Thursday, May 28, 2020

Coronavirus Lockdown XVIII: Why India urgently needs SOPs for decision-making

For a republic at work since 1947, decisions on issues of national importance without prior consultation with experts, opposition parties, state governments and other stakeholders are not only inconceivable but come with consequences that could be easily avoided

twitter-logo Prasanna Mohanty        Last Updated: May 28, 2020  | 18:48 IST
Coronavirus Lockdown XVIII: Why India urgently needs SOPs for decision-making
India is undergoing an unprecedented crisis but its highest decision-making body, the Parliament, and important stakeholders like the opposition parties, are missing from the scene

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May 25 marked the resumption of domestic flights after a lockdown of two months. But the day was also marked by chaos at airports with more than 80 flights getting cancelled and hundreds of passengers stranded.
This was a direct fallout of Civil Aviation Minister Hardeep Singh Puri's decision to open domestic flights without consulting states or giving them adequate time to prepare (for screening, transportation and quarantine). In fact, several states like Maharashtra, Tamil Nadu and West Bengal had flatly refused to allow such flights. Maharashtra chief minister Uddhav Thackeray revealed that states had not been consulted on the matter.
Unmindful of the ground realities, however, Puri tweeted on May 25: "Indians soar in the skies again".
When Puri declared the resumption of flights on May 22, he had said there would be no requirement for 14-day quarantine for passengers. Two days later, on May 24, the Union Health Ministry issued a notification that ended with a note: "NOTE: States can also develop their own protocol with regards to quarantine and isolation as per their assessment".
The states went into an overdrive to put in place the required mechanisms.
Something similar had happened earlier in the month when train services were started to ferry migrant workers. Inadequate time to prepare had forced several states, including Bihar and West Bengal, to either cancel or delay several trains.
This last-minute panic reaction from states and people getting stranded for no fault of theirs has become a recurring feature of decision making in India. The continued plight of migrant workers, walking or cycling hundreds and thousands of kilometres with kids, pregnant women and loads on their heads even while train services resumed after nearly 50 days of lockdown, reflects the other extremes of the decision-making process: too slow to react, half-hearted measures and lack of empathy to human suffering and pain.
For a republic at work since 1947, that is, for 73 years in the running, this is inconceivable, and painfully so.
Decisions without clarity of purpose  
These are not the only problems with decision-making.
One of the first decisions taken by the current dispensation was to dismantle the Planning Commission in 2014, dismissing it as a Soviet-era relic making five-year plans for central and state governments. Five years later, the Prime Minister was asking the central government ministries to "prepare a five-year plan".
Niti Aayog came in as a think tank to replace it but has been more active in areas outside its domain or competence. For example, it withheld 2011-12 GDP back series data for nearly four years (from January 2015 to November 2018) by insisting on lowering the growth numbers for the UPA years (read: What's the problem with re-basing India's growth calculations).
More recently, it claimed that the COVID-19 cases would reach zero on May 16 - the day India actually registered the highest number of cases (until then), numbering 4,987, then apologised but made another questionable claim: the lockdown had averted 14-29 lakh infections and saved 37,000-78,000 lives at a time when the effectiveness of lockdown was being seriously questioned.
On May 25, India recorded 6,977 new cases, taking the total COVID-19 cases to 138,845.
Last week, Niti Aayog advised state chief secretaries to "accelerate" the process of setting up private medical colleges (in PPP mode) by using viability gap funding (VGF) of 30% that the central government had announced for social sectors in the 2020 budget.
This is rather strange when private healthcare has spectacularly failed to rise to the occasion and public healthcare is taking the maximum burden. The day (May 22) Niti Aayog issued this advisory, the Maharashtra government took control of over 80% of private hospital beds and capped charges for treatment of COVID-19 and other illnesses.
Niti Aayog has been vigorously promoting private healthcare and its plans include handing over government-run district hospitals to private medical colleges to be set up in the PPP mode with cheap government land (read: Coronavirus Lockdown XI: Why India's health policy needs course correction).
