Chidamabaram didn’t start the rupee fire, but India is burning because of it

Vivek Kaul
P Chidambaram, the finance minister, made the routine let’s not get worried statement, over the rupee’s recent fall against the dollar.“We are watching the situation. RBI will take whatever action it has to take. We will (do) whatever has to be done…My request is you should not react in panic. It’s happening around the world,” he said.
This was something that was reiterated by 
Arvind Mayaram, secretary of the department of economic affairs, in the ministry of finance. “No, I don’t think the government needs to take any measures…We are watching the situation closely…If you see weakening of all currencies vis-a-vis the dollar, the rupee is also not unaffected in that sense…this panic in the market is unwarranted.”
A finance minister and his bureaucrat are expected to defend a falling currency. And yes, it’s true a lot of currencies have lost value against the dollar recently. But does that make the pain any lesser for India? Are there no reasons to worry as Mayaram wants us to believe?
Chidambaram’s “it is happening around the world” argument can be tackled with a simple analogy. Let’s say one of your neighbours starts a fire by mistake, which eventually spreads to your house. What do you do in such a situation? You try and stop the fire from spreading further, rather than sitting and blaming your neighbour for it or saying that I should not panic because I did not start the fire. Irrespective of where the fire started, the damage is yours, if you do not work towards putting it off.
Even though the rupee is falling against the dollar because of 
certain actions taken by the Federal Reserve of United States, it is clearly damaging India.
A depreciating rupee means that India has to pay more in rupee terms, for its oil imports. The price of the Indian basket of crude oil was at around $98 per barrel at the beginning of June.
It rose to $104 per barrel on June 19, 2013. On June 20, 2013, it fell to $101.8 per barrel. The rupee during the same period has fallen to Rs 60 to a dollar(Rs 59.75 as I write this) from around Rs 56.5 at the beginning of .
What this means is that India’s oil import bill has gone up in rupee terms. If the government decides to pass on this increase to the final consumer in the form of an increase in the price of diesel, petrol and kerosene, then it will lead to inflation or higher prices.
In fact CNG prices have already been hiked in Delhi by Rs 2, because of a weaker rupee.
If it decides to take on a part of the increase then it means greater expenditure for the government. A greater expenditure in turn means a higher fiscal deficit for the government. Fiscal deficit is the difference between what a government earns and what it spends. A higher fiscal deficit means that the government has to borrow more to finance its expenditure and this leads to higher interest rates, which holds back economic growth.
Coal is another big import item. With the rupee losing value against the dollar the cost of importing coal is going up. Coal in India is imported typically by private power companies to produce power. The government owned Coal India Ltd, does not produce enough coal to meet the needs. The Cabinet Committee on Economic Affairs recently 
decided to allow private power companies to pass on the rising cost of imported coal to consumers.
This will lead to a higher cost of power, which will add to inflation. 
As Anand Tandon writes in The Economic Times “Inflation at the consumer level will start hotting up in the third quarter of the fiscal year as increases in power and fuel cost work their way through the system.”
A depreciating rupee will benefit Indian exporters, or so goes the argument. As rupee loses value against the dollar, an exporter who gets paid in dollars, gets more rupees, when he converts those dollars into rupees, thus boosting his profits.
This argument doesn’t really hold. 
The Economic Times quotes Anup Pujari, director general of foreign trade (DGFT), on this issue. “It is a myth that the depreciation of the rupee necessarily results in massive gains for Indian exporters. India’s top five exports — petroleum products, gems and jewellery, organic chemicals, vehicles and machinery — are so much import-dependent that the currency fluctuation in favour of exporters gets neutralised. In other words, exporters spend more in importing raw materials, which in turn erodes their profitability.”
The other thing that seems to be happening is that in a tough global economic environment, buyers are renegotiating contracts with Indian exports as the rupee loses value against the dollar.”The moment the rupee falls sharply against the dollar foreign buyers try to renegotiate their earlier deals. As most exporters give in to the pressure and split the benefits, the advantages of a weak rupee disappear,” Pujari told 
The Economic Times.
What this means is that a weaker rupee is unlikely to lead to higher exports. This means that the trade deficit or the difference between imports and exports will continue to remain high, which can weaken the rupee further against the dollar.
In fact, a depreciating rupee has rendered 
nearly 25,000 diamond workers in Surat jobless, reports The Times of India. “The depreciating rupee has resulted in nearly 1,200 small and medium diamond unit owners in shutting shops as they are unable to purchase rough stones whose prices have touched an all-time high. This has led to at least 25,000 workers being rendered jobless since last Thursday,” the report points out.
