Crossing our River Styx

Crossing our River Styx

Last fortnight’s passage of the Food Security and Land Acquisition legislation was a tactical triumph for the ruling coalition.  The opposition had to bite its tongue; it was a clever feint, but the body blows are landing fast and hard on growth and investment, and we are against the ropes, bloodied and dazed.  The truth is that those in authority have lost all credibility, and those in business have lost their social contract.  Crony capitalism coupled with cruelly capricious decisions has gutted what was not so long ago a raging bull of an economy.

If you go back to the mid-2000s, India was growing very rapidly and the belief of the middle classes and business was that there was a very talented team running the economy, with an economist prime minister and a half-decent finance minister. There was faith that the central bank would keep inflation low and all would be well.

All of that has come to nought. The RBI let inflation get out of control. Relations between the RBI governor and the finance minister were appallingly bad.

Most of us do not seem to grasp the seriousness of the situation.  Food price inflation was ignored under the pretext that the benefits of growth needed to spread to rural India.  Gorged with high inflows of foreign funds, the government threw money around like a drunkard at a casino.  Indians felt they had an inalienable right to grow rapidly, that India was finally getting the growth it deserved.  The goal of “spreading” the riches to the mythical aam admi  became a moral and not an economic issue.

India did not recognise the fragility of growth. Prices – chiefly of food – rose and rose inexorably. If inflation is very high, people turn away from money.  They stop saving through the financial system and turn to gold.  What had almost never happened in any developing economy happened here – as the economy slowed down, there was a blowing out of the current account.  Instead of imports slowing, Indians shipped in more and more gold.  As the downturn deepened, investments fell and savings fell even more because of inflation, so people ‘saved’ with gold.  India’s current account was being financed by foreign savings, a.k.a. foreign fund inflows.  That was fine so long as growth was rapid.  But in 2012 India really started to slow down.  This had nothing to do with the United States, or Ben Bernanke, or the terror of “tapering”. Simply put, foreigners became very reluctant to lend money to spendthrift India.  The rupee’s exchange rate began to weaken a little over a year ago. When P. Chidambaram took over he initially tried to restore the credibility of the government but here’s what happened:

1.    The government still did not tackle Consumer Price Inflation.

2.    Chidambaram’s attempts to introduce reforms and reduce the budget deficit proved to be a chimera. The bankruptcy of policy was badly exposed when the government passed the Food Security Act.  This meant that it could not care less about the budget deficit.

Gold imports will climb even higher in the months ahead.  The rupee, which has already been factored in at 70 to the dollar, will slip even lower.  So what can we do? We need to restore credibility to policy.   We need big measures, and political courage.  We need to be able to stand up and say that the Food Security Bill is great but we cannot afford it right now.  We need to be able to say “We learned a lesson – when you have excellent growth, you don’t spend all the money.” 

The trouble is that our policy dinosaurs don’t view inflation as a problem or growth as fragile.  The result is that investors, both domestic and foreign, who have to deal with the real economy, have lost confidence.

The two most important and critically urgent goals now are: keep inflation low, and keep the budget deficit under control, or we will end up like Zimbabwe. 

“I would not use ‘crisis’ and ‘India’ in the same sentence,” new central bank governor Raghuram Rajan told reporters on September 4.  Yes, but how quickly have ‘growth’ and ‘India’ become antonyms.

(This column appeared in Business Today, Sept 29 2013)

Fussbudget

Far away in Los Angeles, “The King’s Speech” won four Oscars, including Best Picture and Best Actor, just as Pranab Mukherjee rose to present the Union Budget for 2011-12 in Parliament. The finance minister spoke for 110 minutes, but certainly does not win any prizes for dramatically pushing India’s reforms into a new geostationary orbit.

...for the rest of my post go to http://bit.ly/pranabthree

It’s the elections, stupid

Pranab Mukherjee is starting to look worryingly like a feckless heir squandering his generous inheritance while his fretful guardian in the person of Duvvuri Subbarao tries to board up the door and keep the wolves at bay with a nail here and a nail there.

The “history sheet” is simple and clear. Later this month, Mukherjee will present his third budget since the United Progressive Alliance came to power in the 2009 election. UPA-I, by hugely increasing social-sector expenditure in its two final years, 2007-2009, effectively torpedoed the Fiscal Responsibility and Budget Management Act, which mandates that fiscal deficit be cut to 3 per cent of GDP by 2008/09.

