Official Reforms and India’s Real Economy, Pt. 2

By Sunanda Sen, guest blooger

Part two of a three-part series, a version of which was published in Economic and Political Weekly on September 21, 2019.  Find Pt. 1 here.

Pt. 2: How effective to revive the economy?

Sops as above as tax relief—to portfolio as well as corporate investors within and outside the country—while effective in temporarily stimulating the secondary stock market, may not work to reverse the tendencies for the stagnation, even in the financial sector and let alone in the real economy. Contrary to what was expected, the initial response of the stock market continued to be rather non-committal over nearly a month between August 23 and September 20 when the big tax bonanza package was announced. It is possibly too early (and nearly impossible) to project the stock market movements in future. Still more doubtful is an expected positive impact of all above policy moves on capacity creation via the market for initial primary offers (IPOs)—short of which there can be no expansion in the real economy of output, investment and employment.

The stark realities relating to the contrasts between the real and the financial economy reflect itself in the low value of the initial Primary Offers (IPOs). As is well known, the latter indicate new physical investments rather than financial transfers alone as in the transactions of shares in the secondary stock market. A revival of the stagnating real economy demands additional investments in physical terms with related expansions in jobs. Little of those are likely to be fulfilled by a boom in the secondary market of stocks and the related gains on speculative and short term investments. Also in terms of simple national accounts, capital gains or losses relating to the portfolio investors in the secondary stock markets are always treated as ‘transfers’ between parties, and as such not even considered in calculating the GDP in their first round. Possibilities, however, remain of net injections/withdrawals of real sector demand by agents who face capital gains/losses, which deviates from their underlying inclinations to further speculate in the market. However, while the proposed tax benefits will further widen the inequalities within the country, little of those may finally be channelled beyond the speculative zone of stock markets and real estates.

Additions to corporate savings, if generated, will not generate real investments unless demand for the latter is forthcoming in the market. This comes as the home truth that Keynes spelt out more than 80 years back in the context of the Great Depression of 1929-30! Sops to speculation in the market and the lenient tax breaks for super-rich as well as corporates may only help to invigorate the current spate of speculation, in stock markets (or even on real estates and commodities) further.

Official concerns as such for the public sector banks sound more than deserving, given the issues with the near bankrupt NDFCs (or shadow banks) with their easy access to the formal banking sector which generated a large part of the on-going NPAs. In our judgement, the vacuum created with shrinking banking facilities and branches and the total absence of development banks will continue to provide space to the NBFCs and their malfunctionings.

Research, as available indicates how the corporates have made use of credit from banks to meet their liabilities (as interest payments on past debt as well as payments of dividends to share-holders), replicating a typical Ponzi strategy. Simultaneously investments by corporates have switched from the real to the financial sector with offers of better earnings on financial securities. Corporates, in the process, also have often taken recourse to bankruptcy while adding further to NPAs held by banks. Finally, NPAs also resulted from the absconding and corrupt clients of banks who could run-away with their liabilities. One wonders if the change in governance as suggested by the recent mergers which aim to combine the weak banks with the stronger ones (in terms of current performance), will help in lifting the PSBs from the current mess.

Incidentally, the soft-pedalling by the RBI with four consecutive cuts in the repo rates, while signalling a nod to expansionary monetary policies, will work to lower the lending rates of banks only if there will be a pick-up of credit demand from the public. And that in turn demands more of investment/consumption demand, especially from the real (rather than the financial) sector. This is because the growth of credit supply is determined by credit demand and not the other-way round! This does not rule out possibilities of additional borrowings at the lower rates to finance speculation in financial markets, which will not help revival of the real economy.

Pt. 2 of 3.

Sunanda Sen is a former professor at the Centre for Economic Studies and Planning, Jawaharlal Nehru University.

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