Decisions with little relevance to current crisis
While announcing economic stimulus packages of Rs 21 lakh crore to meet the current challenges, the central government announced several reform proposals, the relevance of which are not clear.
The May 16 package talked about 'structural reforms' for privatisation of coal and other mining activities, defence production, aviation, power distribution, atomic energy and space research such as "planetary exploration". Has any assessment been made about the strategic or security implications of such wide-ranging changes? Also, how would these projects help in the current crisis?
The May 18 package talked about agricultural reforms that included (i) amending the Essential Commodities Act (ECA) of 1955 to impose stock limits only in exceptional circumstances like national calamities, famine with surge in prices (ii) providing adequate choices for farmers to sell their produce, free inter-state trade and e-trading and (iii) facilitating farmers to engage with processors, large retailers, exporters etc.
In reality, all of this exists now.
Limits on stockpiling and trade are imposed in exceptional circumstances. Most farmers freely trade and engage with food processors, large and small traders and retailers. The Shanta Kumar Committee report of 2015 had pointed out that only 6% of farmers directly gained from the government's procurement operations. If such a situation has helped farmers in raising their income is highly debatable.
What does the government intend? Dismantle the Agricultural Produce Market Committee (APMC)-run mandis through which procurement happens? These mandis were set up to prevent exploitation of farmers. They have their own problems, like cartelisation of mandi operators and dominance of commission agents, called 'arhatias' in Punjab and Haryana. Just throwing out the mandis would mean dismantling procurement too. What will happen to the public distribution system (PDS) and minimum support price (MSP) to provide remunerative price to farmers? How secure will that make farmers or food security?
Besides, the APMC-mandis are run by state governments and can't be dismantled with a mere statement. The online trading (e-NAM) of agricultural produce that circumvents state boundaries is an old project that has made little difference to farmers' fortune.
So, the central government's privatisation or reform projects are more for the headlines than anything else.
Decisions with questionable objectives and little preparations
The twin economic shocks that unquestionably derailed India's growth story before the pandemic hit were the demonetisation of 2016 and the Goods and Services Tax (GST) of 2017.
The demonetisation caused incalculable damage to India's informal economy, the full extent of which was never studied by the government. This decision was even after the then RBI governor Raghuram Rajan advised against it, as he revealed later. That the government was not clear about its objectives, public justifications or utterances notwithstanding, was clear when it repeatedly shifted the goalposts from fighting black money and terrorism to cashless economy and bringing down real estate prices.
Once it became clear that the move had caused immense pain to people queuing up outside banks for months and millions of daily wagers, farmers and small businesses who lost their livelihoods, the decision was not rescinded.
A few months later came the GST, damaging the economy further by its poor design and lack of groundwork. Three years down the line, it is still a work-in-progress. The businesses are at liberty to file monthly details or submit vouchers; input credit claims are refunded on the basis of summary declarations without verification and they are not even required to provide GST details in their tax audit reports yet (read: Coronavirus Lockdown XII: Why the wealthy should be taxed more).
The 2019 decision to cut corporate tax to the tune of Rs 1.45 lakh crore in the middle of a slowdown is another decision the objective of which is not clear. The move was strange, to say the least, since there was enough official data in public domain then to show that the industry had cut down production and capacity utilisation because of falling demand and hence, there was a little gain from such a move.  
Decisions without recognising the problems or involving other stakeholders
India also suffers from not recognising its problems.
Before the pandemic, India's unemployment rate had hit a 45-year high as the Periodic Labour Force Survey (PLFS) of 2017-18 showed. But this problem went unacknowledged. Similar was the case with the economic slowdown. As a result, there was no remedial measure from the government either.
The COVID-19 pandemic has worsened both but the approach remains unchanged. An examination of the Rs 21 lakh crore economic stimulus package would show that only a small fraction of it, Rs 1.5-2 lakh crore, is set aside for actual fiscal spending essential to address unemployment and slowdown problems.
There is another reason to worry.
India is undergoing an unprecedented crisis but its highest decision-making body, the Parliament, and important stakeholders like the opposition parties, are missing from the scene. In contrast, the US Congress has met repeatedly to deliberate, devise and clear multiple packages to battle the coronavirus pandemic's aftereffects. The difference between the stimulus packages is too glaring to be missed.