The rupee could have fallen to a much lower level against the dollar, but it did not. This is primarily because the Reserve Bank of India(RBI) has been defending the rupee, by selling dollars from its foreign exchange reserves, and buying rupees.
But the question is till when can the RBI keep selling dollars? “Foreign exchange reserves are barely sufficient to cover seven months of imports — the lowest it has been in the last 15 years. As a comparison, the other Bric members have 19-21 months of import cover,” writes Tandon. 
According Bank of America-Merril Lynch, the RBI can sell up to $30 billion to support the rupee.
The RBI cannot create dollars out of thin air, only the Federal Reserve of United States can do that.
Given this, there are reasons to worry. And yes, the Chidambaram’s UPA government did not start this rupee fire, but that does not mean that India is not burning because of it.

The article originally appeared on on June 25, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Why Ben Bernanke must be now singing the Hotel California song

ben bernanke
Vivek Kaul
Ben ‘Shalom’ Bernanke is the Chairman of the Federal Reserve of United States, the American central bank. In the Monetary Policy Report to the Congress issued on March 1,2011, the Bernanke led Federal Reserve had assured the world at large that they had the tools needed to “remove policy accommodation at the appropriate time.”
In simple English what it meant was that as and when needed the Federal Reserve would stop printing money and at the same time be able to gradually withdraw all the money that they had printed and pumped into the financial system. This could be done without much hassle.
In the aftermath of the financial crisis starting in mid September 2008, the Federal Reserve of United States had started to print dollars and pump them into the financial system. This was done to ensure that there was enough money going around and thus interest rates continued to remain low. At low interest rates the hope was that the American consumer would start borrowing and spending money again. And this spending would help revive the American economy, which had slowed down considerably in the aftermath of the financial crisis.
This process of printing money in the hope of reviving economic growth came to be referred as “quantitative easing”. The risk with quantitative easing as is the case with all money printing was that too much money would chase the same number of goods and services, and push up their prices considerably. Hence, there was a risk of high inflation. Given this, at an appropriate time the Federal Reserve would have to stop money printing and gradually pump out all the money they had printed and pumped into the financial system.
Speaking to the media on June 19, 2013, Bernanke said
If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year…And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year.
Bernanke further said that “in this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7%, with solid economic growth supporting further job gains.”
What he meant by this was that if the American economy keeps improving and growing, the Federal Reserve would reduce money printing gradually later this year and would totally wind it down by the middle of next year. The Federal Reserve prints $85 billion every month to buy both private and government bonds. It pays for the bonds it buys by printing dollars. This is how it pumps printed money into the financial system and ensures that interest rates continue to remain low.
The idea of the Fed first going slow on money printing and then stopping it totally, has sent markets (stock,bond and commodity) around the world into a tizzy. When the Federal Reserve started printing money to keep interest rates down, the hope was that it would manage to get the American consumer borrowing and spending again.
But that did not happen at the same pace as the Federal Reserve hoped it would, given that the American consumer was just coming out of one round of a huge borrowing binge and wasn’t in the mood to start borrowing all over again. Meanwhile the financial system was flush with money available at close to 0% interest rates. This led to big financial investors (the investment banks and the hedge funds of the world) spotting an opportunity.
They could borrow money at very low interest rates and invest it all across the world, and make huge returns. This trade, where money was borrowed in American dollars and invested in financial assets all across the world, came to be referred as the dollar carry trade.
The difference between the return the investors make on their investment and the interest that they pay for borrowing money in dollars is referred to as the ‘carry’ they make.
The dollar carry trade would work only as long as the interest rates in the United States continued to remain low. Bernanke’s recent statement made it very clear that chances were that the Federal Reserve would gradually wind down on money printing. This meant that the financial system would no longer be flush with money as it had been, in turn leading to higher interest rates. Or as Bernanke put it “if interest rates go up for the right reasons – that is, both optimism about the economy and an accurate assessment of monetary policy – that’s a good thing. That’s not a bad thing.”
This is as clear as a central banker can get and has led to a bloodbath in markets all over the world. The Dow Jones Industrial Average, America’s premier stock market index fell by 353.87 points to close at 14,758.32 points yesterday. The BSE Sensex fell by 526 points to close at 18,719.29 points yesterday.
