#288 Reversals

Consumption Multiplier vs Capex Spend, Trump2.0 and India, and DEI Policies Wither Away

India Policy Watch: Course Correction Perhaps

Insights on current policy issues in India

—RSJ

Between the budget last week and the MPC meeting this week, we have a holistic view now of the fiscal and monetary policy direction for the next year. The core message from the budget was that the government is keen to put money into the pockets of the consuming class (up to ₹1 trillion) to spur consumption. The hope is this will kick-start a stronger demand cycle, which will signal the rest of the economy to invest in capacity. The virtuous cycle then gets going.

Looking at the budget math, this ₹1 trillion tax break has been traded off with a lower government capex budget for FY26. There were not a lot of options to play with anyway after pegging the fiscal deficit target at 4.4 per cent. Broadly speaking, the expectation now is consumption will create some kind of multiplier based on marginal propensity to consume. Depending on how these households decide (consume or save?), we might have a couple of trillion extra consumption that will get added to the GDP for a year.

I’m sceptical of this logic. The consumption multiplier works only for a year, whereas the multiplier that comes with capex or infrastructure spending spills over four or five years. This doesn’t look like a great trade-off except that politically, the consuming class was seeing itself as a victim of budget every year, and it was time to show them some love. The other, more palatable, explanation is that we have been undershooting the government capex targets by a wide margin every year. It is better to keep a more realistic target (it is 10 per cent for FY26), meet it for a change, and let the remaining outlay go to support consumption. We shall see how this works out.

The MPC that concluded its meeting on Friday continued building on the budget script. It cut policy rates (25 bps) for the first time in five years and indicated that with growth slowing (FY26 estimated at 6.5 per cent) and with the inflation projected to moderate (FY26 at 4.2 per cent), the policy space to support growth has opened up.

Does that mean more rate cuts in the near future? Not really, because the policy stance remained neutral, and the RBI governor called out global uncertainties as the reason for not changing the stance. My view is that if, and it is a huge if, inflation stays in the narrow range of forecast for FY26 (the base effect will help), we might see a couple of more cuts during the year. The cuts will be shallow, though. Notwithstanding that, a rate cut will mean the existing stock of loans linked to the external borrowing rate (a large part of retail loan books) will lower by 25 bps by Q1 of next year. This will mean some more money in the pockets of the consuming class. The new loans might not see a fall in rate because I don’t see a quick transmission of this cut to new disbursements. So, we might have some relief for the overleveraged consumer and, therefore, for the asset quality issues in the unsecured loan segment. But not a significant consumption uptick because of this.

Two key messages stood out for me during the MPC press briefing.

First, there was an acknowledgement that counter-cyclical measures like tight liquidity, increasing risk weightages for lending in different asset classes, and checking banks' loan-to-deposit ratios seem to have gone a bit too far. The credit growth for the system has fallen from 18 per cent to about 10 per cent in the last six quarters, and this weak monetary impulse has contributed to the slowdown in the economy. This is a point made by many analysts in the past quarter that more than rate cuts, we should be looking at some prudential easing of monetary norms around liquidity that have been tightened in the normal course of business. There was also an acknowledgement that the regulator will look at durable liquidity infusion into the system beyond the steps they have taken on variable repo rate auctions (to stabilise overnight rates) and the open market operations (OMO) window. This is a good signal of intention that the central bank will be ‘proactive’ in providing liquidity support to the system.

