Bank mergers will not bring the economy out of this recession: Economist Prabhat Patnaik

Shahid Tantray for The Caravan
12 September, 2019

In the budget unveiled in July, the finance minister Nirmala Sitharaman ambitiously claimed that India’s economy would hit $5 trillion by 2025. In the weeks that followed, the Central Statistics Office revealed that the gross domestic product growth rate for the April–June quarter fell to a six-year low of five percent; the Reserve Bank of India cleared a surplus transfer of Rs 1.76 lakh crore to the union government; and the government announced the merger of ten public-sector banks into four combinations. These announcements came against the backdrop of the precarious state of the Indian economy. The country is witnessing an economic slowdown that has spread from the auto sector to other segments, the unemployment rate is at a 45-year high and the tax collections from the previous fiscal year presented an estimated shortfall of Rs 1.67 lakh crore from the revenue expected by the Bharatiya Janata Party government. The going seems difficult for both Sitharaman and the Indian economy.

Kaushal Shroff, a staff writer at The Caravan, spoke to Prabhat Patnaik, an economist and former economics professor at the Jawaharlal Nehru University, to make sense of the economic crisis. Patnaik is a known critic of India’s policy on fiscal deficit—the difference between the government’s total revenue and its total expenditure. Indian economic policy prescribes a fiscal-deficit target of up to 3.3 percent of the gross domestic product, which leaves little elbow room for the government to incur large public spending. In addition to explaining his opposition to it, Patnaik explained the circumstances that led to the current state of the economy, and why the government’s response to it will be ineffective. “The BJP government does not have a way of tackling this crisis, which is going to get aggravated,” Patnaik said.

Kaushal Shroff: The GDP figures show that the economy posted a dismal five-percent growth rate for the April–June quarter. At the same time, the government made an effort to retard the impact of these figures by declaring bigbank mergers. How should we read these two announcements?
Prabhat Patnaik: If the impression is given that the bank merger is somehow going to bring the economy out of this depression or this recession, it has no basis. Bank mergers are not going to make one iota of difference to this crisis. What will bank mergers do? It will spread overheads over some large amount of business and it might reduce some transaction costs—all of which would ultimately help, at best, in reducing the unit cost for the banking services. The government is hoping that would actually enable the banks to reduce the interest rates they charge.

Now, the point is that the interest rates themselves are not very effective in increasing larger expenditure. That is because the interest rate is supposed to help primarily by enlarging the level of investment. In such a situation, where demand is not growing in the economy, even if the government brings down the interest rate, it is not going to make any difference to the level of investment in the economy. These investments are substantially interest inelastic [which means that investments do not change depending on the interest rate]. As a result, the idea that actually if you lower the interest rate, then expenditures will go up, is a flawed idea.

In the United States, for instance, they brought down the interest rates to virtually zero but nonetheless it did not have much of an impact. Interest-rate policy is always blunt anyway and in this particular situation, it is not going to help at all. As a result, the BJP government does not have a way of tackling this crisis, which is going to get aggravated.

KS: What about the slowing down of the growth rate of the Indian economy?
PP: Even when the government was claiming seven or seven-and-a-half percent growth rate, we know that the chief economic advisor [Arvind Subramanian,] who was there earlier, had said that [the growth rate] was four-and-a-half percent, which means that the growth rate figures were actually exaggerated. But if [the official figure] says four-and-a-half for a seven percent growth rate, then you can imagine that when it is down to five-percent growth rate, how much lower the actual growth rate must be. So, we are really in an extremely serious situation of developing recession.

KS: The RBI board recently cleared the surplus transfer of Rs 1.76 lakh crore to the government. How are we to look at this action? Is it the government exercising its right over the central bank?
PP: There are two questions: one is [about] the basis on which the government is taking this money. Obviously, the government—that is, the president of India—is the owner of the Reserve Bank of India. And as a result, the RBI every year gives dividend. This year, the only extra thing that has happened is that the RBI has dipped into its own reserves to make more money available to the government. Now, that is one question—the legal basis—should the RBI dip into its resources for the government?

However, the more interesting question is: is this an expansionary step? Basically, what is required now is an expansion of demand. More purchasing power must be put in the hands of the people, in which case, you will have an increase in demand. Is the government now planning to enlarge expenditures? To that, my answer is no, because when you look at the budget that had been presented and you actually look at the calculations of expected revenue, there is a shortfall of about Rs1.7 lakh crore, which is more or less matched by the money from Reserve Bank. So, the money from the Reserve Bank is only to make sure that the level of expenditure remains where it was budgeted to be, not that there is any extra expenditure being undertaken. Where it was budgeted to be is simply not enough to get the government out of the recession.

