3 years


Mr Prime Minister, You Are Defaulting

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For all his reformist credentials, the PM is in danger of being remembered as a failure on the issue that matters most—inflation

Dear Dr Singh, this is to inform you that your EMI has been further revised due to increased interest rates prevailing in the Indian economy as a result of high inflation.

Imagine the Prime Minister of India getting a letter worded to that effect from his home loan financier. He won’t, though. Going by his affidavits filed at the time of elections, Dr Manmohan Singh is a fiscal conservative, who does not use borrowed money-—any money, actually—to speculate or invest. But he dons a decidedly different costume when he steps into his office, going all out for ‘growth’ even if the price to be paid is unbearable inflation.

It is not likely that India’s ‘A Team of reformers’, which began implementing an agenda of market reforms 20 years ago, will feel chided by the Supreme Court’s scathing remarks on ‘neo-liberals’. The apex court has characterised the economic policies of successive regimes since 1991 as ‘neo-liberal’, promoting a form of predatory capitalism guided by the ‘Washington Consensus’. This is a term often used to capture a US-advocated shift towards free market policies (which assign market forces the task of balancing economic variables on their own) that followed the displacement in the 1970s of Keynesianism (which gave State intervention a clear role in fostering economic stability). However, even the poster boy of this grand shift, Ronald Reagan, had this to say: “Inflation is as violent as a mugger, as frightening as an armed robber, and as deadly as a hit man.”

If you go by Indian officialese, inflation in India is stabilising at last year’s levels of 10-11 per cent, and not getting any worse. Still, what it means in simple terms is that last year prices of a basket of common-use products rose from Rs 100 to Rs 110, and this year they have moved to Rs 122. In other words, prices are up 22 per cent over the past two years. How reassuring does that sound?

For the 500-odd million people living below the poverty line, that assurance of ‘stability’ is about as comforting as a knife aimed at the pit of your stomach. If you are one of the  millions of home loan customers of India’s usurious banking sector (that’s another story to be recounted), your Rs 1 lakh EMI has shot up to a bothersome Rs 1.22 lakh in two years.

Reagan may be hard to recall in the era of 24x7 TV, but India’s policymakers might recall Warren Buffett, who visited some of them earlier this year, on exactly this subject. The world’s richest investor called inflation “a cruel tax on people”.

Let’s examine those words. The Union’s 1997-98 ‘Dream Budget’ of P Chidambaram, then Finance Minister, had one overriding theme—tax cuts. The middle-class and media sang hosannas to him for those tax cuts that varied from 5 to 10 per cent. But now, the same ‘dream team’ seems oblivious to this other ‘tax’ creeping up on us in the dead of night. For home loans, lenders typically lend up to what translates, in EMI terms, to about 40 per cent of a family’s income; aggressive large banks frequently cross this limit, but even at this threshold, an EMI rise of 22per cent in two years means an additional burden of 9 per cent on the borrower’s total income. That is the ‘cruel tax’ Buffett is talking about. And this inflationary phase is not even done yet. If that doesn’t sound like a nightmare…

So, is the top team in charge of managing the economy oblivious to that tax? The only good thing that can be said for inflation is that without it, there would be no football. No kicking the issue off, no passing the blame around. But if you listen to India’s top economic managers, it’s not all that bad.

Montek Singh Ahluwalia claimed in March 2010 that India must aim to slow inflation to an “acceptable” level of 5 to 6 per cent. This was a good two months after the Planning Commission’s deputy chairman had promised that raging food inflation would ease by ‘the end of next month’, saying, “The dominant part of inflation that is of concern is food price inflation. I don’t believe that is the result of excess liquidity [money, that is].” This was not a stray remark. Earlier, he had said, “Rise in food prices is hyped up.” He maintained that soaring food inflation was not a worry, arguing that the issue was being blown out of proportion since it hurt the “interests of the urban middle class” while ignoring that of “farmers”.