India’s financial mandarins argued that fiscal stimulation was called for to battle the global downturn and to deepen “inclusive” growth. The fiscal deficit shot up to 6.0 per cent in 2008/09, 6.7 per cent in 2009/10, and is projected at 5.5 per cent in 2010/22. As a Royal Bank of Scotland analysis put it, even if you take the windfall from the 3G spectrum auction into account, achieving next year’s 4.8 per cent target seems impossible. And to think that back in 2004, flush from its victory, the UPA actually predicted a balanced budget by 2008/09.

Experts will tell you that once the economy had come through the recessionary shoals, the aam admi stimulus ought to have been pulled back and more funds poured into infrastructure and manufacturing. Instead, populist spending is only likely to increase, said Dr Rajiv Kumar, Director General of the Federation of Indian Chambers of Commerce and Industry, or FICCI. Mukherjee, ever the fixer-upper for the Congress party, will have to keep an eye out for five key state elections this summer, including West Bengal, Tamil Nadu and Kerala. The spending cannot stop. The Uttar Pradesh state election in 2012 will call for some huge sops. Then comes 2013, and the general election – assuming the UPA government is still in power, scandals, legislative gridlock and all.

An international economist who closely watches India said with ample revenues in its coffers, the fiscal situation ought to have improvc1ed. “But it is not. Instead, all the revenues (and more) are being spent on new social programmes. Now it is true that social indicators are poor, and more needs to be done to help the poor. But it is hard to avoid the impression that the government sees the poor as vote banks, which they can tap as long as they provide them with funds. And surely at least a portion of the revenues could be saved, to give India some manoeuvring room in case a crisis hits?”

“There has been too much stoking up of consumption demand,” said Kumar, “and not enough capacity expansion.” The central bank, too, says only by spending more on capital expenditure will the government be able to fight some of the bottlenecks that contribute to supply-side inflation.

Inflation is now entrenched, and food price inflation is here to stay, fuelled by rising consumption of proteins as buying power increases in the countryside. The RBI’s review of the September-December 2010 economy commented drily that “The rise in food inflation has not only persisted for more than two years now, the increase has been rather sharp in the recent period.” And Subbarao, in his January 25 statement after the central bank raised interest rates for the seventh time this fiscal year, said: “Food inflation has remained at an elevated level for about two years and the prospect of it spilling over to the general inflation process is rapidly becoming a reality.” And so the RBI has raised its estimate for inflation to 7.0 per cent by March-end.

“If you chart inflation, there seems to be a clear break in 2006. Before that, inflation wasn't much of a problem; since then, it has been. Initially much of this was because of food price increases. But now prices are rising more widely, and it is hard not to conclude that monetary policy needs to be tightened substantially, so we can put inflation ‘back in the box’,” Joshua Felman, a former International Monetary Fund, or IMF, representative in India, said.

But monetary policy is a blunt instrument to beat inflation over its head with. The RBI rubbed this in: “Monetary policy works most efficiently while dealing with an inflationary situation when the fiscal situation is under control.”

Because of poor storage and infrastructure, there are huge productivity losses. “And supply is unable to keep up,” said Kumar. “At the same time, cereal yields have been stagnating.” A Nomura paper on food prices last September noted that the food weighting in consumer price inflation, or CPI, in advanced economies was typically between 10 and 20 per cent, whereas it was about one-third in China and as high as 46 per cent in India. “A sustained surge in food prices can have more pernicious effects if it unmoors inflationary expectations, impelling workers to demand higher wages to compensate for rising food costs, thus setting off a wage-price inflation spiral,” the Nomura report said. This is exactly what is happening in India.

With bank lending rates upward of 11 per cent, manufacturers face a nasty squeeze. FICCI’s Kumar pointed out that 90 per cent of State Bank of India lending over the past three quarters went towards infrastructure projects, and only 10 per cent went to manufacturing. “The cost of capital is likely to go up further,” said Kumar.