Not just that, there is little role of experts. Several investigative reports have established how experts, including a Task Force set up to devise strategies to handle the COVID-19 pandemic, were either not consulted or ignored, severely compromising the response.
Going forward
Making the right decisions is no rocket science. Institutions do it by keeping things simple: identify the problems, take the help of experts, consult stakeholders, make plans and strategies, prepare and then go ahead. Once a decision is made and enforced, carry out a periodic review and take corrective measures.
But all this seems really a tall order for India.
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Coronavirus Lockdown XVII: The economics behind India's Rs 21 lakh crore package

The package is completely aligned to self-professed agenda of the IMF of limiting fiscal spending, relying on liquidity and credit to households, privatising government-run companies and more deregulations for private enterprises. This agenda has brought immense grief to a large number of countries to be comforting

twitter-logo Prasanna Mohanty        Last Updated: May 27, 2020  | 19:40 IST
Coronavirus Lockdown XVII: The economics behind India's Rs 21 lakh crore package
The need of the hour is to take stock of ground realities, think afresh policies and priorities that better suit India's interest

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By now it is clear that a very small fraction of India's Rs 21 lakh crore economic package to fight the COVID-21 impact - 7-9% of the package or 0.75-1% of its GDP - is the fiscal component, the rest being liquidity measures.
In designing its economic package, India ignored repeated suggestions from top economists to increase fiscal spending and provide cash support to the poor. Instead, it chose to outsource the job to banks and financial institutions which would be helming the collateral-free loans, credit guarantee schemes and new funds (liquidity measures) being proposed.
The moot question is why did the government choose a fiscal austerity path?
What economics are at play here?
Fiscal austerity: Limiting fiscal deficit and public debt
Fiscal austerity is a key principle of neoliberal economics (called orthodox, conservative, or ultra-right) that gained currency since 1970s.
Multilateral lending agencies like the World Bank and International Monetary Fund (IMF) have been imposing it on countries seeking bailouts, and in the case of European Union (EU), it is a binding condition under the Maastricht Treaty of 1992 that created the union.
There are two critical components to austerity: (i) limiting fiscal deficit to 3% of GDP and (ii) limiting public or government debt-to-GDP to 60% of GDP of a country.
For India, the IMF has mandated a fiscal deficit limit of 3% for decades. Its 2017 "Fiscal Rules at a Glance" does not mention any public or government debt-to-GDP limit for India, though such limits are prescribed for many countries. There is, of course, an 'escape clause' for the fiscal deficit limit for 'exceptional circumstances' which allowed India to reset its fiscal deficit target at 3.5% for FY21. The IMF rulebook says it has been setting fiscal limits for 96 countries since 1985.
But the IMF is not a solo player. There are international rating agencies too which play in tandem. Upsetting rating agencies mean risks to foreign investment inflow. One such rating agency, Fitch Ratings, issued a virtual warning to India on April 27, saying that its debt-to-GDP ratio is likely to be 77% in FY21, up from 70% in FY20. It reminded India that it had affirmed 'BBB-' in December 2019 when at 70% its debt-to-GDP ratio was more than the 'BBB' median of 42%.
The IMF may not have set a borrowing limit for India, but the Indian government follows the IMF regime and hence while allowing states to expand their borrowing limits from 3% to 5% of their state gross domestic product (SGDP) as part of the economic package, it set four conditions or reforms for doing so, just like the IMF. These reform conditions are: universalisation of one-nation-one-ration-card, improvement in ease of doing business, power distribution reforms, and reforms in urban local body revenues.
Do fiscal numbers work?
Do these numbers (3% for fiscal deficit and 60% for debt-to-GDP ratio) work?
Economics professor and a well-regarded authority on the subject Mariana Mazzucato of the University College London (UCL) says no, they don't. In fact, she is unambiguous in her view: "These numbers are taken out of thin air, supported by neither theory nor practice" (in her 2018 book 'The Value of Everything: Making and Taking in the Global Economy' (page 235). Nevertheless, she points out how the 'troika' of the IMF, European Central Bank, and European Commission have been pushing countries to adhere to these numbers and penalising them for violations (page 234).