Stock markets in other parts of the world fell as well. This was primarily on account of the unravelling of the dollar carry trade. With American interest rates expected to go up, investors were busy withdrawing their money from various markets and repatriating it back to the United States.
The wave of selling in the Indian bond market was so huge that the market had to be briefly shut down yesterday when there were only sellers and no buyers in the market. This also had a huge impact on the rupee dollar rate. When foreign investors sell out of Indian financial assets they get paid in rupees. When they repatriate this money back into the United States the rupees need to be converted into dollars. So the rupees are sold to buy dollars from the foreign exchange market.
When this happens there is a surfeit of rupees in the market and a huge demand for dollars. This has led to the rupee rapidly losing value against the dollar. Around one month back one dollar was worth Rs 55. Yesterday one dollar was worth close to Rs 60. It touched Rs 59.98 during the intra day trading.
In fact the big financial investors are even selling out on American government bonds. The return on 10 year American treasuries rose to 2.42% yesterday as investors sold out of these bonds. The 10 year American treasury is a bond issued by the American government to finance its fiscal deficit or the difference between what it earns and what it spends. In the beginning of May, the return on the 10 year American treasuries was at 1.63%.
It is important to understand here that interest rates and bond prices are inversely correlated i.e. an increase in interest rates leads to lower bond prices. And given that interest rates are expected to rise, the bond prices (including that of the 10 year American treasury) will fall. Hence, investors wanting to protect themselves against losses are selling out of these bonds. When investors sell out on bonds there prices fall. At the same time the interest that is paid on these bonds by the government continues to remain the same, thus pushing up overall returns for anybody who buys these bonds.
This explains why the return on the 10 year American treasury bond has been going up. The trouble is that the return on the 10 year American treasury acts as a benchmark for interest rates on all kinds of loans from home loans to dollar carry trade loans. So if the return on the 10 year American treasury is going up, then the interest rates on all kinds of loans goes up as well. This is because the government is deemed to be safest lender and hence returns on all kinds of other loans need to be higher than the return made on lending to the government.
Rising interest rates could very well put the American economic recovery in a jeopardy, which wouldn’t have been the idea behind what Bernanke said two days earlier.
What this tells us is that investors and markets all around the world haven’t really liked Federal Reserve’s decision to wind down money printing in the months to come and are voting against it. Also, Bernanke had clearly said that the Federal Reserve had no plans of withdrawing all the money it had printed and pumped into the financial system. It was only planning to go a little slow on the money printing. Or as Bernanke put it
akin to letting up a bit on the gas pedal.”
“Putting on the monetary brakes would entail selling bonds out of the Fed’s portfolio, and that’s not happening any time soon,” Bernanke said.
As has been pointed out earlier, the Federal Reserve had been buying bonds to pump the money that it is printing into the financial system. When it wants to withdraw this money it will have to start selling back all the bonds that it has bought. But there are clearly no such plans.
So even the idea of the Federal Reserve slowing down money printing is not acceptable to the market and the big financial investors, who have got so used to the idea of ‘easy money’ and all the benefits that it has brought to them.
Imagine what would happen once the Federal Reserve wants to start sucking out all the money that it has printed and pumped into the market. Just the idea of going slow on money printing has led to a market mayhem all over the world. Ben Bernanke and the Federal Reserve are now finding out that removing the so-called policy accommodation is going to be nowhere as easy as they thought it would be more than two years back.
Or as the last few lines of
Hotel California sung by The Eagles go “We are programmed to receive. You can check-out any time you like, But you can never leave.” Chances are Ben ‘Shalom’ Bernanke must be humming that number right now.
The article originally appeared on on June 21, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)

Mr Chidambaram, India's love for gold is just a symptom, not a problem

Vivek Kaul 
P Chidambaram, the union finance minister, has been urging Indians not to buy gold. But we just won’t listen to him.
In the month of May 2013, India imported $8.4 billion worth of gold, up by 90% in comparison to May 2012. This surge in gold imports pushed up 
the trade deficit to $20.14 billion in May. It was at $17.8 billion during April 2013. Trade deficit is the difference between the merchandise imports and exports. Commerce Secretary S R Rao said “As far as trade deficit is concerned, it is very worrisome…It is largely contributed by heavy imports of gold and silver.”
A trade deficit means that the country is not earning enough dollars through exports to pay for all that it is importing. To correct this, it either needs to increase its exports and earn more dollars to pay for imports or cut down on its imports. Indian exports have been growing at a very slow pace. In fact they fell by 1.1% in May 2013 to $24.5 billion. Imports on the other hand rose by 7% to $44.65 billion.
