Covid crisis: India can not afford a ‘shock therapy’ of the kind Russia experienced in early 1990s

By Ajay Shankar

Profits are private and losses are public, is an accurate characterisation of the modern market economy. In a severe crisis, the state ends up having no option but to put in public money to save the market economy and its private enterprises. We are seeing this now as the global economy is in a Covid-induced recession. Governments in the US, the UK and Europe are implementing huge relief packages; making payments for workers and providing money to keep enterprises afloat. The response to the 2008 financial crisis and the Great Depression was no different.

The 2008 financial crisis was triggered by a sharp fall in housing prices in the US which led to the collapse of the associated sub-prime mortgages. To save the financial sector, the US Treasury nationalised Fannie Mae and Freddie Mac, the principal players in the secondary mortgage market for housing loans, as they were on the verge of bankruptcy. The Treasury pledged to cover their debt of $1.6 trillion. Lehman Brothers, the fourth-largest investment bank collapsed.

Seeing the sharp downward spiral this precipitated in the financial sector, the US Treasury and the Fed working jointly over a weekend arranged a bailout for the beleaguered AIG (American Insurance Group). The orthodoxy of leaving markets alone, not interfering in bankruptcies, and of arms-length between an independent Fed and the Treasury was abandoned. A collapse was averted though the crisis did become severe and global. A $700 billion Troubled Asset Reconstruction Program (TARP) was put in place, of which $250 billion was made available to the Treasury to buy stocks to shore up troubled financial institutions. General Motors, which was bankrupt in 2009, was saved through what was, effectively, nationalisation. With stabilisation in a short period, the state disinvested. The idea of being ‘too big to fail’ and the need for the state to use public money for a bailout acquired legitimacy. Three G-20 summits were held between November 2008 and September 2009 to coordinate recovery measures.

In 1933, when Franklin D Roosevelt became the US president, banks and firms were still collapsing, unemployment was rising, and prices were falling. Roosevelt steered the economy to recovery and clear leadership of the global economy by the end of World War II. The range of instruments used were quite unconventional. The underlying premise was that the state had to revive the economy. The Emergency Banking Act of 1933 provided funds to enable sound banks to reopen and others to survive. The National Industrial Recovery Act (NIRA) of 1933 was the most unusual. It got the industry to get together voluntarily and agree to a floor price below which they would not sell so that they would start earning profits from higher prices. The industry was also made to agree to higher minimum wages. Workers with better incomes would buy more, and this would lead to higher production. This Act was struck down by the Supreme Court as being unconstitutional in 1935. By then it had also lost political support. But in these two years, industrial production increased by 22%.

During War War II, the US built planes, warships, tanks etc. on a massive scale. These were bought by the government from private firms and were then loaned, not sold, to the Allies, including the Soviet Union, to fight Germany under the Lend-Lease program. This was critical for the defeat of Germany. But it also acted as a huge stimulus for the economy leading to full employment, higher wages and a rising GDP.

There are some clear learnings for us from historical experience. First, unusual times call for unconventional decisions. It can be plausibly argued with hindsight that, after taking over of ILFS, saving it with public money rather than sending it for bankruptcy, would have moderated the impact on the financial sector and the overall cost to the economy. Similarly, an earlier takeover and bailout of YES Bank may have been a better and cheaper option. Going forward, a clear signal about setting the financial sector, banks and NBFCs, on a sound footing with a pragmatic rescue plan would help. The initial announcements of a loan repayment moratorium and keeping in abeyance bankruptcy proceedings for borrowers were timely and welcome. Clarity about the restructuring of the debt of potential NPAs and IBC proceedings going beyond the present moratorium would help in shoring up of market sentiment which, at the moment, is naturally downbeat.

Till recovery takes place, proceeding with disinvestment and privatisation may need to be put on hold. There is no capacity in the Indian private sector to participate in such processes as they are themselves struggling to survive and need state support. The bankruptcy route would lead to handing over a very large number of good firms who were, say, profitable in 2017-18 to foreign entities at a fraction of their fair value. In the process, the downturn would only get aggravated. India can not afford a ‘shock therapy’ of the kind Russia experienced in the early 1990s at the behest of US-based policy experts. Russia is yet to recover as an industrial power though it was far ahead of China then.

Once concern on the fiscal deficit is shed after recovery begins, raising resources and prioritising their use would be the challenges. Increasing government borrowings should not be difficult. In addition to increasing normal borrowing, the government could itself, or through a financial agency, issue long-term bonds for retail investors who have been rushing to put money in bank FDs. When the crisis is as severe as it is now, then the standard positions of not interfering in the market and not rescuing failing enterprises even by temporary nationalisation, if necessary, have to be given up. The sooner it is done, the better.

The author is Former Secretary DIPP and distinguished fellow, TERI. Views are personal