She gives the example of Greece and Italy to drive home her point. Between 2010 and 2017 Greece received a bailout on the condition of cutting government expenditure but such cuts turned its recession into a full-blown depression because the problem was too structural to be solved by a simple austerity measure. "Rather than decreasing Greece's debt, the lack of growth (due to lack of fiscal spending) has caused the debt/GDP ratio to rise to 179 per cent. The cure is killing the patient", she commented.
In the case of Italy, for two decades its budget deficit had rarely exceeded 3% yet it had a high and rising debt-to-GDP ratio of 133% in 2015, a year when its GDP grew by 1% after three successive years of austerity. Why? She explains that a part of the reason was inadequate investment that raised GDP, such as vocational training, new technologies, and R&D. To make matters worse, prolonged squeeze on fiscal spending weakened demand and lowered incentive to investment.
As for debts, she writes, a 2010 article in the American Economic Review by two economics professors Carmen Reinhart and Kenneth Rogoff claimed that when the size of government debt rises over 90% (much above 60% set by multilateral lending agencies) economic growth falls. This finding found support and guided policymaking in both the UK and the US.
But in 2013, when a Ph.D. student at the University of Massachusetts Thomas Herndon tried, he couldn't replicate the finding. The student found a simple spreadsheet error and inconsistencies in the countries and data cited. The professors wrote articles defending their general results while accepting the spreadsheet error.
She gives many examples with data to support her contention that these numbers don't work. There is more to economics than these 'magical numbers'.
In 2016, the IMF also admitted that fiscal austerity is self-defeating.
Its three top economists carried out a multi-country study 'Neo-liberalism: Oversold?' in which they concluded: "However, in practice, the episodes of fiscal consolidation have been followed, on average, drops rather than by expansion in output."
Earlier this month, Nobel laureate Joseph Stiglitz told the US that "the true danger is austerity..." while suggesting measures to reviving its economy.
He explained that lower government spending would constrain GDP growth and cause a higher debt-to-GDP ratio, contrary to what fiscal austerity seeks to achieve. In 2014, he had said "austerity has failed" while writing on the Eurozone's political economy.
Why a smaller or limited government
Fiscal austerity is a part of the IMF's agenda which seeks to limit the role of government.
Top three IMF economists explained neoliberal economics in 'Neoliberalism: Oversold?'
They write that "the neoliberal agenda" is based on two main planks: (i) the first is increasing competition, achieved through deregulation and the opening up domestic markets, including financial markets, to foreign competition and (ii) second one is a smaller role for the state, achieved through privatisation and limits on fiscal deficits and debt.
A strong push for limiting the role of government came in 1980s from multilateral agencies like the IMF Prof. Mazzucato calls it "backlash against government" and writes that in part it was driven by the notion that economies should worry more about 'government failure' emerging from 'Public Choice' theory associated with American economist James McGill Buchanan.
Buchanan was awarded the Nobel for economics in 1986 when Ronald Regan was the President. Regan and Margaret Thatcher of the UK pioneered the neoliberal political economy.
She says there were two major consequences of the public choice theory: (i) a wave of privatisation through sale of government assets and outsourcing, first in the UK and then the US new sets of regulatory bodies between state and market players (ii) rise of private finance initiative (PFI) to fund public activity, like building hospitals (like India's PPP model) and outsourcing to private providers to run a wide range of services.
The lesser-known aspects of limiting government
In 2017 came shocking revelations about the life's work of Buchanan.
Nancy McLean, professor of history and public policy at Duke University, North Carolina, accessed private papers of Buchanan after his death in 2013 and wrote 'Democracy in Chains: The Deep History of the Radical Right's Stealth Plan for America'.
She reveals the dark side of the US's radical right movements that sought to undermine the state in which Buchanan played the backroom-boy role. These included movements to dismantle and privatise social security, public healthcare, and education, tax cuts for the wealthy, and weakened environmental protections, etc. Buchanan also played a key role in designing the disastrous economic policies of Chile's military dictator Augusto Pinochet (1973 to 1990) which ruined the country's economy and people.