Second, the RBI Governor made a point about doing a thorough ‘cost-benefit’ analysis for all policy decisions. This is a veiled acknowledgement of the potential costs of some of the new policy guidelines that were imminent for the financial sector—Liquidity Coverage Ratio (LCR) that would have meant more capital for banks to set aside instead of lending, Expected Credit Loss (ECL) norms on provisions for riskier assets (again a negative on capital), and Project Finance (PF) guidelines that were extremely prohibitive for banks to lend for greenfield projects—have all been pushed down the road with the possibility of a review of the key recommendations. A thorough cost-benefit analysis is a key step in evidence-based policymaking. The costs are often hidden and unintended, and a good policy-making process spends a lot of time trying to uncover or anticipate them. There’s a tacit acknowledgement now that some of the decisions around liquidity, Rupee-Dollar exchange rate and countercyclical monetary measures were taken with good intentions but could have benefitted from more analysis at the formulating stage. Even when the on-ground evidence suggested the costs of the policy were beginning to hurt growth, it was ignored as short-term pain or the private sector was made the scapegoat (see edition #282). I hope this specific call-out means we will have a more deliberate and quantitative approach to future policies.

Back in late September, in edition #274, I had written this while discussing the fiscal and monetary packages (‘near bazookas’) that were unveiled by China to jump-start its economy:

“Looking at China’s economic issues at this time presents a fascinating contrast with India, where the central bank has kept liquidity really tight over the past two years, tried to dampen loan growth by increasing risk weights for banks for unsecured loans, and has signalled that credit growth cannot be higher than deposit growth in the banking system. These are all countercyclical measures to tame inflation, prevent the possibility of asset bubbles building up and keeping powder dry in case global macro gets worse. All of these will start impacting growth soon, if not already.

If China is a case of too little too late, maybe India is doing too much too early.”

Four and a half months later, we seem to be on the path of correcting this.

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Global Policy Watch: DEI Must Die?

Insights on global issues relevant to India

— RSJ

Trump’s war on DEI has reached corporate boardrooms. Companies ranging from McDonald’s, Walmart, and Target to Accenture have all decided to end their specific DEI policies while continuing to work on a fair and equitable workplace. Of course, the Big Tech players were first to move in tandem with Trump’s purge of DEI staff and departments in federal departments and universities by scrapping their DEI programmes. The Accenture memo on this made for interesting reading (As the FT reports):

A memo to staff from chief executive Julie Sweet said the New York-listed consulting group would begin “sunsetting” its diversity goals set in 2017, as well as career development programmes for “people of specific demographic groups”.

Sweet said in the memo on Thursday that the change followed an “evaluation of our internal policies and practices and the evolving landscape in the United States, including recent Executive Orders with which we must comply”.

In this week’s memo rolling back the DEI targets, Sweet said they would no longer be used to measure staff performance, and she also announced a pause on submitting data to external diversity benchmarking surveys pending an evaluation.

“We are and always have been a meritocracy,” Sweet wrote in the memo, echoing Trump’s vow to discard DEI policies in favour of “a society . . . based on merit”.

All good. But here is what Julia Sweet wrote in 2020 when Biden won the elections:

”Progress (on DEI) just isn’t fast enough. Why aren’t companies more diverse and inclusive, when the business case in favor of a culture of equality strengthens each year? And why is the share of women in leadership positions still so low?”

The idea is not to call out a specific company or a CEO on their convenient change in stance but to remind everyone that politics may be downstream of culture, but everything else is downstream of politics.

This is also a reminder that social change is brought about through grassroots efforts to change mindsets, debates, persuasion, and acceptance. Not through top-down legislation and convenient virtue signalling. That only leads to a ‘checking the box’ kind of change without real conviction, which turns over at the first provocation.

Since the civil rights movement in the 60s, there has been a gradual but irreversible movement on racial and diversity metrics across American society. Most of it has been supported by legislation eventually that found bipartisan support. Could those metrics have been better? Of course, yes. Could they have been achieved faster? Not sure about that. This is the way it went till the last decade when this desire to accelerate DEI goals came in with all kinds of clauses and sub-clauses on intersectionality, gender and other issues that weren’t borne out of grassroots activism. Instead, they were what’s derisively called the ‘woke’ agenda. The top-down enforcement of this agenda has now met its match in the top-down annihilation of it and, in the process, possibly upending the gains that were consolidated painstakingly over the years through a broad social contract.

