Lecturer Introduction:
Raghuram Rajan, Catherine Dusack Miller Distinguished Service Professor of Finance at the University of Chicago, gave the 15th installment of the O.P. Jindal Distinguished Lectures. He served as the 23rd governor of the Reserve Bank of India from 2013 to 2016 and was chief economist of the International Monetary Fund from 2003 to 2006. His research interests include banking, corporate finance, and economic development. He has received numerous awards, including the Financial Times Goldman Sachs Prize for the Best Business Book, the Infosys Prize in the Economic Sciences, and the Deutsche Bank Prize for Financial Economics.

Lecture Overview:
Rajan’s lecture focused on the current state of India’s economy and how it arrived at this point. He promised to address potential solutions in a subsequent lecture.

False Pretenses:
Rajan jokingly admitted to using false pretenses to attract the audience, as he would only discuss the historical context of India’s economy in this lecture.

Growth Slowdown:
India’s growth rate has slowed considerably, from 7% over the last 25 years to a much lower rate today. Consumption has been relatively strong and holding up, but it has also recently started to decline. Investment has been falling steadily since the global financial crisis. Net exports were never a strong source of additional growth, and recently exports have been growing slower than GDP growth.

Fiscal Concerns:
India’s fiscal deficit to GDP is officially 7%, but this conceals a lot. Revenue projections for the coming year are very optimistic, and a recent corporate tax cut will add to the burden of the fiscal deficit. There is a lot of borrowing which is going off balance sheet and not being counted in the fiscal deficit, such as the Food Corporation of India’s borrowing.

Fiscal Deficit Understated:
National Highway Authority of India’s borrowing increased from 0.2% to 0.7% of GDP, adding 0.5 percentage points to the fiscal deficit. The finance ministry accelerates revenues and delays payments to artificially lower the fiscal deficit.

Contingent Liabilities:
Rising non-performing assets require bank recapitalization. Non-bank financial companies are in trouble and may need state support. The new Ayushman Bharat healthcare program will require more resources in the future.

JP Morgan’s Estimate:
JP Morgan estimates India’s actual fiscal deficit to be between 9% and 10% of GDP, significantly higher than official figures.

Inflation and Debt:
In the past, inflation could be used to inflate away debt, making finances appear healthier. With low inflation, this is no longer possible, leading to concerns about India’s fiscal situation.

Household Savings:
Household savings are falling, indicating potential financial distress.

Economic Challenges:
Indian households are saving less and borrowing more, leading to higher debt levels and emerging signs of distress. Corporate sector is facing stress, with the ratio of credit upgrades to downgrades at a six-year low. Slow demand, slow earnings growth, and difficulties in servicing debt are contributing to the economic slowdown.

Roots of the Problem:
Lack of significant economic reforms since 2004 has hindered economic growth. Reforms in the early 1990s and during the Vajpayee government led to strong growth, but the Vajpayee government failed to capitalize on this growth and lost re-election in 2004. The Congress-led UPA government focused on populist policies and spending rather than growth-enhancing reforms, leading to high levels of inflation and fiscal deficits. Supply bottlenecks, land acquisition difficulties, and risk aversion among bankers further contributed to the economic slowdown.

Course Correction:
The Congress government initiated fiscal consolidation to address macro stability concerns. The RBI joined efforts to bring down inflation.

Transition from UPA 2 to Modi 1:
The transition from the UPA 2 government to the Modi 1 government marked a shift in focus towards macro stability and economic reforms.

Investment and Inflation:
Investment has been plummeting since UPA II and has remained low since then. Inflation has been brought down from double-digit levels to low levels under the Modi government.

Macro, Sectoral, and Household-Focused Reforms:
The Modi government implemented reforms on the macro side, sectoral side, and to some extent on the household and populist side. The mixed bag of reforms has not been able to revive investment. Many promoters who started projects in the past are now highly stressed with high levels of debt and cannot start new projects. Banks are not interested in lending to these promoters. Stalled projects have been increasing and have not been brought down significantly.

Promoters’ Interest and Inflation:
Promoters have lost interest in stalled projects. Both the UPA and NDA governments gave the RPI a free hand to bring down inflation, which has been a success.