Revelations include training academics, lawyers and others and setting up institutions to push corporate interests with the objectives of altering power relations, weakening pro-public forces, government, constitution and democracy, in collaboration with powerful businesses.
It now makes sense when Prof. Mazzucato starts one of her chapters with this extraordinary observation: "Economics emerged as a discipline in large parts to assert the productive primacy of the private sector". ('The Value of Everything', page 239)
Privatisation of government-run companies
Two of India's economic packages (May 16 and 17) specifically talk of privatisation and ease of doing business. Privatisation includes entry of private players to strategic areas, disinvestment, or outright sales, again a part of the IMF's agenda.
The May 16 package includes 'structural reforms' listing private participation in coal and other mining activities, defence production, aviation, space research, particularly in "planetary exploration", privatisation of airports, power distribution and atomic energy sector.
The May 17 package talks of enhancing the ease of doing business - a World Bank project - decriminalisation of Companies Act defaults etc. It also says that a new policy would be notified for privatising strategic sectors.
The new policy would limit PSUs in each strategic sector from one to four and privatise or merge the rest.
Reliance on liquidity and financial institutions
India's liquidity-heavy design is in sync with 'financial deepening' the IMF pushes as its second plank of the neoliberal agenda.
A large and growing financial sector has been sold as the magic formula for high growth. The IMF admitted in its January 2020 study, 'Finance and Inequality' that beyond a point financial deepening (growth of financial sector) worsens inequality and then causes financial crises. During the crisis, inequality falls but then goes up again (the graph below).
Business Today (Coronavirus Lockdown XVI: Why India should be wary of excessive push for liquidity or credit) explained how financial deepening is risky and should be handled with caution. Too much liquidity and household debt were the primary contributors to the 1929 Great Depression and 2007-08 Great Recession.
One of the saner voices of the 1929 Great Depression era, economist Ludwig von Mises had this to say about the subject in 1930s: "Credit expansion cannot increase the supply of real goods. It merely brings about a rearrangement. It diverts capital investment away from the course prescribed by the state of economic wealth and market conditions..." ('The Causes of the Economic Crisis').
The first few years of 1929 crisis saw a rise in liquidity and did no good, until John Maynard Keynes stepped in to prescribe demand-side solutions. Post-depression, Keynes is said to have claimed that even paying men simply to dig ditches and fill them up again could revive the economy (Mariana Mazzucato, The Value of Everything, 2018, Penguin, page 260)
In India's context, liquidity measures like cutting headline interest rates or Rs 1.45 lakh crore corporate tax cut did not stop the GDP growth to slip before the pandemic. The futility of liquidity infusion would be clear from the following graph.
Has neoliberal agenda worked elsewhere?
The world is full of countries which underwent immense pain directly as a result of this neoliberal agenda.
The examples of Greece and Italy in more recent times have already been narrated. Plenty of literature exists on how this agenda destroyed the people and economies of Argentina and Chile, worsened the East Asian crisis of 1997, caused food riots in Indonesia (1998) and Bolivia (2000) and riots over domestic gas in Ecuador (2001).
Some of these accounts come from Stiglitz, and others from investigative journalist Greg Palast, and many others. Stiglitz was World Bank's chief economist during 1997-2000 and was fired for criticising its policies that damaged countries that received its bailouts.
As an insider once, Stiglitz brings lesser-known facts out.
He often describes 'privatisation' as "briberisation" and explained to Palast why when the latter sought to know why national leaders don't object to the sell-off of state industries to private operators (as World Bank-IMF seek).
"You could see their eyes widen" at the prospect of 10 per cent commission paid to Swiss Bank accounts for simply shaving a few billion off the sale price of national assets", writes Palast in his 2002 book 'The Best Democracy Money Can Buy' (page 51).
Stiglitz also provides one insight into why the IMF does what it does while knowing that its agenda has harmed many countries.