It is another sad and timely reminder of how not to frame policies.

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Matsyanyaaya: Trump2.0 and India

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

The Indian PM will be in the US next week. There will be a lot of news coverage of the visit. Anticipating pushback from Trump on his favourite topic of “trade imbalance”, the Indian government has smartly re-floated the idea of a “mini trade deal”. The idea would be to package a reduction in India’s import tariffs as part of a deal where the Indian side also saves face by extracting some concessions. Any such deal will be extremely limited in scope unlike a Free Trade Agreement. Apparently, such a mini trade deal was discussed during Trump1.0 as well. So, expect some of those ideas to be back on the table. The union budget had already factored in the Trump shock by announcing unilateral customs duty reductions on motorcycles, and some other items. The announcement to amend the Atomic Energy Act and the Civil liability for the Nuclear Damage Act will, amongst other things, also help India position itself as a destination for American nuclear sector companies.

While some modus vivendi on trade and economy was being worked out, the issue of deportation of Indians who had illegally escaped to the US popped up. The government was forced to answer on the floor of the Parliament as to why the deportees were handcuffed and transported using an American military plane; it could have all been done with less theatrics. Nevertheless, these deportees broke the laws of atleast two countries and put at risk the prospects of several other Indians who hope to migrate legally. They must be dealt with the full force of law. Meanwhile, this issue isn’t going away anytime soon as India remains the third-largest source of undocumented migrants in the US, and nearly 18000 of them are awaiting deportation. Expect this item to be on the agenda of the PM’s visit.

Taking a step back from recent events, the bigger question is what should India expect from Trump2.0? Predicting Trump’s actions is difficult and hence I haven’t come across many systematic analyses on this subject. So here’s one attempt.

Given the uncertainties involved, it’s worth thinking in terms of a 2x2 scenario analysis. The two most uncertain yet important factors that form the two axes are:

1. US-China relations. This is an exogenous factor but perhaps the most important one for the US-India partnership. While the structural competition between the US and China will continue, it might take two different shapes. If Trump were to continue with Biden’s China policy, there would be a further decoupling of US and China’s high-tech sectors, and more aggressive economic coercion. But that approach is not guaranteed, given the business interests of Musk and Tesla in China. Trump has expressed that he wants to strike a deal with China. So the alternate possibility is that the US and China could come to an understanding on trade that limits the chances of a conflict in other areas—something we refer to as “coopetition”, a hybrid of competition and conflict.

2. State of India-US deals. It seems that the two most important issues for Trump are about striking a balance in bilateral trade deals, and being tough on illegal immigration. Thus, India’s willingness and ability to enter into a deal on these issues will be a crucial factor for the relationship. Specifically, there will be pressure on India to make some big-ticket military platform purchases from American firms.

Considering an interplay of these two factors, here’s how the scenarios stack up.

As the framework shows, the upper two quadrants seem to favour the Indian interest most. This implies that the ball’s in India’s court. India should urgently propose a “deal” on trade and commit to addressing the issue of illegal immigration. Throw some defence and nuclear power plant purchase promises into the mix, and hope for the art of dealmaking to work in your favour.

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HomeWork

Reading and listening recommendations on public policy matters

1. [Podcast] This interview with C Raja Mohan on Trump2.0 and India is insightful

2. [Podcast] Continuing with Indian foreign policy, here’s a deep dive Puliyabaazi with Dhruva Jaishankar on India’s strategic thought, major bilateral relationships, and state capacity in foreign policymaking. Do check out his book, Vishwa Shastra.

   भारत का विश्वशास्त्र। India’s Foreign Policy in a New World Order ft. Dhruva Jaishankar

3. [Framework] In a previous edition, we developed a useful framework to interpret the India-US relationship.

4. [Article] Jeff Ding’s post Three mistaken assumptions in the debate on DeepSeek and Export Controls raises uncomfortable questions. Do read.

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