India's Formalisation Of Business Is Ill-Timed, Says Raghuram Rajan
Former Reserve Bank of India governor Raghuram Rajan has said that increased formalisation of India's economy, while preferable, is coming at a challenging time as informal business activity continues to reel under the impact of Covid-19.
"Formalisation broadly is a good thing if you allow the informal sector an easy way to become formal. But if the informal sector survives because of its informality, and as soon as they start paying the taxes, et cetera, they simply cannot survive," Rajan told editor-in-chief of Quintillion Media Pvt., Raghav Bahl, in an interview. "Then what you've done is you've forced them to formalise at the worst time."
Longer term this makes sense, but forcing them to formalise when the whole economy is being hit, is basically they close down.Raghuram Rajan, Former Governor, Reserve Bank of India
While large businesses have weathered the pandemic and accompanying lockdowns better and have gained market share the full extent of the impact on small businesses is not yet discernible due to loan moratoriums etc. Eventually, the weakness in the informal sector will start to show up in the demand for the formal sector, Rajan pointed out.
You can talk a lot about the formal corporate sector but it's the rest that is also needed in order to supply the demand for that formal corporate sector. That's not going to come back easily.Raghuram Rajan, Former Governor, Reserve Bank of India
Debt Overhang And Credit Assistance
It's only when the economy fully reopens that the financial stress on small and medium enterprises will be visible. Rajan urged speedy debt resolution for SME using quasi-judicial approaches.
"Not the formal debt tribunals, but more informal negotiating structures. You set up many of these," he said "Maybe under a retired judge, they can come together and very quickly settle what is reasonable and go away with the imprint of a quasi-judicial structure on it. Because there's going to be a lot of debt overhang once we actually require these firms to pay, which currently they’re not doing."
He emphasised on the need to focus on SME debt restructuring as well as easier credit terms to get back on their feet. "Try and push towards easing credit flows to these once the debt restructuring happens because clearly in an attempt to come back, they need a lot of credit flows."
That, he said, will also help them ease into the formal economy without much pain.
Risk From Higher Protectionism
The pandemic has nudged economies towards protectionism and forced them to look inwards and safeguard their domestic interests. India itself has seen a major push by Prime Minister Narendra Modi with his call to turn India into a self-reliant or atmanirbhar manufacturing powerhouse.
However, Rajan thinks protectionists tendencies are a slippery slope for developing countries right now. "I would say that given the weakness of demand, this is the worst time for us to push protectionism," he said. "We need external demand, we need to service the rest of the world and the more protectionist we are, it hurts us."
Taking the example of import tariffs, Rajan said that any such protectionists policies will only end up making India's exports less competitive.
"If I start taxing imports, put tariffs on steel, put tariffs on aluminium, I can't export cars and I become cost uncompetitive," he said. "So, it's extremely important to keep that notion in mind because we need exports as a big factor in our growth going forward."
It also doesn't mean that India should kill its Atmanirbhar Bharat programme, Rajan said. The country needs cleverer ways of selling its goods and services to the world and that can be done if it sees Atmanirbhar as a policy beyond just manufacturing, he said.
"We want to export services and if there's one thing the pandemic has told us—services can be done at a distance. So why don't we start pushing our strength in high quality services, which we already occupy a place in, but much more widely," he said. "I'm not saying don't focus on manufacturing but focus on everything else also."
Here are edited excerpts from the conversation...
What we are seeing in India is a much larger formalisation of the economy. Corporate profits have gone up dramatically, but the informal sector is in pain. On a normal day, formalisation is a good thing. But in an abnormal situation, how good is it? And is there need to calibrate that?
Raghuram Rajan: You hit on a very important issue. If you look at the stock market in India, people would ask, what pandemic? There’s nothing. The reality is that that’s the tip of the iceberg and it is a very well-to-do tip of the iceberg. If you look at upper-skills services, many people have been able to work from home, their incomes are assured, there’s really no problem there. That is the formal tip and that is the consultants, the lawyers, the investment bankers and so on; that is very healthy right now.
But the problem lies with what lies beneath the tip and so many people in the informal sector have had very precarious jobs and lockdowns have hurt them, their ability to work. You can see loans, gold loans go up. Gold loans going up as a is a concern because our households don't part with their gold until they are in dire straits. You see these consumption services, consumption has fallen you see, food and that's another worry. If you look at unemployment basically from 39.5% of the workforce being employed we've gone down to 36.5%. The employment to population ratio has fallen by 3%. That's a huge number if you think of the number of people involved. It is many millions, so this is something we have to pay attention to because you can see that this in longer term, this will affect demand.
What you're seeing initially is the higher-level discretion demand has still stayed firm. Four-wheeler demand for cars, look like two-wheeler demand that has not been as healthy, look at the bottom of the rank two-wheelers the kind of stuff that entry level people buy that's fallen tremendously. That is suggesting inequality within the country has increased.
Formalisation, broadly, is a good thing if you allow the informal sector an easy way to become formal but if the informal sector survives because of its informality and as soon as they start paying the taxes etc., they simply cannot survive. Then what you've done is you’ve forced them to formalise at the worst time. Yes, longer time longer term this makes sense but forcing them to formalise when the whole economy is being hit, is basically the close down.
The extent of damage in the SMEs—I mean we've had a whole bunch of moratoriums we simply do not know when we reopen we will find the true extent of damage how many of these can pay, how many can sit on machinery and land which they simply cannot use because they have no access to working capital. So, we need to think more carefully about what’s underneath the tip of the iceberg and focus on what that needs to come back when the economy comes back.