In an interview to The Guardian in 2002, he said the IMF made "two big errors" in 1990: (i) it bowed to Wall Street's demand for new markets by making its loans conditional on opening up financial markets and (ii) prescribed a mix of fiscal austerity and high-interest rates for the countries in the speculators firing line.
The relevant part of the article is reproduced below.
World Bank-IMF and India's liberalisation
India was also forced to adopt the World Bank-IMF's agenda in 1991 when it sought a bailout from its foreign exchange crisis. The liberalisation that followed brought high growth. But it is not as black-and-white a story as it is often presented.
For one, Manmohan Singh, then finance minister, was selective in applications. For example, he didn't go for an outright sale of PSUs, one of his successors, Atal Behari Vajpayee, did. How that has impacted India calls for a separate article.
For another, Manmohan Singh realised mistakes of his liberalised regime and did a course correction as Prime Minister during 2004-14.
He went for "inclusive growth" and brought a series of progressive laws, like the rural job-guarantee law MGNREG Act of 2005, Forest Rights Act of 2006, Food Security Act of 2013 and a new land law of 2013.
The MGNREGS and Food Security Act are two of the most significant tools now to provide real relief to pandemic-hit people. So are his two other initiatives, direct benefit transfer (DBT) and zero-balance, no-frills bank accounts (now renamed).
India has undergone a significant change since the days of Manmohan Singh. For example, absolute poverty fell in India until 2015, but has started rising now as the Niti Aayog's December 2019 report pointed out. Business Today's 'Budget 2020: Niti Aayog shocker; Poverty, hunger, and income inequality up in 22 to 25 States and UTs' provides a detailed account of it.
The need of the hour is to take stock of ground realities, think afresh policies and priorities that better suit India's interest.
Calling the Rs 21 lakh crore package as a means to make India 'atmanirbhar' (self-reliant) but basing it entirely on the decades-old IMF agenda that has caused immense pain to far too many countries does not really sound convincing or comforting.
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Thursday, May 21, 2020

Coronavirus Lockdown XVI: Why India should be wary of excessive push for liquidity or credit

The 1929 and 2007-08 financial crises have amply demonstrated how unbridled growth of liquidity and household credit caused havoc in people's lives and economies. Pushing for more of the same at the time of massive loss of jobs and incomes is not such a good idea

twitter-logo Prasanna Mohanty        Last Updated: May 21, 2020  | 15:52 IST
Coronavirus Lockdown XVI: Why India should be wary of excessive push for liquidity or credit
Many leading economists, including Nobel laureate Abhijit Banerjee, have been repeatedly asking for large cash transfers to the poor who have lost jobs and incomes

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The extraordinary aspect of the central government's economic package of Rs 21 lakh crore to deal with the COVID-19 impact is its complete reliance on liquidity measures with very little fiscal spending. Even the schemes targeting small businesses (MSMEs), self-employed, street vendors, poor farmers, and migrants are about collateral-free loans, credit guarantee schemes and new funds to be helmed by banks and financial institutions.
Estimates of actual fiscal impact of the seemingly huge package range from just about Rs 1.5 lakh crore or 0.75% of India's GDP by the British brokerage firm Barclays Research to Rs 2 lakh crore or 1% of the GDP by the State Bank of India's research desk. India's central bank RBI's liquidity support (of Rs 8 lakh crore) alone constitutes 38% of the total package.
This is problematic for two reasons.
Firstly, the supply-side measures like liquidity infusion don't help an economy hit by demand recession, as has been India's case even before the pandemic appeared. Many leading economists, including Nobel laureate Abhijit Banerjee, have been repeatedly asking for large cash transfers to the poor who have lost jobs and incomes. Business Today had earlier shown how lack of demand led to lower industrial output and capacity utilisation, thereby reducing industry's need for credit. There is little reason to believe that poor households or industry would now rush for credit.
Secondly, India is risking 'financialisation' of economy, a term increasingly becoming familiar and refers to the growth of financial sector relative to economy. The world over, economists are warning against unbridled growth of this sector, linking it to financial crises and worsening inequality, especially after the 2007-08 financial meltdown. These economists include those of the global champion and driver of financialisation, the International Monetary Fund (IMF).