This was around the time that HSBC Group described the Reserve Bank of India (RBI) as ‘behind the curve’ on tackling inflation, which had exceeded the rate in all other G-20 economies. According to Goldman Sachs, India was ‘complacent’ on inflation risks. The RBI had raised its key interest rates—a tool to keep less money chasing all available goods and services, a chase that pushes prices up if there’s too much cash—by only a quarter percentage point. It was hardly enough to be effective. But Ahluwalia was impressed. “The Reserve Bank’s move clearly spells out that things need to be done to keep inflation under control,” he said.

Ahluwalia was not alone. In February 2010, RBI Governor D Subbarao had made it clear that the central bank could not focus just on inflation, given the importance of economic growth—in need of benign interest rates as a spur. He kept ‘all indicative policy rates unchanged’, while raising the RBI’s GDP growth projection for 2009-10, as also its inflation forecast. As it turned out, both growth and inflation overshot expectations.

Subbarao’s stance seemed a reversal of his ‘inflation hawk’ predecessor’s. But then, the new Governor had assumed charge in late 2008 around the time Lehman Brothers went belly-up. The odd part is, a year-and-a-half later, India was still deemed to be recovering from the Great Recession (of the West as it turned out), upon which the G-20 had called for coordinated ‘stimulus measures’—extra spending, easier lending—across the world. In a country that saw only a slight slump in demand, an over-delayed ‘exit’ from this mega money stimulus, combined with some supply shortages, was almost sure to prove inflationary.


Dissent within the RBI was muzzled. In an unprecedented move, Deputy Governor KC Chakrabarty was stripped of a large part of his job because he was seen shooting his mouth off on inflation worries. Subbarao, on his part, had this to say: “The crisis has given fresh impetus to the ‘new environment hypothesis’ that pure inflation-targeting is inadvisable, and that the mandate of central banks should extend beyond just price stability.” He argued that price stability does not ensure financial stability. Rather, “The more successful a central bank is with price stability, the more likely it is to imperil financial stability.”

By December 2010, Subbarao had to relook at inflation. He felt the rate coming down, but said it was still above the central bank’s tolerance level. Other analysts have also been proven wrong on persistently rising prices. A year ago, Chief Economic Advisor Kaushik Basu expected inflation to decline in the months ahead. “I feel we will reach the comfortable level of below 5 per cent sometime during the next fiscal [year],” Basu told PTI. He added that inflation for March was likely to be a little over 7 per cent.

It didn’t happen. The team managing the show has missed deadline after deadline. And now the stock phrases they use seem so familiar that few bother paying attention; they almost make 10 per cent annual inflation sound ‘normal’. But if you look at a decade-long graph (see alongside), you realise how devastating the last two years have been.

If you work in the private sector and missed your business forecast for two years running, chances are you will be in trouble with your boss. A strict boss may even sack you as a ‘non-performer’, while a benevolent one might transfer you to a lighter department. If you run a listed company, such frequent mis-forecasts would probably send your share price tumbling. But the Prime Minister of India simply looks the other way while his finance team messes up.

So, what now? Investment firm JP Morgan’s sense is that ‘we are probably going to see inflation well into double digits by August [which is now]. If you look at the 9.4 per cent print, we know that it’s going to be 10.2 or 10.3 per cent when the revised numbers for June come out. The diesel price hike hasn’t [yet] filtered through into price. So that’s probably another 1 percentage point. All in all, we are looking at least at about 11.5 per cent inflation by July-August.’

Rural Affairs expert P Sainath sums it up well. In the past five years, he says, we have seen the highest food price rise in Indian history. He reminds us that North Africa’s civil unrest began with protests against runaway food prices. The Indian Government, however, smugly believes that having provided NREGA, it has shielded the poor from the ravages of inflation. This is a flawed argument that assumes that anyone who is now covered by NREGA was completely unemployed earlier, and it is the Government’s benevolence that has put money onto his outstretched palm. It also ignores the system’s infamous leakages. It even ignores such basic mathematical principles that while the wages or wage hikes are for a period of 100 days a year, food prices rise all through the calendar.

