Raghuram Rajan, Former Governor, RBI in conversation with CNBC-TV18

Q: How do you explain this – markets in the US rising to new highs and even in India, even if it’s an underperforming market, doing better and better every day of July, although the macro economy, the GDP numbers are getting revised lower and lower. How is this possible?

A: There has been so much intervention, and certainly that’s true in the United States, much less true in the emerging markets, so much intervention both in terms of fiscal intervention which has kept income level especially for the low income people at maybe on par or even higher than what they were earning earlier, but also there is a massive amount of financial market support to all kinds of entities and rates have been kept low forever. So given that rates are needed to discount stock prices, maybe that’s keeping stock prices buoyant because we are discounting with a very low rate.

But even that, you would think that a couple of years of low earnings are going to depress stock prices and that means few other possibilities that I can think of -- one is that the sectors that are represented in the stock market are going to do better than the sectors that are not. For example, industrial firms will recover faster, but also within industrial firms if their small competitors are knocked out, the firms that are traded on the market may do better. For example HDFC is going to do well because if other firms in the banking sector are held back by poor performance, HDFC has more space to benefit.

Lastly, this is when all else fails, you have to say there is some amount of irrational exuberance. I think some of these put together could explain what is going on.

Q: But can this end badly? One big reason obviously is that the global central banks are printing a lot of currency and that spills over into emerging markets as well. Of course, even Indian and other emerging market central banks have kept liquidity plentiful. So is this an equity inflation, an asset inflation and can it end badly?

A: It obviously depends on what is driving it. There is a certain amount of money as you said of liquidity chasing asset prices, there is a certain amount of fear of missing out -- there are small retail investors who think that things are going to be fine and they will join in especially if the market has already bounced back quite a bit and that could take the market even higher only to correct down the line.

Now I think at this point it’s probably a fool’s game trying to decide how much of what is responsible for the prices, but from an investor’s perspective what is most important is to be well diversified -- not to put all your eggs in one basket, to have your money properly distributed in different baskets -- some domestic, some international, some in fixed income, some in the stock market. Don’t go chasing after one particular sector.

Q: If you have to advise on how India should design macroeconomic policy, what would that be?

A: First I would say we got to get our medical policy right. I understand the enormous efforts that is going, I understand the brave people who are on the frontlines, but now we are the third largest number of cases and no matter how you spin it, it is true that poor countries, developing countries with the large rural area have had relatively low deaths. India is not an exception in that, in fact the World Bank has a paper suggesting this is a puzzle – why is it that the deaths per million is so much lower amongst emerging markets and developing countries? So that is a beneficial thing.

But the number of cases is increasing and until we contain it, it is going to be very hard to open up. Your program just had some vignettes about what is happening in Tamil Nadu; if you have to keep closing down, it creates a lot of uncertainty for business, but also business gets stuck at a moderate level. So there is no second guessing the fact that we need to contain the virus, bend the curve.

We haven’t bent the curve -- I see some statements about yes we have bent the curve, but we haven’t. We need to bring the number of cases down on a reliable basis, until we do that, we cannot rest. We have to bring it down to a low number so that we can actually start testing, tracking and containing it.

Q: When we have to do that then we probably have to lockdown, then we are losing lives to poverty, to hunger?

A: I am not suggesting we do a massive lockdown again, I think we need to understand, we need to look around the world, especially the emerging and developing world, what has worked there, why has Ethiopia got a low number of cases, why did Vietnam work and figure out from that what seems reasonable responses in order to bring the virus down significantly from where we are.

Clearly, a massive amount of education is involved, clearly a massive amount of additional sort of medical equipment etc. is involved, but until we fix that, it is not clear to me that we will make progress on the economic front more than a certain amount. I am, again, not an expert on epidemiology, but it seems to me that there are lessons we can learn from what is happening around the world and we don’t necessarily need to look to the West only for lessons.

