Indian economy – The problems for Chidambaram ….

Right now, the various credit rating agencies are probably the biggest saviors of the Indian economy, and are the only ones standing in the way of the ongoing destruction of fiscal principles (some would even call it the rape of the Indian economy) by the 2 UPA (chiefly Congress) Governments. But this is not something that really finds too much attention in the ongoing debates or the various investigations by the media; only through the economic discussions that happen in economic newspapers is there a serious discussion happening on this front.
In a nutshell, here is the summary of what the situation is and why it is causing significant problems for the Congress in an election year. The Congress for the past many years has believed in a strategy where it spends huge sums of money on various measures (such as loan waivers, rural jobs act, Bharat Nirman, and now the Food Security Bill) in various populist schemes and these are supposed to bring it votes. To some extent, this strategy has working in the UPA-1, where the economy was rolling along well and the Government was generating sufficient tax to fund such schemes (well, actually the deficit was going up, so the Government was increasing its spending higher than the growth in tax). But this were good and so this minor problems was ignored. The BJP claims that it was the superior policies of the NDA government which left the economy in a strong shape and the UPA-1 Government reaped the benefit of this stronger economy. However, that is a separate discussion.
When it came to time for the UPA-2 Government, the world economy had changed, with a major economic crisis underway. And within a few months, the Government was suffering the sharp wounds of the 2G scam, and other such scams which talked of wastage or theft of incredibly large sums of money. The investigations by the CAG, by the CBI under the supervision of the Supreme Court, all of these did strike fear in the heart of the Government and there was a policy paralysis that set in. The economy started sputtering, but when this was brought to the explicit attention of the Government, the Government really did nothing other than try to reassure people that it was the global problems which caused this downturn, but it was the superior abilities of the various economists in the Government who would make things right, and they could see green shoots in the economy. In the meantime, the approval of infrastructure projects had got much slower because of slower processing, and yet nobody was bothered. The consumer economy also started going down, and yet the Government would just point to the next 6 months and claim that things would get better and point to ‘green shoots’.
What was the impact of all this ? With the Government seeing a decline in its approval rating, the response was to become more populist, and so the humane and poor-concerned Sonia Gandhi, in the last year of UPA-2, decided to provide the most expensive populist measure, the Food Security Act. In the meantime, audits and other investigations have revealed huge amounts of corruptions and diversions of funds in these various schemes, and yet there are no major efforts on behalf of the Government to ensure that funds diversion does not happen, and some of this funds diversion in fact leads to greater inflation. So, the amount of funds required are huge, and seeing the policies of the Government, one is convinced that they feel that these populist measures will ensure their re-election.
But the impact of all these years of corruption, scams, paralysis, and overall deepening economic gloom is that the rate of growth of the economy has reduced drastically, and in some measures, comes to a stop. One good index, the rate of growth of car sales is actually downward for the past many months, the index of industrial production has months where it goes negative, and so on. This has lead to reduced tax collection, and when you look at this mathematically, the growth in tax collection is much lower than the growth in expenditure, and what does this mean ? It means that the deficit that the Government is incurring in the economy has to rise. And were it upto the Congress government, ministers and Rahul Gandhi, it does not matter since the need to have more populist measures is much more important. And yet Chidambaram is withstanding all these pressures and trying to hold down the deficit to 4.8%. Why so ? Because the credit rating agencies have given due warning that they believe that the Indian economy is tottering on the verge of danger unless the expenditure matches the revenue, and if they see that the Government does not take steps, they will downgrade the Indian economy. 4.8 % is what Chidambaram promised, and going beyond that is the danger zone.
A lot of people are dismissive of credit rating agencies. However, they are there, and their word matters. If they do downgrade, the Indian economy will be below investment grade and steps into the junk rating status. This will be a catastrophe for the Indian economy. It will have an incredible effect on the reputation of India, and as a practical matter, many of the large overseas investment funds have policies that prevent investing in economies which have a junk rating. Already FDI in India is lower than many other countries, and going into junk rating will cause a severe reduction in such investments. And once you get into junk rating, the amount of steps and austerity that the Government will have to take to get back to an investment rating will be much higher than what is required right now.
But when Chidambaram is trying to implement reduced allocation to various wings of the Government, he is getting a lot of push-back from other ministers who want more money to spend; already for the year to date, expenditure is higher than expected and tax revenues are lower than expected, so there is already creative accounting going on to try and park some of the liabilities for the next year to improve the figures. However, he really does not have an option, since it has been clear that the Government will not take the required steps to check the leakage in the various schemes – maybe because some of the leakage comes back to the funds of the party ?

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