Challenges in the Indian Banking Sector:
Stalled projects and rising bad loans (NPAs) in public sector banks. Banks’ tendency to hide or push bad loans under the carpet to maintain profitability in the short term. Evergreening, or continuously providing new loans to keep afloat struggling projects instead of restructuring them.

RBI’s Asset Quality Review:
The RBI forced banks to recognize their bad loans, leading to a surge in NPAs. Banks were encouraged to work on these loans and find solutions with the promoters. Bank recapitalization efforts were initiated to provide banks with sufficient capital for new lending.

Insolvency and Bankruptcy Act:
The Insolvency and Bankruptcy Act was passed to address the difficulty in recovering money from borrowers. It initially instilled fear in borrowers and forced them to repay their loans. However, promoters have found ways to circumvent the law, and the judiciary’s involvement has made the process longer and more costly.

Public Sector Banks’ Troubles:
Public sector banks faced problems due to rising bad loans. Their lending slowed down significantly, affecting credit availability in the economy.

Reforms and Challenges:
The RBI undertook various reforms, such as opening up branching, licensing, and improving retail electronic payments. The Universal Payment Interface (UPI) was introduced as a state-of-the-art payment system for retail payments. Despite these reforms, the challenge of addressing bad loans and strengthening the financial sector remained.

Public Sector Banks and Non-Bank Financial Companies:
Post-financial crisis, public sector banks increased lending, but later faced trouble with loans and reduced lending. Non-bank financial companies also increased lending, but faced issues due to developer loans and ILFS’s implosion in 2018.

Legacy Problems and Demonetization:
Legacy issues, stuck projects, and slow clean-up of banks persist. Demonetization in 2018 caused disruptions in the informal sector and sectors dealing with cash, especially real estate.

Impact of Demonetization:
Demonetization led to a growth setback of 2-3% of GDP for a few quarters or 2-3% of GDP annually. Measuring the impact on the informal sector is difficult, but anecdotal evidence suggests many businesses suffered. Sectors reliant on cash, such as real estate, faced further challenges due to demonetization. Demonetization also affected employment, with unemployment rising significantly afterward.

Demonetization and Goods and Services Tax (GST):
Demonetization was poorly planned and executed, leading to short-term economic pain without achieving its aims of reducing black money or increasing electronic payments. GST was a sound concept but was also poorly implemented, causing disruptions due to unprepared computer systems and frequent changes in rates.

Agriculture:
Some reforms have been made, such as crop insurance and direct benefit transfers for fertilizers. However, agriculture remains a challenge, with low productivity, agricultural stress, and periodic loan waivers benefitting richer farmers. There is a need for increased investment in agricultural extension, seed provision, and technology upgradation. Reducing fragmentation of agricultural holdings and eliminating middlemen are also crucial to improve farmers’ income.

Power:
India has the potential to generate sufficient power to meet the needs of its population. However, distribution companies between consumers and producers often face issues such as transmission and distribution losses, leading to unreliable power supply.

Infrastructure:
Infrastructure development has seen some progress, with investments in roads, airports, and railways. However, challenges remain in terms of land acquisition, environmental clearances, and coordination between different stakeholders.

Conclusion:
While India has made some progress in implementing economic reforms, challenges persist in various sectors. The government needs to address these challenges to achieve sustainable and inclusive economic growth.

The Power Sector:
Distribution companies in India face financial challenges, leading to inefficiencies and losses. Restructuring these companies has been attempted multiple times, but they continue to struggle due to inadequate revenue and high levels of electricity theft. Despite the country’s large unutilized generation capacity, providing 24-7 power to consumers remains a challenge. India’s power consumption has grown significantly, but this growth is primarily driven by new states gaining access to electricity rather than increased consumption in industrial states.

Banking Sector Reforms:
Efforts have been made to improve governance in public sector banks, which have faced issues due to bad loans and politicization. The Bank Board Bureau was created to recommend appointments in public sector banks, but it lacks independence and its recommendations are subject to political influence. Public sector bank boards have limited power in decision-making, including appointing chief executives and taking significant actions. Overpayment at the bottom and underpayment at the top in public sector firms, including banks, hinder the attraction of talented individuals to leadership positions.