The trouble is that when India imports gold it pays for it in dollars. Indian rupees are sold to buy these dollars. Given this there is a surfeit of rupees in the market and a scarcity of dollars, pushing up the value of the dollar against the rupee. This leads to the country paying more for imports in rupee terms.
Hence, the logic goes that India should not be importing as much gold as it is. 
Or as Chidambaram said a few days back “I would once again appeal to everyone please resist the temptation to buy gold…If I have one wish which the people of India can fulfill is don’t buy gold.”
But the same logic applies to oil as well. India imported $15 billion worth of oil in May 2013. Of course, oil is more useful than gold, and we need to import it because we don’t produce enough of it.
And given that gold is as useless as something can be, we don’t need to import it. Or as Chidambaram said “I continue to hope and suppose if the people of India don’t demand gold if we don’t have to import gold for a year just imagine the whole situation will so dramatically change. Every ounce of gold is imported. You pay in rupees, we have to provide dollars.”
So what comes out of all this is that the government does not want Indians to buy gold. It recently increased the import duty on gold to 8% from 6% earlier. 
Chidambaram even set a personal example when he recently said “I don’t buy gold, I put my money in financial instruments and I am happy.”
There are multiple problems with what Chidambaram is saying. The first and foremost is the fact that buying or not buying gold is a free economic decision that people choose to make. Or as economist 
Bibek Debroy wrote in a column in The Economic Times “The gold policy is futile because buying gold is a free decision of rational economic agents and gold imports are a symptom, not the disease.”
And what is the symptom? The symptom is the high consumer price inflation that prevails. People have been buying gold to hedge themselves against that inflation. 
As the Economic Survey of the government for the year 2012-2013, released in February pointed out “Gold imports are positively correlated with inflation: High inflation reduces the return on other financial instruments. This is reflected in the negative correlation between rising imports and falling real rates.”
What this means is that because inflation is high the real rate of return on financial instruments is very low. Why would people invest in a financial instrument like a fixed deposit or a PPF account or a National Savings Certificate, at an interest of 8-9%, when the consumer price inflation is higher than that? So what do they do? They invest in gold because they have been told over the generations, that gold holds its value against inflation.
Chidambaram has asked people not to buy gold and even gone to the extent of saying that he does not buy the yellow metal and puts his money in financial instruments. Of course, being the finance minister of the country he is unlikely to face any problems while investing in financial instruments.
But here is a small suggestion. Chidambaram should try investing in a mutual fund once on his own without going through a bank or an agent. And the bizarre number of requirements that need to be fulfilled to invest in a mutual fund, will give him a real flavour of how difficult it is to invest for an individual to invest in a mutual fund.
Or take the case of a senior citizen who invests his retirement funds in the senior citizen savings scheme run by the post office and is given a thorough run-around every time he has to go and collect the interest on the money that he has deposited.
Or take case of the spate of smses banks recently sent out to their customers asking them to furnish documents and account opening recommendations, even when customers have had accounts for more than a decade.
Given this, it is not surprising that people buy gold which is available hassle free over the counter. The Economic Survey nailed it when it said “The overarching motive underlying the gold rush is high inflation and the lack of financial instruments available to the average citizen, especially in the rural areas. The rising demand for gold is only a “symptom” of more fundamental problems in the economy. Curbing inflation, expanding financial inclusion…and improving saver access to financial products are all of paramount importance.” Hence, people will continue to buy gold when they want to, irrespective of the appeals made by Chidambaram.
Inflation is something that the government of this country has created. And when people protect themselves against it, you can’t hold them responsible for creating other problems.
When a country runs a trade deficit it doesn’t earn enough dollars to pay for its imports through exports. What happens in this situation is that dollars coming in through other sources like foreign direct investment, foreign institutional investment and citizens living abroad, are used to finance imports.
In India’s case remittances a well as deposits made by NRIs play an important part in filling up the trade deficit gap. 
As Andy Mukherjee points out in a column in the Business Standard “For every rupee of time deposits that Indian banks have raised from residents in the past year, 13
paise has come from the estimated 25 million people of Indian origin who live in other countries.”
World over interest rates on savings deposits are at very low levels. The same is not true about India where interest rates continue to remain high and hence it makes sense for NRIs to invest money in India.
