BQ Exclusive: Fixing India’s Financial Sector A Top Priority, Says IMF’s Gita Gopinath

We have projected that the global economy will go from 3 percent growth in 2019 to 3.4 percent in 2020 but that recovery is not coming from the core economies. So, our prediction was that China continues to slow and Japan continues to slow. The recovery will come from emerging markets, particularly from stressed emerging markets like Turkey and Argentina. Also, economies like Brazil and Mexico and even India have been fairly weak in 2019. Relatively they will look better in 2020, is what we expect.

The risks, of course, depend on how the global environment shapes up in terms of trade policy. We are seeing some welcome signs, some positive signs on the U.S.-China trade front but it will depend upon the details. We also have to worry about whether there can be an escalation of tensions on other fronts; on the technology front or trade with other countries. So those downside risks remain and there are still geo-political risks. Also, the recoveries that we are projecting in emerging markets may not come about as soon as we think. So those, I think, are the concerns for us.

A fair amount of monetary stimulus was put in the system in 2019. Pretty much all the central banks in the world cut interest rates and in a fairly coordinated fashion. Given that the monetary policy works with lags, we would expect to see the effects coming in 2020. So, its unclear at this point whether there will be further rate cuts. I think what certainly has been conveyed by all the major central banks is that they stand ready to do more if that is needed.

What we are seeing right now is some signs of stabilisation. We were concerned with what was happening with manufacturing and global trade in 2019. Manufacturing slowed very sharply but we are seeing some bottoming out now. So, the question is whether there is a bottoming out and if there is some recovery. Given that the services sector continues to hold up, maybe we are entering into a somewhat steadier phase as opposed to 2019. But again, the downside risks remain and it is important that those don’t materialise.

The services sectors are holding up fairly well. In a country like Germany, which depends much more on manufacturing than the U.S. does, you do see some weakness in the services sector that starts showing up but that is tentative. But what we are seeing right now is that if you look at the sources of slowdown in manufacturing, besides the trade front, there has been the weakness in the auto sector and there was a downturn in the technology cycle.

Now those two sectors seem to have bottomed out and may see some recovery.

We are calling for a balanced approach. The policy response so far has relied heavily on monetary policy. That has been the only game in town. But that cannot be the only game in town.

Now that said, obviously there are constraints (even in fiscal policy). There are countries that have the space. Germany does and Netherlands does. These economies have the space to do more fiscal stimulus. But there are countries where that space does not exist. So, I think our primary advise would be to not make policy mistakes and to provide a certain global environment so we can see a recovery in investment and that helps in holding up consumption and services. I think that is very important.

We are tracking all aspects of it. One of the lessons we learned from the global financial crisis was to pay very close attention to financial conditions. On the plus side, the regulated banking sector in many of these major economies, particularly in the U.S., seems to be in a fairly safe space. The concern, of course, is in markets where we don’t have regulations, which is the corporate debt market, for instance.

So, we are calling for more macro-prudential policies to be used in this low interest rate environment and for markets where macro-prudential policies don’t exist, we are calling for more action to be taken on that front.

There is a good reason why monetary policy has kept interest rates low — it is important for the economy. But one has to be very careful about the financial risks that come with it.

I would say that there are many idiosyncratic factors that are hitting different emerging markets in different parts of the world.

Now, there are some countries like China which were hit directly by the trade tensions and then there were other emerging markets that also felt the spill-over from that. If you look at different regions in Latin America or if you look at India, there have been other local issues.

If you look at Hong Kong, we did see an impact from the U.S.-China tensions but there was also the civil strife at home. So, we are seeing country-specific factors that hurt emerging economies in 2019.

The developed world is fighting more of a structural slowdown. They have to deal with two important factors, which is age and demographics and low productivity growth. What that means is, if you look at the projections going forward for advanced economies as a whole, we expect them to slow more over time.

Now, the U.S. is in a pretty strong position, relatively speaking, with very low unemployment rates. It has had a fair amount of monetary stimulus and fiscal stimulus. As that winds down, we should see some slowdown. For the emerging markets, I think what’s a big plus are the fairly easy financial market conditions that have persisted. EMs are receiving portfolio flows, there is no stress on the financial flows and that is important to keep in mind. Second, there are some emerging markets that depend heavily on commodity prices. The weakness in global demand has kept commodity prices low . Of course, the outlook depends on geo-political tensions and what happens there.