Q: But what next - I mean yes of course that is the health imperative, but what should the government do for the economy? Is therea large amount of fiscal stimulus spending that they ought to do, how do they ought to finance it?

A: During this process of waiting to deal with the virus, we should be preparing for the next phase, right. Certainly, I would say that a repair of our companies is extremely important, we need to make sure our companies come out from this in a position to actually reopen and grow. They need working capital, some of them need to make investments. We need to make sure they have that ability and that means a couple of things.

One, they shouldn’t be over indebted. So that means looking at their debt log because you have been spending during this time, keeping on your employees etc. and that means you have been taking on debt or at least running down your reserves. So you should have the ability to borrow, but that means you should not be over borrowed already. So restructuring your debts may be on the cards for a number of them and certainly access to finance going forward is really important for a number firms. This is where I think cleaning up the financial sector, making sure they can lend when that is needed, both to the individuals, retail, but also to firms is extremely important.

We should be spending a lot of time on that now. The NCLT should be working 24/7, we should have multiple new offices even though we have put a moratorium on the new cases, clear out the old cases and be prepared for an avalanche of new cases because we need to fix that. We don’t have the money to bail out every small firm like the US has done with Paycheck Protection Program, but we have to make sure that those companies are ready to turn. So that is one example of what we need to do.

But we also need to create impetus for growth. Some of that will come from stimulus spending which means spending on potentially infrastructure, which is going to create construction jobs and is also going to create demand for steel, demand for cement all that which can be revitalizing. Those sort of projects should be in the process of being brought to the front quickly and that means again working on that 24/7 right now.

So, I don’t think we should be waiting and twiddling our thumbs, and I am sure that is not happening, but we should be really preparing for when the economy opens up fully and doing everything we can both in terms of repairing the old damage that is made in the past in the power sector and the financial sector, but also creating sort of stimulus spending.

Lastly, I think the government has talked about reforms. Certainly the reforms in the agriculture sector look promising if they are carried out, but there are other reforms which have been promised, what has happened on that? You said the stock market is buoyant, why aren’t we selling public sector firms at this point? Are we waiting for stock market to come down to start selling more?

We talked about privatization; why haven’t we spent these 4-5 months preparing the entities to be privatized and to sell them so that we can have more resources to spend on repairing the economy. These are the questions we should be asking.

Q: There is one buzz which I do want to check with you; this is only a buzz – Mr. KV Kamath himself said no, he has not been sounded out when we interviewed him a little while back, but do you think that is a good idea to get people like KV Kamath into government?

A: I think getting professionals into government, especially on the economic and financial side, because we really need much more capability there and we need people who can think about macro, we need people who can think about financial sector because we really need a lot of effort to compensate for our more modest resources. We need to do things much more cleverly, much more quickly, on a much bigger plane if we are to come back as an economy. This year looks terrible, all the projects are getting worse, but let us not make next year bad also by failing to take action.

Q: Would you want to pick a number; we started with -1 percent when COVID first started and then a lot of people said -3.5 percent, then it went -5 percent, yesterday Citi put out a report saying -6 percent, and Dr. Pronab Sen whom I really respect the most thinks it could be minus double digit like -10 percent. Do you think the economy can be as bad as that?

A: The reality is nobody knows. Surely it is going to be a contraction, but when you look at some of the mobility numbers, mobility/activity failing very closely, we saw mobility come down after lockdown, we have seen it come back up as we opened up but it is plateauing around 70 percent. That means we are down 30 percent in terms of activity that requires movement.

That is a huge number and for that to be sustained for a few months means we are looking at very low levels of activity. I think it is wrong to be mis-lead by the fact that every activity number that we are going to see over the next few months, looks like double digit levels of growth. That is from a real low and obviously we are going to grow fast from a real low.

But are we going to make up the plunge that took place in the first few months of the lockdown and that is still continuing? That requires much stronger growth for almost the same period and that is why we need much more activity on the economic front. I think people like Mr. Kamath and other professionals recruited in would add capabilities to our current government.