Overview:
Raghuram Rajan, a renowned economist, presents his perspectives on the Modi government’s economic policies, focusing on sectors like banking, trade, and investment. He highlights issues, concerns, and successes while suggesting areas for improvement.

Banking Sector:
Rajan emphasizes the need for capable people in public sector banks and criticizes the recent consolidation of banks, claiming it diverts attention from necessary governance reforms. He expresses concern about the government’s mandates on banks, such as lending to small and medium companies, which often result in poor loan quality and delayed cleanups. The introduction of loan melas is questioned for its hasty loan approvals, leading to concerns about credit assessment and potential pressure on banks.

Trade and Investment:
Rajan highlights the importance of increasing the ease of doing business to promote trade and investment. He criticizes the focus on World Bank indicators rather than addressing actual conditions that hinder business operations in India. Fluctuating tariffs and taxes, especially in certain sectors, are seen as obstacles for businesses and hinder India’s integration into global supply chains. The recent corporate tax cut is welcomed, but stability in rules, regulations, and taxes is emphasized as crucial for attracting foreign investment.

Successes and Challenges:
Rajan acknowledges successes in assembling cell phones in India, leading to reduced imports and increased exports. However, he emphasizes that this is primarily assembly-based, and the country needs to move towards value-added manufacturing. He points out India’s slow progress in capturing the textile market despite China’s withdrawal, suggesting that logistical, infrastructural, and manpower issues hinder export competitiveness.

People-Oriented Schemes:
Rajan praises the government’s initiatives like Jam, Aadhaar, and mobile phones, which have facilitated direct benefit transfers for pensions, subsidies, and scholarships, improving people’s lives. He also acknowledges the progress in building toilets under the Swachh Bharat program, although concerns remain about the functionality of these toilets. Initiatives like providing cooking gas connections for the poor are seen as beneficial in reducing the health risks associated with burning wood.

Conclusion:
Rajan provides a comprehensive assessment of the Modi government’s economic policies, highlighting areas of concern and suggesting improvements. He emphasizes the importance of governance reforms in public sector banks, ease of doing business, and stable regulations to attract investment. While acknowledging some successes, he also points out challenges in export competitiveness and the need to move beyond assembly-based manufacturing.

Analysis of India’s Economic Reforms:
Raghuram Rajan acknowledges the positive impacts of the government’s subsidies, direct benefit transfers, and healthcare initiatives. He emphasizes the need for rigorous evaluation of these programs to ensure their effectiveness and address issues like unused accounts or unutilized toilets. Rajan also discusses accusations of fraud, such as private hospitals allegedly submitting false claims under the healthcare program.

Reasons for India’s Economic Slowdown:
Rajan argues that external factors like the global economy, oil prices, or trade are not the primary causes of India’s slowdown. He identifies two main reasons: lack of investment and significant reforms, particularly since the global financial crisis. The sequence of demonetization and the implementation of the goods and service tax acted as a straw that broke the Indian economy’s back.

Impact of Demonetization and Goods and Services Tax:
Demonetization led to a substantial fall in growth, followed by a rebound. The introduction of the goods and services tax, combined with the NBFC crisis, compounded the slowdown.

Concerns Regarding Growth Measurement:
Rajan mentions Arvind Subramanian’s critique, which questions the accuracy of India’s growth measurement. Subramanian argues that growth may be mismeasured, as investment, credit, exports, and imports have declined while GDP has not. Subramanian also highlights the fall in central government’s direct tax collections, indicating a broader economic slowdown.

Conclusion:
India needs to focus on enhancing growth and addressing the challenges of investment, reforms, and the impact of demonetization and the goods and services tax. Rajan emphasizes the importance of addressing these issues before considering Arvind Subramanian’s critique of growth measurement.

Diagnosis of India’s Economic Malaise:
India is experiencing a deep malaise, characterized by low growth, widening fiscal deficit, rising debt, and widespread distress. The malaise is not recent but has been afflicting the economy since the global financial crisis of 2008. The two main engines of growth, investment, and exports, have collapsed post-global financial crisis. Consumption, the third engine of growth, also declined and only briefly perked up in 2016-17 and 2017-18 due to a credit bubble fueled by Non-Banking Financial Companies (NBFCs).