Prof Mariana Mazzucato of the University College London (UCL), an acknowledged authority on the subject and author, writes in her 2018 book 'The Value of Everything: Making and Taking in the Global Economy' that a large and growing financial sector has long been presented as a sign of UK and US success.
Countries aspiring to achieve their level of prosperity have been advised, especially by multilateral creditors like the International Monetary Fund (IMF), to make 'financial deepening' - the expansion and deregulation of banks and financial markets - as part of the wider liberalisation.
However, she warns against the financial sector's increasing reliance on rent-seeking, speculative activities, extracting value from other sectors of economy, rather than creating value on its own and financialising other sectors of economy to the detriment of society.
She calls for wholesome changes in the way economic values are measured and favours tighter control on finance that the 1929 and 2007-08 financial crises brought about but have weakened considerably thereafter.
But before getting more into that, here is what the IMF itself says on the subject.
Growth of financial sector, financial crises and inequality
Though the IMF has been prevaricating, especially after the 2007-08 financial crisis, it is persistent in its push for the financial sector liberalisation or 'financial deepening', nevertheless.
For example, in 2015, its study meant for internal consumption, 'Rethinking Financial Deepening', said its first and foremost finding was that "many benefits in terms of growth and stability can still be reaped from further financial development in most EMs" (emerging markets).
Why does the IMF talk about emerging markets, not advanced ones? It knows that the financial deepening has already damaged advanced economies. While providing the rationale for its study it admits as much by saying that "the 2008 global financial crisis raised some legitimate questions...that the crisis originated in advanced economies (AEs) where the financial sector had grown both very large and very complex". Instead of answering those legitimate questions, it hedged the bet.
Is there a direct link between financial crises and growth of financial sector (credit)?
The IMF answers this in another internal study marked 'Finance and Inequality', published in January 2020. The answer is in the 'third' finding of this study.
The IMF admits a direct relation between growth of financial sector and financial crises. It particularly talks of "too much credit, including to lower-income households" in the US contributing to the 2007-08 crisis.
Does this ring a bell in India in the way the Rs 21 lakh crore economic package has been designed to provide more and more credit to poor households running small businesses, street vendors, migrants and farmers, rather than cash transfers that economists have been asking for?
The initial finding of this IMF study is also significant. It says, initially, financial depth--that is, the size of financial sector relative to economy, helps in reducing inequality, but only up to a point after which inequality rises.
At what point the financial sector's growth becomes a liability?
The study presents a graph reproduced below.
In the graph, Gini Coefficient (Y-axis) has been plotted against financial depth indices of financial institutions and financial market (X-axis) for about 200 countries over a period of 1993-2017.
The index for financial institutions combines four ratios: private sector credit to GDP, pension fund assets to GDP, mutual fund assets to GDP, and insurance premiums to GDP. That for financial markets combines five ratios: stock market capitalisation to GDP, stocks traded to GDP, international debt securities of government to GDP, total debt securities of financial corporations to GDP, and total debt securities of non-financial corporations to GDP.
Where does India fit in the graph? This is difficult to answer as it calls for an elaborate exercise and availability of adequate data. The IMF study does not provide India specific data or calculations.
Other critical findings relevant to India are: (i) inequality increases before a financial crisis (ii) inequality falls during the crisis and begins to rise afterwards as lower-income households disproportionately experience income loss and (iii) higher growth in debt is associated with a greater probability of banking crisis.
There is enough evidence to show that both the 1929 Great Depression and 2007-8 Great Recession were heralded by the collapse of insufficiently regulated banks and stock markets.
The financial sector built up bubbles that burst, leading to banking collapse, massive job loss, and damages to non-financial sectors. Governments had to then bail out some of the banks and economy in general by pumping in taxpayers' money.
Unbridled speculative and betting activities by the financial sector, rather than genuine value creation, played a big role in creating those crises. There have been regional financial crises too, like in Latin America in 1982-83 and East Asia in 1997, in which the role of financial sector has been questioned.