Now, don’t be deceived by rebound. You go down a lot, you are going to rebound. Just because people come back to the office, come back to work etc., that rebound looks spectacular because we went down spectacularly it looks like this year we are going to grow 10%, wonderful when did we ever grow 10%? But we went down eight and-a-half-percent or 9% last year or 7% according to the official statistics. So, the question is going forward are we going to go get back to that 6-6.5% growth? What do we need to do that?
If you've got a large segment of the population without jobs dipping into poverty, with their kids are not learning, that's not a recipe for strong growth. You can talk a lot about the formal corporate sector but it's the rest that is also needed in order to supply the demand for that formal corporate sector. That's not going to come back easily.
There is a need today to protect the informal sector, maybe as a temporary measure. So, what kind of safety nets should be created now?
I would do a two-prong thing. One, make it easier for the informal to become formal that's the reform we've been talking about so long, doing business reforms. Now, this is a little bit of a sham because doing business, we sort of target the World Bank's assessment of these things which means what the World Bank wants to hear, rather than the true ease of doing business on the ground.
What I would say is, if we can really ease doing business on the ground, that would be a huge positive for our informal sector, making it easy for them to become formal, and perhaps one can think of ways in which the costs of doing business ramp up as you become much more formal, and they lower initially, without the kind of—if you make it too abrupt then people want to stay small forever below 10 employees for example because the costs of formalisation were much higher. You don't want to do that, but maybe some benefits as you start small and some positive benefits as you grow larger would be a good thing. That requires rethinking of our regulatory structures somewhat.
The second is, many of these entities have borrowed. Some of them have benefited from the government loans and guarantees to SMEs, but I think we need to think about the level of indebtedness of the sector and try and find ways that we can have easy ways for them to renegotiate the debts with the landlords. Not the formal debt from tribunal, but more informal negotiating structures that you set up many of these so that with maybe a retired judge, they can come together they can very quickly settle what is reasonable and go away with the imprint of a quasi-judicial structure on it because there's going to be a lot of debt overhang once we actually require these firms to pay, which currently they’re not.
I would say, focus on debt restructuring as much as possible and try and push towards easing credit flows to these once the debt restructuring happens because clearly in an attempt to come back, they need a lot of credit flows. So all that will be useful, work on both sides, both helping the informal but help them also become more formal in an easier way.
Another pandemic-related economic phenomenon is the increasing footprint of protectionism across the globe, including India. Is this a good thing? Or do you think it is something temporary that will revert once the pandemic eases out?
I would clump protectionism with also internal competition. These are two facets, both of which lead to greater competition. Now I would say that one of the consequences of the pandemic what you just said is the former larger corporations have in fact grown bigger. In India we also have a problem of competition we have a few business houses which dominate relative to the rest and have gotten bigger over the course of the last many years. So, we have to be careful about that also. I'm not saying every big house is a problem, but I am saying that too little competition is a problem and where there is too little competition, too close access to the government, the ability to change laws and rules according to what you think is best for your business, I think that becomes a problem for the country.
We have to be very careful both on domestic competition—our Competition Commission has to be much stronger and more effective than it has been. I think for a while it was getting stronger but now, to my mind, it has to look in its past and figure out what it has done wrong because simply it is not working as advertised.
The second, I think, is this external competition what you're talking about as protectionism and they work together because the big internal people also see, let me keep the big external people out so that I don't have to face them domestically and that creates even less of a competitive environment within the country. I think we need to be careful about that. I would say that given the weakness of demand in developing countries, in emerging markets going forward because of the consequences of the pandemic, this is the worst time for us to push protectionism.
We need external demand, we need to service the rest of the world and the more protectionist we are first, it hurts us, we do know that a tax on imports is a tax on exports, that's what economists keep saying. The public needs to realise that. Every time I increase the cost of the imports to the stuff I export it makes my export so much less competitive. Therefore, if I start taxing imports—tax steel, put tariffs on steel, put tariffs on aluminium I can't export cars and I become cost uncompetitive.
It's extremely important keep that notion in mind because we need exports as a big factor in our growth going forward. This is a wrong time to kill it but also I would say, we need to be much more clever, we keep thinking that the way to export aatmanirbhar is all about manufacturing, be like China. I mean, that reflects a lack of what I would say, creativity, we have other strengths.
Why don't we think about exploiting those other strengths? We have doctors who speak English, telemedicine took off during the pandemic, can we find a way to offer telemedicine around the world without exporting our doctors? Let's keep our doctors domestically, but maybe they can have value added work and don't need to emigrate, they can stay in India and we can have many more doctors as a result. What does that require? That requires negotiating with the West. How do we get our doctors licensed there so that they can practice telemedicine? How do we get organisations? How do we store medical data, do we store it there or do we store it here? How can we make you trust that we will protect your medical data? This requires a lot more thinking, if we want to export services but if there's one thing the pandemic has told us—services can be done at a distance.
So why don't we start pushing our strength in English, our strength in high quality services, which we already occupy a place in, but much more widely? That requires thinking, a new, not the old way yes, we're going to provide incentives for people to set up manufacturing but let's think of other ways also. I'm not saying don't focus on manufacturing but focus on everything else also.
Watch | Raghuram Rajan's full conversation with Raghav Bahl.