Unless Team Manmohan believes that to expect a meal every day is asking for too much. If you accept the argument that the poor need to eat every day, then even single-digit inflation can turn indigence into starvation. And double-digit inflation can turn life into death.

So, how are the poor meeting their food requirements in an era of inflation? They probably go hungry. Perhaps they also borrow from the microfinance institutions (MFIs) that have boomed in the past two-three years, and are facing a crunch in collections only now, possibly because most of these loans did not finance assets, just kept kitchens running. Given that MFIs are funded by regular banks, rural impoverishment will not just impact the health of the poor, but also hurt the fiscal health of the banking sector.

What causes inflation? Excessive money chasing too few goods, as mentioned earlier, is the broad reason. There are many factors that lead to this. Product shortages, for example, have varied reasons—from crop failures to weak factory output. In the farm sector, supply-side bottlenecks have persisted for decades. Half of India’s foodgrain rots because of creaky storage, transport and distribution facilities. There has been no increase in agri-productivity, no Green Revolution II, no Operation Flood II.

On the other side of the equation, excess money in an economy is typically caused by ‘black’ funds illegally, and by large foreign exchange inflows—unless mopped up by the RBI—into domestic property and stockmarkets, legally. Crucially, how much excess money there is in the economy at any point depends on how much cash has been/is being pumped in by way of bank loans. Lately, the RBI has been moving to withdraw easy loan terms by raising key interest rates. But inflation, like fire, is hard to tame once it breaks out. The very expectation of higher prices can push up wages, costs and prices.

The solution? As a monetary measure, clamps on foreign investment in ‘hot sectors’ could cool these markets. Other inflows also need to be mopped up, which would go hand-in-hand with rising rates. Also, we need bigger cash cushions that banks must keep to make up for un-repaid loans. On the supply side, active and large investments can be spurred in supply chains and cold storage systems, even as new Green and White revolutions are set in motion. The earlier efforts impacted India’s Northern and Western states. This time round, it could be the turn of the East, with Bengal, Bihar and Orissa leading the way. Clamping down hard on commodity hoarding and speculation would help. As for fuel inflation, new investments and incentives for non-conventional energy would bring down the fuel bill, albeit slowly.

But does India have the political will? The Government seems distracted by Telangana and YSR’s rebellious son, unreliable allies such as the DMK and NCP, forthcoming polls in UP, Anna Hazare’s Lokpal agitation, cross-border terrorism, judicial overreach… the list goes on. Meanwhile, many in the media argue that Corruption is the Big Issue for India’s electorate. It could well be. But with anti-incumbency back in vogue, as state governments change across the country, could it be that the voter is also voting against incumbents in anger against inflation? While corruption rankles the voter’s mind for sure, inflation hurts directly. Shelling out extra cash for food, fuel, EMIs and other must-pays is always painful, no matter what.

Those who take comfort from the fact that there have been no mass protests against inflation forget that once a pain turns chronic, suffering it is taken in the spirit of heroic resilience, as with Mumbaikars after terror attacks. That does not mean there is no anger.

It would be comical but for the tragic consequences. India’s political leaders exit on exactly those strengths that bring them to power in the first place. Indira Gandhi ascended to power as a ‘dumb doll’, but left office in the garb of a dictator. Son Rajiv arrived as Mr Clean, but went out sullied by corruption charges. VP Singh rode to power as an atypical politician, but ended up caught in Mandal-kamandal politics. The Left Front’s greatest achievement in West Bengal was land reforms (Operation Barga), but its undoing was a land grab (Singur and Nandigram).

Is Dr Singh just upholding tradition? Letting the arenaof his success—the economy—undo his leadership? As things stand, history might judge him as the man who liberalised and boosted India’s economy, but then just let it slide when it came to containing inflation.

The Prime Minister is fond of quoting Victor Hugo, but perhaps it’s time for him to pay attention to Ernest Hemingway for a change. ‘The first panacea for a mismanaged nation is inflation of the currency,’ as he put it, ‘The second is war. Both bring temporary prosperity. Both bring permanent ruin.’