But this investment carries the currency risk. Lets understand this through an example. An NRI decides to invest $100,000 in India. At the point of time he gets his money into India, one dollar is worth Rs 50. So he has got Rs 50 lakh to invest. He invests this in a bank which is offering him 10% interest. At the end of the year he gets Rs 55 lakh (Rs 50 lakh + 10% interest on Rs 50 lakh).
Now lets say a year later $1 is worth Rs 55. So when the NRI converts Rs 55 lakh into dollars, he gets $100,000 (Rs 55 lakh/55) or the amount that he had invested initially. Hence, he does not make any return in the process. This is because the Indian rupee has depreciated against the dollar, which is something that has been happening lately. This is the currency risk.
In this scenario, the NRIs are likely to withdraw their deposits from India because if the rupee keeps losing value against the dollar, chances are they might face losses on their investments. When NRIs repatriate their money, they sell rupees and buy dollars. This leads to a surfeit of rupees and shortage of dollars in the market, and thus leads to the rupee depreciating further.
This is a scenario that is likely to play out in the days to come. Over and above this there is also the danger of foreign institutional investors continuing to withdraw money from the Indian debt market, as they have in the recent past.
This danger has become even more pronounced with Ben Bernanke, the Chairman of the Federal Reserve of United States, the American central bank, announcing late last night that they would go slow on money printing.
As he said “the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.”
The Federal Reserve prints dollars and uses them to buy bonds to pump money into the financial system. This ensures that interest rates continue to remain low as there is enough money going around.
As and when the Federal Reserve goes slow on money printing, the American interest rates will start to go up (in fact they have already started to go up). Given this the investors who had been borrowing in the United States and using that money to invest in India, would be looking at a lower return as they will have to pay a higher interest on their borrowing.
A prospective lower return could lead to some of these investors to sell out of India. In fact as I write this the bond market has come to a halt because there are only sellers in the market and no buyers. Such has been the haste to exit India.
When foreign investors sell out of bonds (and stocks for that matter) they get paid in rupees. This money needs to be repatriated to the United States and hence needs to be converted into dollars. So the rupees are sold to buy dollars from the foreign exchange market.
When this happens there is a surfeit of rupees in the market and a huge demand for dollars. This has led to the rupee rapidly losing value against the dollar. Around one month back one dollar was worth Rs 55. Now its worth close to Rs 60 ($1 equals Rs 59.9 to be precise).
A lower rupee means that the price of gold is likely to go up in rupee terms. And this can attract more investors into gold pushing up India’s gold import bill further. But then do we blame for the gold investor for that? And if that is the case why not ban all speculation, starting with real estate.
The article originally appeared on on June 20, 2013

(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Before Bernanke’s statement: Why foreign investors are selling out on bonds

3D chrome Dollar symbol
Vivek Kaul
The foreign institutional investors have sold out $4.6 billion worth of bonds from the Indian debt market over the last one month. This is primarily because of the unwinding of the dollar carry trade.
In the aftermath of the financial crisis that started in September 2008, the Federal Reserve of United States, the American central bank, started printing truckloads of money. This money was flushed into the financial system. The idea being with enough money going around, the interest rates would remain low. At low interest rates American citizens were more likely to borrow and spend. And this spending would create economic growth, which had fallen dramatically in the aftermath of the crisis.
The trouble of course was that Americans were just coming out from a horrible round of borrowing binge which had gone all wrong. And given that they were in no mood to borrow more. They first wanted to pay off their existing loans. So the financial system was flush with money available at low interest rates but the American citizens did not want to borrow.
This led to banks and other financial institutions borrowing at very low interest rates and investing that money in different financial markets across the world. This trade came to be known as the dollar carry trade. Money was raised in dollars at low interest rates and invested in stock, bond and commodity markets all over the world.
The difference between the return the investors make on their investment and the interest that they pay for borrowing money in dollars is referred to as the ‘carry’ they make.
This trade has been a boon to big financial firms which were reeling in the aftermath of the financial crisis and has helped them back on their feet. But like all things which seem ‘good’, this might be coming to an end as well.
Later today the Federal Open Market Committee(FOMC) of the Federal Reserve will issue a statement in which it is likely to hint that it will cut down on further money printing. Ben Bernanke, the Chairman of the Federal Reserve, 
hinted about it in a testimony to the Joint Economic Committee of the American Congress on May 23, 2013.
As he said “if we see continued improvement and we have confidence that that is going to be sustained, then we could in — in the next few meetings — we could take a step down in our pace of purchases.”