KS: How do you read the slowdown in the current economy? How do you see the BJP government making its way out of it?
PP: This slowdown, which is evident in manufacturing, is something which arises because of a shortage in demand. The shortage of demand, in turn, arises because of the fact that there has been a very serious adverse shift in income distribution against the poor—who have been demanding a whole mass of goods—and towards the rich. Any such shift is going to have a demand-depressing effect because for every rupee that is shifted to them, the rich tend to have a lower propensity to consume, a higher propensity to save and also a higher propensity to import.

So, any such income-distribution shift has a demand-depressing effect. Obviously, the shift is not of recent origin. It has been going on for some time. But I think that the demand-depressing effect had been offset partly because of the fact that our capacity to export to the international market was not seriously impaired. In other words, we continued to export to the world market, and countries like India and China did not immediately feel the pinch of slowing down of the world economy.

The second thing, of course, is the fact that we have an asset-price bubble, the stock market bubble and the real-estate bubble. These tended to offset the demand-depressing effect and the adverse income-distribution shift. Now these bubbles have collapsed and the impact of the world economy slowing down is also beginning to reflect. All these are adding together in order to create this slowdown in the Indian economy.

Against this, it is possible for the state to emulate demand, but the BJP government is not planning to do that. It is really keen on maintaining the fiscal-deficit target and it is also very keen to ensure that there is really not much taxation of the rich. Suppose you tax the poor and spend it, then there is not much increase in demand. The poor are spending much of their income anyway. But on the other hand, if you tax the rich, then precisely because they have a higher propensity to save, you actually are generating additional demand. Now, the BJP government is really not taxing the rich. I know in the budget there was some kind of suggestion [that they would tax the rich] but on the other hand, it was really quite trivial. So there is really no fiscal stimulus as far as the economy is concerned.

KS: You have earlier suggested that the BJP government could have levied inheritance tax, which would have helped the BJP government amass something to the tune of Rs 5.6 lakh crore. Are you disappointed that it never materialised?
PP: Before the budget, there was talk that they were going to have a wealth tax. I did not seriously expect them to go in for it because let’s not forget that the BJP basically relies on corporate funding. They reportedly spent Rs 27,000 crore in the last election, which is [nearly] Rs 50 crore per constituency, and that is the kind of money you cannot raise if you go for wealth taxation.

KS: India Inc seems to be obsessed with the fiscal deficit figure. It is often considered to be a sacrosanct figure not to be meddled with. Your take is a little different.
PP: I am not in favour of fiscal deficit as a means of financing government expenditure. But the reasons why I am not are very different from the reasons [in favour of a fiscal deficit] put forward by the World Bank, the International Monetary Fund, the finance ministry and the government. The reason why I am opposed to it is because it increases wealth inequality. You see, there is this wrong conception that there is a pool of savings in the economy, and the government borrows from those savingswhen it runs a fiscal deficit. But that is not correct because if you talk in terms of a year—the government is borrowing and the government is spending. Every spending on part of the government enlarges demand, enlarges output and therefore enlarges the pool of savings. Therefore, the government does not borrow from a fixed pool of savings; the government enlarges the savings, or if you like, the government actually puts in private hands what it is borrowing. That is a very elementary proposition in economics which nobody seems to understand, not even our ministers or our bureaucrats.

So, the thing is, if you have an economy in which lies unutilised capacity and unemployment, and the government borrows, then the government actually takes away from the private sector what it is putting into their hands through an enlargement of private activity. Now why I am opposed to this is: suppose the government runs a fiscal deficit of Rs 100, then it increases private wealth by Rs 100, which it then borrows. Now suppose the government taxed away this Rs 100, then there will be no reduction in the private sector’s post-tax savings. But on the other hand, there will be no increase in wealth inequality. Therefore, I am opposed to fiscal deficit as a means of financing government expenditure, in so far as it increases wealth inequality. It puts more wealth in private hands and since the poor have no wealth, it actually raises wealth inequality. I would much rather that the government had tax-financed spending rather than deficit-financed spending.

But on the other hand, deficit-financed spending in a situation of involuntary unemployment and unutilised capacity is not harmful for other reasons that are often put out by the likes of IMF, World Bank and the government. It does not give rise to what is called “crowding out,” because that assumes a fixed pool of savings. [“Crowding out” describes a scenario where private players are unable to raise funds due to an increase in government borrowing from the financial markets. The government borrowing often raises the cost of borrowing, which has a prohibitive effect on these players.] It does not give rise to inflation because you have unutilised capacity. Those kinds of arguments are invalid.

KS: The BJP government has set up really ambitious goals for itself in this budget. It wants to become a $5 trillion economy by-
PP: (Laughs) That is just hype. There is a slowing down in the economy. Unemployment is at a record high of 45 years. To talk about becoming a $5 trillion economy is like talking about a doubling agricultural income by 2022. This is all the BJP government’s hype. I mean, there is not an iota of perceptible, sustained efforts towards it. This is not seriously worked out as part of a plan that has been made public.

This interview has been edited and condensed.