is structural and what is cyclical.
If you look at the work that Gita Gopinath and others have done five-six years ago, they will say that almost everything in emerging market is essentially structural, there is very little cyclicality in emerging market growth.
But setting aside the semantics, whether it is a structural problem or cyclical problem, I think the key to the analysis is whether this requires demand-side solutions, or supply-side solutions. And if it requires demand-side solutions then what it is that is troubling the Indian economy.
I would say that just like any other emerging market economy, barring perhaps China, all these emerging market economies are having the same problem. They were addicted to globalisation, they hitched their entire growth model to that bandwagon that served them extremely well for the last 10-15 years. Unfortunately, that game is over more or less. They are struggling, almost every one of them, struggling to put together the structural reforms that would turn around and change the drivers of growth. The search for the alternative engine growth, that is missing in almost every emerging market and India is not an exception. I think, that is where the problem lies.
Emerging market economies cannot continue to believe that as long as we keep our body and soul together for another year. Somehow miraculously the global growth is going to pick up, global trade is going to pick up and we will be once again back to the old days of 8-9 percent growth.
So, you are essentially saying that we shouldn’t hope for a V or U-shaped recovery? We are looking at a fairly long period of time where you have six-odd percent of growth and you must settle for that?
Let’s not get into what the numbers of growth are. We will spend the next day talking about it given the state of statistics in India. But, in terms of pace of recovery, it will be slow. Mostly because there is not any demand, globally there is not any demand.
There is some recovery taking place in emerging markets. If you look at big emerging market economies--Brazil, Mexico, South Africa, Turkey--all of them have similar problems. I think, the largest, biggest drivers of this slowdown, particularly in the last 1one and half to two years, has been the fact that we have entered the phase unseen in last 50 years, where there is a serious pushback against trade, against global trade, against a rule-based trading system that we have been used to. That has been pushed back and that uncertainty has driven down global business sentiments significantly. That has been the one key driver of the global woes and India is just part of that. We need to recognise that.
There has been a decline in global sentiment, which by the way is still declining, and alongside, there has been a commensurate decline in global capital spending. With the two of them on the decline, there is a very little chance that external demand is going to drive the pick-up in emerging markets. Emerging markets then necessarily will have to make a call. Is this temporary or is this going to happen for next four-five years because the global trade or the globalisation regime in the world has changed.
To the extent that the domestic demand component may have softened in the last five-six quarters, is the policy direction right? We had 135 basis point rate cuts and then the surprise pause suddenly. Is that monetary accommodation necessary but not sufficient?
Let’s talk about the policy response separately.
Let’s talk about investment, which is the domestic component of India’s growth. I mean not the largest component, but the largest driver of India’s growth. I would suggest that those people who talk about the domestic demand component simply draw two lines--export-to-GDP ratio, investment-to-GDP ratio and in another chart draw export-to-GDP ratio and consumption-to-GDP ratio. In the case of India, you will find that there is a little daylight between the two lines. To say that there is an independent domestic driver of growth, which is domestic consumption, is not correct. Just because it is domestic consumption doesn’t mean that it is driven by domestic conditions. That, too, is driven by external demand. So, to argue that there is a separate independent domestic driver of growth which is either consumption or investment that is independent of what is happening globally. I think, it is bit of a stretch. I think we have been wrong for last six-eight years going down that path. I think, we are still wrong. So, there isn’t really a separate domestic driver of growth.
Now to the second part of your question, should the rates be cut? Yes, rate cuts are reducing the cost of funding and it is clearly the right path to go. I was very puzzled and very surprised to why the RBI stopped but we should also take into account that we had almost 135 basis point in rate cuts and hardly any of that has been passed on to the lending rates. So, there is clearly also supply-side issue which is halting transmission.
Which is an issue which you have spoken fairly often in the past? No longer it is just the banking system, it is the non-banking system which is completely clogged. That continues to be the problem.
If we do not do the right things at the right time, you let it fester, then not only does that sector by itself--in this case it is the banking sector--start to get worse but there is contagion. The contagion spreads to non-banking sector and then to all other sectors that rely on non-bank financing. That’s exactly what happened.
We have been identifying, as you just mentioned, since at least 2014 that there is a looming problem in the banking sector. The government took its time, the Reserve Bank took its time, not only to accept that there was a problem but then to come up with the solution. The solutions like putting up the bankruptcy code etc. are all the right things to do but they also must recognise that it takes very long time for such structural reforms to start loosening or correcting the problem. The fact that it hasn’t been corrected meant that the non-bank financing of the economy also got affected by it and now we are in the mess where both the banking and the non-banking sectors are a serious problem.
The government keeps on providing the same solution, which is that we will use the bankruptcy code, put a little bit of capital there, a little bit of capital here rather than addressing the problem and saying that look this is urgent, requires immediate solutions and let’s solve the problem. It might be a dirty solution; it might be not nice and aesthetically pleasing but we need to find a look for such a solution.
A bad bank like solution.
We can try and create a bad bank outside of the banking sector or we can do what every other developing country’s central bank has been doing for last five-seven years. Now, it has become part of the banking solutions. You basically socialise the bad loans directly onto the Reserve Bank’s balance sheet.
You still think they can do that; I mean after the balance sheet review and any excess capital being passed on.