Explanation of the Malaise:
Raghuram Rajan posits that India is losing its economic way due to the centralization of power without a clear economic vision. Arvind Subramaniam disagrees with this explanation, arguing that the malaise is rooted in the twin balance sheet challenge. The twin balance sheet challenge refers to the over-indebtedness of firms and the stressed balance sheets of banks, resulting from excessive investment during the boom period. This has led to low corporate profits, reluctance to invest, and a jammed financial system.

Implications and Conclusion:
The twin balance sheet challenge is a complex issue that requires careful attention and policy interventions. Subramaniam emphasizes the need for a comprehensive understanding of the malaise and its underlying causes to develop effective solutions.

Recognition:
The government, RBI, and Raghu recognize stressed balance sheets as a challenge, but may underestimate its severity. The asset quality review in 2015-2016 helped bring transparency to the banking system, but stress estimates were still below reality. Recognition of the problem has been delayed, leading to renewed uncertainty about the extent of non-bank company issues and their impact on public sector banks.

Resolution:
The five Rs (recognition, resolution, recapitalization, regulation, and reform) are necessary to solve the problem of stressed balance sheets. Resolution of bad loans is essential for companies to clean up their balance sheets, invest, and for banks to take necessary hits and recapitalize.

Recapitalization:
Recapitalization of banks is crucial to strengthen their financial position and enable them to absorb losses.

Regulation:
Effective regulation is needed to prevent the recurrence of stressed balance sheets and ensure sound banking practices.

Reforms:
Reforms are necessary to change the way banks operate and prevent future problems, particularly in public sector banks in India.

Need for Another Asset Quality Review:
Given the current uncertainty, another asset quality review is urgently needed for both banks and non-bank financial companies (NBFCs).

Inadequate Regulation and Weak Resolution:
The quality of regulation in India’s financial system has been seriously inadequate, both by the RBI and the government. Major problems and scandals, such as the ILFS crisis, have gone unrecognized and unresolved for a long time. The Insolvency and Bankruptcy Code (IBC) has not been fully successful in resolving stressed assets, leading to a reassessment of its effectiveness.

Limited Reforms and Twin Balance Sheet Challenge:
While some reforms have been implemented, many public sector banks continue to thrive, and banks under closed supervision have been revived. The financial system has been kept alive through recapitalization and weakening of regulatory standards, such as NBFC lending. The twin balance sheet challenge has evolved into a twin plus twin balance sheet challenge, with non-bank finance companies and real estate companies also facing stress. Rising NPAs and intensification of corporate stress continue to be major concerns.

Subramanian Law of Non-Recognition and Bottlenecks:
The Subramanian law of non-recognition suggests that the actual stress in the financial system is always higher than what is officially recognized. Investment and growth cannot durably revive without addressing the financial system challenge. The failure to crack the financial system issue has resulted in a cycle of bad lending, problematic financing, and limited reforms. This persistent twin balance sheet challenge remains a significant bottleneck for the Indian economy going forward.

Vision and Implementation:
The speaker disagrees with the claim that there is a lack of vision in the Modi government. He points to the household welfare programs, GST, IBC, demonetization, and corporate tax reform as examples of the government’s vision. He acknowledges that there may be problems with implementation, but argues that the government is learning and improving.

Alternative Vision:
The speaker challenges the argument that the alternative vision of land reform, labor reform, ease of doing business, state capacity improvement, etc. is better. He points out that these reforms have been talked about for 40 years but have not been implemented. He questions why these reforms are suddenly seen as binding constraints when India experienced gangbuster growth without them between 2002 and 2011.

State Capacity:
The speaker argues that the question should not be why state capacity is poor in India, but why it is good in some areas and weak in others. He points to the successful rollout of GST, Aadhaar, and MGNREGA as examples of strong state capacity.

Agriculture and Cooperative Federalism:
The speaker agrees that agriculture is a huge problem in India but notes that it is a shared responsibility between the center and the states. He emphasizes the need for cooperative federalism, as seen in the successful implementation of GST, to address such issues.