Dr Chakravarty Rangarajan, Chairman of the Prime Minister’s Economic Advisory Council, said food inflation has been a problem for over two years. “In a situation like this, management of the supply side is critical,” he told Business Today. In mitigation, Rangarajan said, prices of cereals like wheat and pulses have dropped, but the prices of meat, fish, eggs, vegetables and fruit have risen sharply.

Felman, who now works in the IMF’s research department in Washington, D.C., said he was worried about whether investment is truly recovering. “Here the signs are very mixed. Credit is growing nicely, and infrastructure projects such as power and roads seem to be moving ahead. But other greenfield projects seem stuck, held back by investor caution, land issues and the complex process of securing environmental clearances. So, investment does not seem to be booming the way it was before the crisis, and this is worrisome.”

The RBI’s quarterly review echoed with warnings. The current-account deficit, or CAD, will hit 3.5 per cent this fiscal year, and is “unsustainable”, the central bank said. But with global commodity prices rising, import bills look like staying high. Foreign direct investments, or FDI, could help finance this deficit, but the bad news is that FDI flows into construction, real estate, business and financial services have declined, while foreign institutional investors’ equity investments accounted for 79 per cent of net capital inflows of $36.7 billion during April-September 2010. This is clearly not desirable or sustainable, and the central bank said that “environment sensitive policies” – read Jairam Ramesh’s activism – have triggered a fall-off in FDI. “Added to this are the persistent procedural delays, land acquisition issues and availability of quality infrastructure,” the RBI said.

Will the UPA government quicken reforms to address these problems? The international economist was not sanguine. “Everyone expected that once the Left Front was kicked out of the coalition, reforms would accelerate. Instead, they've slowed down,” he said.

The IMF’s Felman said his final concern was the “governance deficit”. “A decade ago the question for reformers was whether the government would give the market sufficient space to operate,” he says. “Now, the issue is the reverse: whether the government has sufficient room to do what it needs to do, namely set fair rules of the game in which firms would operate. In a nation where there are more than one billion competing people, each striving for a fair chance in life, this is not just a problem. It is a tragedy.”

The Secret Life of the Manic Depressive Market

Not very long ago I watched a fascinating documentary by Stephen Fry on manic depression. I was reminded about the rollercoaster mood swings of people in that movie as I watched the markets on Budget Day. Panel after panel of pundits debated why the budget had not delivered the flavourful cocktail they thought the people had been thirsting for. Although the salaried class, senior citizens and women wage-earners benefited from some tax trimming, the consensus was that this was not a go-for-it reform budget.

Wait a minute – so the speculators and the day-traders and the swashbucklers were caught with their shorts down. Public memory is very short. People have forgotten that the Bombay Sensex rocketed 52.57 % between January 1 and June 30 this year. In comparison, the Dow Jones Industrial Average has actually fallen from 9034 on January 1 to 8447 on June 30. And China’s benchmark Shanghai Composite Index has also rocketed 71.6 % between January and June – but don’t forget that China’s much bigger economy is recovering faster than India’s – the OECD estimates that China will grow at 7.7 % in 2009 and 9.3 % in 2010.

So the journey of the Sensex this year can only be described as manic. Did the fundamentals merit this kind of irrational rise – or Monday’s depressive fall? India has been in the grip of a recession, just like the rest of the world.

Nobody really knows how badly the aam admi, the common Indian, has been hit – 92% of the workforce is in the “informal” or unorganised sector, so unemployment figures are poor estimates. Anecdotally, it is clear that millions of people have lost their jobs in the gems and jewellery, textile, leather and small and medium enterprise sectors. India does not also publish reliable bankruptcy figures.

Another indicator is the massive slowdown in industrial production, to 2.4% in 2008/09 from 8.5% a year earlier. Exports and imports both declined sharply; the trade deficit ballooned 35% to $119 billion, and foreign exchange reserves declined by nearly 17% to $262 billion at end-May.

Mukherjee listed several steps to aid exporters. But internal investment has plunged -- growth in fixed capital formation declined from 12.9 % in 2007-08 to 8.2% in 2008/09. External commercial borrowings dried up, capital accretion through the stock markets slowed to a trickle, and banks became much more reluctant to lend.

How many people exactly are out of work in India? We can try to piece the answer together from shards scattered in many places. The “Approach to the Eleventh Five Year Plan” (2007-12) said that unemployment rose from 6.1% in 1993/94 to 7.3% in 1999/2000 and 8.3% in 2004/5.