Why go into this convoluted solution of putting together a committee and then trying to get part of the capital onto the government’s balance sheet and then using that capital to recapitalise the banks.
Reserve Bank of India, just like many other central banks, can take over the bad loans onto its balance sheet and then negotiate with corporates as part of the bankruptcy code. But it is the Reserve Bank which does it with the corporates and creditors. It does it within the parameter of the bankruptcy code.
In the meantime, these banks get massive relief. In exchange for that the RBI can do what it always wanted to do, put together an actual governance system for these commercial banks which they think should work. So, rather than worrying about and keep on going back and saying, well there is a problem with governance of these state-owned banks, there is a solution. You take away the bad loans and in exchange for that you ask them to carry out the kind of internal changes that the Reserve Bank as a regulator wants them to do.
There is a little pushback against inflation targeting, which had started even before this last policy review because nominal growth had come off so much. Questions about whether we picked the wrong target and we picked the wrong level of the target. Do you agree?
After a fact, people can say a lot of things but the fact that inflation came down from where it was to where it is now, a significant drop in structural inflation, you have to give some credit, even if you do not like inflation targeting.
Inflation targeting is actually delivering you the low inflation that we all desired, which was our real big problem for 25-30 years. Now, that we have solved that we turn around and say that the problem is inflation targeting?
There is obviously the possibility that if you go and change the inflation targets, you will again un-anchor inflation expectations and you go back to the old problem that we used to have for the last 20-25 years. So, I think, it is a bit disingenuous to say that inflation targeting is the problem when inflation targeting itself contributed significantly to the drop in inflation.
A lot of the narrative has now shifted to the fiscal side. I think they had some room, they seem to have used it to cut corporate tax. Do you see any merit in the argument that you throw out the FRBM targets for a couple of years because the economy needs fiscal support?
Yes and no. I mean let’s start with the yes part of it. If you want to meet 3.3 percent target given you are running around a 1 percent of GDP deficit in net tax collections compared to your target, you will have to squeeze demand or spending by 1 percent of GDP, which will be very bad for growth.
Yes, given the fact that there is a slowdown taking place, whether it is structural or cyclical let’s keep that aside, there is a slowdown taking place. We should use what economists call the automatic stabilisers. Let the slower growth drive down tax collection. Let’s not offset that by cutting spending and let’s use the space provided by FRBM to have a higher fiscal deficit.
But what are you using that space for? If you go back and see what we did, we had the space and we used that space to cut down corporate taxes, that’s a supply-side solution. You cut down corporate tax to cut down the cost of doing business and hope that in the future that decline in the cost of doing business will start easing the supply side. But the problem is demand side, that is the dominant driver. So, yes you can use this space, yes you should use this space but you should also use the right instrument.
If the consensus view is that dominant driver of India’s growth slowdown is on the demand side then the actual instrument on the tax side to use is just cut GST by an equivalent amount. And more importantly you could have made the GST cut temporary so that in two years’ time that GST cut would once again reverse. Instead of that we did a permanent tax cut and permanently increased the fiscal deficit. And by permanently lowering the tax revenue on the hope that this supply-side easing might, in the future, and we don’t even know when in the future, actually go and boost corporate investment that’s a very tall order.
So, beyond that you don’t see any room for either a personal income tax cut or cash transfers or some such.
If you look at what are the solutions that work in these kind of emergency situations, those are typically solutions that boost consumption. The usual way of boosting consumption is you cut indirect taxes and you make it time-bound. You don’t say that consumers have infinite time to make those purchases, give a two-year window within which you get a 20-25 percent decline in the price of the goods that you are buying. If you don’t buy within that two-year period, that window is gone. So, most households are rational, and they do that.
I am going back to the same issue--is this a demand-side problem or a supply-side problem? Again, whether it is structural or cyclical is a separate issue but is it a demand- or supply-side problem? If we continue to believe that these are supply-side issues, we will be taking supply-side measures and those may be the right measures to take but they are not going to have very much of an effect in the very near term.
There are also all these intangibles around the Indian economy. There is too much of centralisation, Raghuram Rajan just wrote. There is the state of economic statistics, there are questions about whether we have ideas from the people who understand Indian economy. As someone who has watched this story for many years and decades, is it worse right now than when you were here and what you have seen before?
There are serious questions about the GDP methodology, particularly the manner in which nominal GDP is converted to real GDP.
I really don’t think that the GDP methodology, which essentially measures the nominal GDP first, is terrible wrong. If you look at the nominal GDP of India, it has been following the same track as every other economy. The problem lies in the real GDP. In the conversion of nominal GDP into the real GDP, a point that most people do not make.
The problem lies in the manner in which the deflator is calculated in India and in particular one kind of deflator. It is the service-side deflator, which we have no knowledge about and in particular financial-side deflator. If you look at these deflators, they have stark differences between what it used to be in pre-2012 era and post-2012 era. Between the two periods there is a 8-10 percentage point average drop in the price of these things. I know inflation has come down, but it is very hard to believe that financial services inflation is running 800 basis points lower than what it used to be in 2012. So, there is a problem.
When it rains it pours. The fact that all of this is happening when India’s growth is slowing down, I think is adding to the anxiety and making the problem look starker than what it is. Let’s say, for some miraculous reason we get back to 8-9 percent growth rate, I think most of these problems will still be there, but we will not talk about it.