Under-diagnosis:
The speaker concludes by suggesting that the problem with the Modi government may not be a lack of vision but rather an under-diagnosis of the challenges facing India.

Challenges in Data Credibility and Implications for Reform:
Discrepancies in various economic indicators, including GDP, employment, and fiscal data, have led to questions of credibility. This lack of credible data has impacted the urgency for economic reforms in areas such as GDP, employment, fiscal policies, and the banking system. The quality of assets in the banking system is a particular concern, highlighting the need for comprehensive reviews and actions to address issues.

Skepticism about Governance Reform in Public Sector Banks:
The speaker expresses skepticism about the effectiveness of governance reforms in public sector banks, citing the challenges of stigmatized capitalism and the presence of skeletons. The regulatory and government institutions face limitations in addressing these issues, resulting in decision-making paralysis and hindering private investment.

The 4C Problem and Decision-Making Paralysis:
The speaker introduces the 4C problem, referring to the hyperactive nature of investigative institutions such as CBI, courts, CVC, and CAG in India. This leads to decision-making paralysis in public sector agencies, including banks, due to the fear of investigations and consequences. The speaker questions whether it is possible to crack this problem and facilitate the revival of private investment.

India’s Narrative about Growth and the Need for a Realistic Assessment:
India has a cognitive benchmark of high growth based on its performance in the 2000s, leading to complacency and the expectation of sustained high growth. The speaker suggests that the 2000s might have been an aberration, and India may need to adjust to a more realistic growth trajectory. The speaker emphasizes the importance of understanding whether the exceptional growth of the 2000s was normal or an aberration, as this has implications for policymaking and expectations.

The Model for Government Behavior and Policymaking:
The speaker raises the question of what model we have for understanding how governments behave and make policy decisions. Different models, such as focusing on low inflation or pursuing reforms and growth, lead to different policy approaches. The speaker suggests that a deeper understanding of political models and their impact on policymaking is necessary, especially in the context of recent developments in India.

Financial System Issues as Symptoms of Broader Problems:
Raghuram Rajan emphasizes that problems in the financial system are symptoms of issues elsewhere in the economy, such as profitability and infrastructure. He cautions against blaming the financial system alone for economic challenges and highlights the need to address underlying factors. Rajan stresses the importance of understanding why India is not growing as fast as it did before the financial crisis, suggesting that blaming external factors is insufficient. He encourages a focus on creating conditions for growth, rather than solely focusing on financial sector problems.

Trade and GDP:
The share of trade in India’s GDP has declined from 40% to 33%, similar to the global trend. In India, the combined percentage of goods and non-factors in GDP is around 45%.

Modi Government’s Vision:
Raghuram Rajan questions the coherence of the Modi government’s broader economic vision.

Demonetization:
Rajan considers demonetization as lacking a clear and beneficial vision, especially given its negative consequences.

GST Implementation:
While the BJP successfully passed the GST legislation, its implementation faced challenges. Rajan emphasizes the need for better planning and execution to avoid such issues.

Bankruptcy Code:
The bankruptcy code was a long-discussed idea finally implemented by the NDA government.

Incoherent Economic Policies:
Rajan points out the inconsistency in the government’s economic approach. He highlights the simultaneous push for exports while implementing measures like increased tariffs, hindering the creation of an export-led economy.

Raghuram Rajan’s Viewpoint:
Rajan emphasizes the need for a coherent approach when empowering bureaucrats with decision-making authority while simultaneously filing cases against previous government bureaucrats for decisions made in the ordinary course of business. He questions the lack of a clear vision and asks for an explanation of the government’s actions.

Arvind Subramanian’s Perspective:
Subramanian acknowledges the lack of independent assessment but mentions some studies indicating a sizable impact of demonetization on the informal sector. He cites the Gita Gopinath study, which suggests a surprisingly small and brief impact of demonetization on GDP. Subramanian expresses puzzlement over the absence of more significant impacts on economic indicators despite the large informal workforce affected by demonetization.

