India can grow at 10% but import substitution policy could hurt that, Arvind Panagariya says

Arvind Panagariya backs Modi govt’s decision to not go in for fiscal expansionary policy, says funds will be needed for demand stimulus and bank recapitalisation.

Columbia University professor and former NITI Aayog vice-chairman Arvind Panagariya | Photo: Twitter | @APanagariya

New Delhi: The Indian economy has the potential to grow at 10 per cent annually for two decades once the Covid-19 pandemic ends, but a policy of import substitution could shave off 2 percentage points from this growth rate, said Arvind Panagariya, professor at Columbia University and former vice-chairman of government think-tank NITI Aayog.

Speaking to ThePrint’s Editor-in-chief Shekhar Gupta at a virtual Off The Cuff conversation, Panagariya said though reformist impulses have returned in the tenure of the Narendra Modi government, on the trade front, import substitution will adversely impact the Indian economy. Import substitution refers to the practice of encouraging domestic production of certain goods by levying custom duties on their imports.

“Reformist impulses as a whole have come back. The second UPA government was the five-year period in which the reformist impulses had completely gone away. A lot of the reforms that have been pending are now happening. But on the trade side, we have gone back. Import substitution has returned but in a different form, but harmful nevertheless,” he said. “We have gone down the wrong road on import substitution. It could shave off 2 percentage points off our GDP growth rate annually.”

Weak financial sector

Panagariya said the Indian economy will take time to recover from the coronavirus pandemic as it will be constrained by a weak financial sector.

“India went into Covid-19 with a very weak financial sector and a very weak economy. Post-Covid economic recovery is also very much impacted by that fact,” he said.

Weakness in financial markets led to growth dipping to 4.2 per cent in 2019-20, even lower than the figure registered in the last two years of the UPA regime, Panagariya added.

The economist added that the government was right to not go in for a massive fiscal expansion in its economic package announced a few months ago, pointing out that it may not have had the desired effect.

“If supply is fixed, a massive expansionary fiscal policy would not have paid off. It would have added to price rise. It is a good thing that India did not go overboard initially. When the recovery begins to happen, we will need some stimulus,” he said, adding that the time for a demand stimulus may be when inventories start piling up.

Panagariya added that India will have to either print money or borrow to meet its funding requirements, and will need a serious fiscal consolidation plan.

“India will not be able to spend leisurely in the years that will follow. Debt-to-GDP ratio will end up at least 90 per cent of GDP, or slightly higher. That is a lot of debt for a developing country. You have to service the debt. Interest payments will eat up the budget for the following years,” he warned.

Recapitalisation of banks

Panagariya also mentioned that a substantial chunk of government funds will need to be used for the recapitalisation of banks.

“Much more resources will be needed to recapitalise banks due to rising NPAs (non-performing assets or bad loans). NPAs may rise to 14 per cent… Part of the revival of the economy will depend on banks being able to give money to borrowers for fresh investments,” he said.

He stressed the need to privatise state-run banks, saying it is one of three measures the Modi government needs to take, along with trade liberalisation and labour market reforms.

Urjit Patel wanted clean-up of banks, not Raghuram Rajan 

Panagariya revealed the government and the Reserve Bank of India were not keen to clean up NPAs in the banking sector in 2015, and the actual process started only in 2017.

“We didn’t start cleaning up the NPAs until 2017. The new RBI governor Urjit Patel was keen to solve the problem, as opposed to his predecessor (Raghuram Rajan),” he said.

He added that credit growth had completely collapsed, especially for public sector banks, which prompted the RBI and the finance ministry to work to clean the books of banks using the Insolvency and Bankruptcy Code.

India right in not joining RCEP

Panagariya said India took the right decision to not join the Regional Comprehensive Economic Partnership (RCEP) agreement, as China could have used trade as a weapon against it.

“It is not inconceivable that China could use trade as a weapon against us. I support the government’s decision to not join RCEP,” he said.

But he also pointed out that the government should not be placing restrictions on Chinese imports.

“It is fine if Indians want to boycott Chinese goods. But the government should not be placing restrictions,” he said. “If we can’t produce Ganesha statues at a lower cost than the Chinese, shouldn’t we ask ourselves if there is something wrong with our production methods?”

Panagariya also said none of the domestic electronic manufacturers are likely to become export powerhouses, as they can’t compete globally.

He also dismissed the argument that the Rashtriya Swayamsevak Sangh, the ideological parent of the ruling Bharatiya Janata Party, is influencing the economic thinking of the government.

“I am sceptical of the RSS influencing economic policy in this administration. In my three years in the government, no one asked me to meet a single RSS functionary,” he informed.