More generally, the developed world, if it stays the way it is and there is no big downside that comes around from the Euro area and financial conditions remain easy, will have a positive spill-over on the emerging economies.

Yes, I mean if you want a significant impact on your potential growth, it will come from home-grown domestic structural reforms.

We have certainly seen inflation having come down over the decade. This is a reflection, partly, of successful inflation targeting in many parts of the world. Not just in the advanced economies but also emerging markets. In the past, it used to be that if your currency depreciates, you will see a very high pass-through to inflation. That pass-through has come down. So that is a welcome sign. I think there is better insulation for domestic inflation from external shocks. So that is welcome.

In India of course, food inflation is high at this point. So, there can be weather-related events that lead prices to move around. I think it is very much the case that central banks have to ensure the inflation expectations remain anchored and that’s in both directions. So it should neither be that people expect inflation to go up nor that they expect inflation to go down, but that they expect it to stay closer to the target. That is something major central banks are working hard towards.

We had put out a projection of 6.1 percent growth for 2019-20 and then we had 7 percent for 2020-21. Our expectation was that the third and fourth quarters of 2019-20 would start seeing a recovery in India.

Now if you look at the most recent high frequency indicators, we’ve seen those suggest that the weakness continues. So, given this data, we will come up with new numbers in January. We are very likely going to see a significant downward revision in growth projections for India.

The financing side has been a major factor. This is not new to some extent because we’ve had the issue of non-performing assets and distressed corporate balance sheets for a while now. If anything, policies have been undertaken to alleviate these negative effects.

What we have seen recently is that there has been greater distress in the financial sector. There has also been an increase in risk aversion on the banking side. There is less appetite to take risks on lending, so you are seeing much lesser pass through of monetary policy rate cuts into lending rates in the financial system. So those are the important factors.

Second thing that is pretty striking is the change in business sentiment that held up fairly well until the last couple of months. You certainly see from the RBI surveys that business sentiment has seen a dip. So that’s another factor.

I think these factors, including what is happening with the real income growth, these factors have compounded and led to greater weakness in the Indian economy. It is the basic overall weakness in private sector demand in India that is hurting the economy and a lot of growth coming through right now is coming from government spending.

It has. But this is not unexpected. I mean, if you look at the experience of countries around the world, that had to deal with these kinds of non-performing asset issues, it takes many years. It is usually 5-6 years to resolve. So, it is not surprising that this is the case even in India.

I think that there are still things that can be done. There is the Insolvency and Bankruptcy Code, there is a National Company Law Tribunal, resolving these kinds of issues but it’s taking much longer. The resolution is taking more time than stipulated by the law which means there are capacity constraints.

A few things need to be clarified about who can be the bidders in these auctions. So, there are pieces that still need to be fixed to make it work more smoothly, that is one. But the second thing we are concerned about is that this is not just a stock problem. It has to be the case that whatever lending is being done right now, whatever allocation is being done right now, is actually of the good kind and not being allocated in a way that there is going to be a repeat of this non-performing asset problem in the future.

So, there has to be serious governance reform. I think financial sector reforms have to be one of the top priorities of this government.

There is a fair amount of stimulus in the economy right now through monetary policy. I think the problem is the pass-through of that monetary stimulus to the economy. So, the question is, what are the issues that are clogging up transmission? That’s why I said that financial sector reforms have to be a priority.

Secondly, I think there is an issue of regulatory uncertainty. There are real problems in the rural income growth so those also have to be fixed to be able to generate the demand.

On the fiscal side, the government did the recent corporate tax cut which has the benefit of lining-up India’s corporate tax rate with its peers and that is positive. That will have a positive effect going forward but at the same time no new sources of revenue were announced. So, it’s a difficult spot to be in, fiscally, at this point and the question is, if that much more space is available? I think it is difficult.

We all agree that having good data is essential for good policy-making. India has made strides to improve data collection but like every other emerging market in a developing economy, there are going to be things that are not great. So, in terms of data coverage or in terms of the kind of deflators that you use, there are issues across the board.

There has this been this national consumption expenditure survey that is supposed to be in place. That is hugely important. That has been announced and I think it is very important if it is actually implemented. There is a new periodic labour force survey, which is needed for providing more data and more information. So, it is never perfect, but I think it has to be viewed as important — that this is important information. Best practices have to be adopted and there has to be considered efforts to make sure that the government gets the right data.