Raghuram Rajan’s Counterargument:
Rajan points to a steep fall in GDP growth in the quarters following demonetization, questioning the attribution of this decline to factors other than demonetization.

Arvind Subramanian’s Response:
Subramanian suggests that the annual GDP growth rate data may not fully capture the impact of demonetization on the informal sector. He highlights the Geeta Gopinath study as a rigorous analysis and expresses surprise at the small annual GDP impact despite the significant informal sector disruption.

Identification of Economic Trends:
The economic growth in India reached its lowest point in 2015-16, followed by a recovery in 2016-17 and 2017-18. The growth peaked in the summer of 2017, coinciding with the first quarter of the Indian calendar year.

Impact of Demonetization:
Demonetization, implemented in the second quarter of 2016-17, caused a significant decline in economic growth. However, the impact of demonetization was partially masked by a surge in credit provided by the non-bank finance sector (NBFC) during the same period.

Control for NBFC Credit Surge:
Geeta Gopinath’s analysis attempted to control for the impact of the NBFC credit surge, but the identification strategy remains debatable.

Economic Policy Concerns:
Raghuram Rajan raised concerns about the lack of a comprehensive discussion and planning process for economic policies in India. He highlighted the need to consider the broader implications of policy decisions, such as corporate tax cuts and demonetization, within the context of ongoing reforms.

Demonetization and GST as Political Strategy:
Rajiv Vora believes that economics drives elections, but religious nationalism is also a significant factor. Raghuram Rajan suggests that demonetization was popular because it was seen as targeting wealthy tax evaders. However, the implementation of demonetization caused significant hardship for the general public, especially the poor. The ruling regime has shown no regret for the negative consequences of demonetization, as it has continued to win elections.

Demonetization and GST’s Economic Impact:
Demonetization and GST both negatively impacted the same population, leading to a double burden on businesses and individuals. GST was designed well, but its implementation was affected by the preceding demonetization.

Sustaining Political Stability:
The current political model is based on low inflation and welfare policies, which helps maintain political stability. However, it is unclear whether this approach can lead to sustained economic growth.

Sustainability of New Welfarism:
A new welfarism policy in India cannot be sustained without a significant increase in tax revenue. Debt levels are rising due to the new welfarism policy.

Short-Term Sustainability:
The new welfarism policy can be sustained for a short period of time, such as one or two election cycles. This is possible by influencing the narrative and keeping the economy booming.

Long-Term Unsustainability:
In the long run, the new welfarism policy is unsustainable without a significant increase in tax revenue. Off-balance sheet spending and a positive narrative may help sustain the policy for a while, but eventually, it will become unsustainable.

Coherence and Patience:
It is unclear whether the people of India have the coherence and patience to sustain the new welfarism policy in the long term.

Example of IT Boom:
The IT sector in India boomed because it was a new sector, providing an example of how a new sector can drive economic growth.

Political Constraints:
Land acquisition reform is a third rail in India, susceptible to protests. The Modi government attempted to reform the Land Acquisition Act but backed off due to political backlash.

Challenges of Land Acquisition:
The current Land Acquisition Act makes it difficult to acquire land for infrastructure projects. Landowners may not receive the highest possible price for their land due to political influence.

Solutions:
Sharing land revenues and developing land to give people back a portion of the developed land are potential solutions. The government needs to invest political capital to find solutions that balance the interests of developers and the poor.

Coherence in Policies:
There is a lack of coherence and vision in India’s economic policies, leading to inconsistent and impulsive decision-making. The government needs to have a clear understanding of how its policies fit together and prioritize the allocation of political capital.

Examples of Incoherence:
The government’s handling of agriculture policy, with fluctuating export taxes and tariffs, creates uncertainty for farmers. The government’s interventions in trade policy, without a clear process or rationale, discourage businesses from investing and expanding.

Corporate Tax Reform:
The recent corporate tax reform was driven by political pressure and a need to show action. The idea of corporate tax reform had been rejected in the past due to political considerations.

Conclusion:
India’s economic policies lack coherence and vision, leading to inconsistent and impulsive decision-making. The government needs to invest political capital in finding solutions to land acquisition reform and other challenges, while also ensuring a coherent and strategic approach to economic policy.