Unemployment among farm workers rose to 15.3% in 2004/05. Growth in real wages of farm workers slowed down in the 2000s as agricultural growth decelerated.

The Planning Commission estimated in 2007 that the number of unemployed totalled 36.7 million in 2006/07. It predicted optimistically that this would fall to 23.3 million in 2011/12. But that was before the global crisis. “This growing integration of the Indian economy with the rest of the world has brought new opportunities and also new challenges. It has made the task of sustaining high growth more complex,” Pranab Mukherjee said, almost ruefully.

Instead of bold changes in direction, the finance minister announced he would pump even more money -- Rs 39,100 crores ($8.3 billion) or a 144% increase over 2008/09 -- into the National Rural Employment Guarantee Scheme, which created jobs for 44.7 million people last year. This is going to be even more critical given that growth in the agriculture sector slumped to 1.6% in 2008/09 from 4.9% a year earlier.

So there may not have been breathtaking reforms, but there was plenty of stimulation, totalling Rs 186,000 crore ($39.6 billion) in 2008/09, and that pushed up the fiscal deficit to 6.2 % of GDP. That will rise further to 6.8% of GDP in 2009/10 – the finance minister proudly remarked that government expenditure will exceed 10.2 trillion rupees ($217 billion) this fiscal year, a leap of 36% over last year. That is going to be fuelled by a 50% rise in government borrowing. After his speech, Mukherjee told a TV interviewer that this was not too alarming because the U.S. fiscal deficit was likely to be 11% of GDP this year. Odious comparison indeed! A recklessly indebted government always crowds out other borrowers, and that can only have a long-term negative impact on manufacturing, services, and therefore exports. And that is why the Fiscal Responsibility and Budget Management Act, which requires the government to cap the fiscal deficit at 3% of GDP and to eliminate the revenue deficit, is so important.

Actually, as the RBI noted in its April policy statement, the combined Central and State fiscal deficits, plus special securities issued by the centre outside the market borrowing programme, will take the nation’s fiscal deficit to 10.8% of GDP. No wonder the ratings agencies are getting more and more twitchy by the day, and that Mukherjee said the challenge of recovery has to be shouldered jointly by the centre and the states.

“The deficit is too high and India cannot go on like this,” a senior international finance official told me. Alarming, he said, was the fact that the Reserve Bank of India had also flouted the FRBMA and started buying government securities again under the market stabilisation scheme – a dangerous spur for inflation. Intertestingly, the RBI’s April policy statement noted that the combined market borrowings of the central and state governments in 2008/09 were two and a half times the level in 2007/08.

Mukherjee said net market borrowings are likely to hit Rs 400,000 crores in 2009/10. In the first half of this fiscal year alone, the RBI has committed itself to purchase government securities under open market operations to the tune of Rs 80,000 crores. In the absence of a corporate-bond market, this means that “real interest rates” will be unrealistically high for companies who are getting muscled out of the debt markets by the government-central bank behemoth.

Mukherjee pledged to return to the “path of fiscal consolidation at the earliest”. But his ministry’s Economic Survey, published last week, said it might be time to go for an “FRBM-2” of zero fiscal deficits.

The stimulation cannot be denied – the Sixth Pay Commission is estimated to have pumped close to an additional Rs 117,000 crores ($25 billion) into government employees’ wallets since last October, and may have added 1.1 percentage points to GDP.

The OECD predicted last month that India’s GDP would likely grow at 5.9% in 2009 and 7.2% in 2010, after 6.7% in 2008/09. Mukherjee said the goal was to return to 9% growth. The stark reality is that India needs to grow at double digits if it is to address poverty, hunger, malnutrition, and illiteracy.

But the past year has laid to rest the myth that India’s “inclusive” economy shields it. Mukherjee referred in glowing terms to Indira Gandhi’s bank nationalisation 40 years ago as one of the bulwarks against global turbulence. “This is complete nonsense,” the international finance official said to me. “No Asian bank has run into any serious problems so why is India patting itself on its back? The conservatism of Asian bankers saved them.”

(This piece appeared in the Khaleej Times on July 10, 2009)