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)

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)