Making and unmaking of global economy
Prof Mazzucato narrates how the enormous clout of financial sector came about in 1970s when it was included in the calculation for GDP. Until then, finance was just an "intermediate input"--a service contributing to the functioning of other industries that were the 'real' value creators. The financial sector was perceived as "a distributor, not a creator of wealth".
The introduction of financial sector into GDP also coincided with deregulation of the financial sector (that had been tightened after the 1929 Great Depression), relaxed controls on how much banks could lend, interest rates they can charge and products they can sell, increasing its hold on the 'real' economy (that produces goods and services, like agriculture, industry, services, rather than banks and stock markets).
"Today the issue is not just the size...and how it outpaced the growth of the non-financial economy (e.g., industry), but its effect on the behaviour of the rest of the economy, large parts of which have been 'financialised'..." she writes. Prof Mazzucato also asserts that rather than creating value by investing in long-term future of businesses, the financial sector is capturing value from other sectors through interest differentials and expensive transaction costs and when private equity (PE) and venture capitals (VCs) control non-financial companies, the main objective is not to produce new things but maximise shareholders' value through stock buybacks (too boost stock prices and executive pay).
Attempts to regulate banks after the 2007-08 crash have led to less-regulated 'shadow banks' to expand into areas where banks were forced to contract.
A similar situation has developed in India. The RBI's 2018 banking trend report clearly states how the NBFCs witnessed a strong credit expansion in FY18 and FY19 (up to September) while that of banks shrunk due to "rising non-performing assets (NPAs) and pervasive risk aversion". The banks actually started lending more to the NBFCs, than industry. The NPAs (many of which are a result of banking fraud that the cases of Nirav Modi, Mehul Choksi, Vijay Mallya and many others have established) have now travelled to the NBFCs, leading to the collapse of some, like IL&FS and DHFL.
UK's financial curse  
British tax expert and author Nicholas Shaxson writes in his 2018 book 'The Finance Curse' how the financial sector's growth has been counter-productive for the UK.
He writes the UK's banking assets stood at 50% of the GDP for a century until 1970 but by 2006, grew to 500% of the GDP and stayed there since then. If the assets of insurance and other financial institutions were added, the actual size of the financial sector would be 1,000% of the GDP.
"You'd expect the enormous growth in our financial sector to have generated a fountain of investment capital for other sectors in our economy, but the exact opposite has happened. A century ago, 80 per cent of bank lending went to finance businesses. Now, banks are lending mostly to each other, housing and commercial real estate, little more than 10 per cent of UK bank lending goes to businesses outside the financial sector", he adds.
Shaxson laments that despite the tremendous growth of its financial sector, the UK's per capita GDP is now lower than its northern European peers, the UK is much more unequal and has poorer overall scores in health and well-being.
Growth of finance sector in India
What is the state of India's financial sector?
Here are some representative indicators of its growth since 2004-05 using the 2011-12 national account series (GDP).
The assets of banks and mutual funds (MFs) as percentage of GDP are two of the four ratios used by the IMF in its 'financial depth' index for financial institutions (January 2020 study).
According to the RBI's data, the assets of Scheduled Commercial Banks (SCBs), minus the Regional Rural Banks (RRBs), have grown from about 74% in FY05 to 122% of the GDP (2011-12 base current prices) in FY18. (RRBs have a relatively smaller asset base, banking sources say.
The assets under mutual fund companies (MF) have gone up from 5% to 17% of the GDP during the same period.
The IMF uses stock turnover and market capitalisation as percentage of GDP as two of the five ratios for its 'financial depth' index for financial institutions (January 2020 study).
The graph below provides how they have grown over the years in the largest Indian stock market NSE (oldest one is BSE).
These growth graphs give a sense of the growth of financial sector, not the whole picture.
Therefore, nothing can be said about India's vulnerability to a financial crisis on the basis of these graphs or how the economic package of Rs 21 lakh crore contributes. But going by the global experiences of nearly 100 years, it is safe to assert that caution is called for. That such a liquidity-heavy package would do little to remove the pain in households or the economy is another debate.
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