The Federal Reserve pumps money into the American financial system by printing money and using it to buy bonds. This ensures that there is no shortage of money in the system, which in turn ensures low interest rates.
What Bernanke said was that if the Federal Reserve feels that the economic scenario is improving, it would taper down the bond purchases. This basically meant that the Federal Reserve would go slow on money printing.
If and when that happened, the interest rates would start to go up as the financial system would no lunger be slush with money. In fact the interest rates have already started to go up. The return on the 10 year US treasury bond has gone up. On May 2, 2013, the return was at 1.63%. As on June 18, 2013, the return had shot up to 2.19%. A US treasury bond is a bond issued by the American government to finance its fiscal deficit. The fiscal deficit is the difference between what a government earns and what it spends.
The return on 10 year US treasury acts as a benchmark for the interest rates on other loans. If the return on 10 year US treasury goes up, what it means is that interest charged on other loans will also go up in the days to come.
This means that those financial institutions which have borrowed money for the dollar carry trade will be paying a higher interest. A higher interest would mean a lower return on investment on their trade i.e. a lower carry.
This is the reason why these investors are unwinding their dollar carry trade. In an Indian context this has meant that they have been selling out on the bonds they had invested in. As mentioned earlier over the last one month the foreign investors have sold bonds worth $4.6 billion.
When the foreign investors sell these bonds they get paid in rupees. This money needs to be repatriated to the United States and hence needs to be converted into dollars. So the rupees are sold to buy dollars from the foreign exchange market.
When this happens there is a surfeit of rupees in the market and a huge demand for dollars. This has led to the rupee rapidly losing value against the dollar. Around one month back one dollar was worth Rs 55. Now its worth close to Rs 59 (around Rs 58.75 as I write).
The question that arises here is how are the foreign investors reacting in the stock market? They have much more invested in the stock market than they had in the bond market.
Over the last one month the foreign institutional investors have bought stocks worth Rs 382.88 crore, which is a low number, though in the positive territory. In the month of May 2013, the foreign investors had bought stocks worth Rs 14,465.90 crore. Since the beginning of this year they have bought stocks worth Rs 57,644.33 crore.
So that tells us very clearly that foreign institutional investors are going slow even on their stock purchases. But they haven’t sold out on stocks totally, as they have in case of bonds. The answer lies in the fact that returns in the bond market are limited. The return on the 10 year India government bond was at 7.28% as on June 18,2013. The borrowing costs for the foreign investors have gone up. A depreciating rupee also limits their overall return. So it makes sense for them to get out of bonds.
In case of the stock market there is no limit to the overall return that can be made. And that explains to some extent why the bond market has borne the brunt of the unwinding of the dollar carry trade. How things pan out from here depends on what the Bernanke led FOMC says later tonight.
The article originally appeared on on June 19,2013.

(Vivek Kaul is a writer. He tweets @kaul_vivek)

Why Nitish Kumar 'really' dumped Modi led BJP

Vivek Kaul 
The Nitish Kumar led Janata Dal (United) (JD-U) ended its 17 year old alliance with the Bhartiya Janata Party (BJP) yesterday afternoon. This was on account of the fact that the BJP has or more less declared Narendra Modi as its prime ministerial candidate, something which did not gone down well with Kumar and JD(U) and thus led to the split.
While prima facie it might seem to be a clash of two strong personalities i.e. Modi and Kumar, there is much more to the split than that. In order to understand the real reason behind the split one has to understand the caste politics of Bihar in its most basic form.
Nitish Kumar belongs to the 
kurmi caste which is the numerically too small to help him win elections. At the same time the people belonging to the caste are geographically concentrated and not spread out throughout the state. The kurmis form around 3.5% of the state’s population. In comparison, the yadavs, who back Lalu Prasad Yadav, Nitish’s biggest political rival in the state, form 11.7% of the population.
Given this, over the years Nitish has had to chip away at votes from other castes. This has included wooing the 
mahadalits (primarily the non Paswan schedule castes, which included Dalits other than the Dusadh, Chamar, Pasi and Dhobi) and the extremely backward classes or the EBCs (primarily the non yadav backward classes). The EBCs formed 32% of the state’s population but had only a 5% representation in the state assembly.
It has also included wooing the backward caste Muslims i.e. the 
pasmandas. This was what helped Nitish Kumar break Lalu Prasad Yadav’s MY or Muslim-Yadav formula. The MY formula was the main reason behind Lalu winning successive elections despite the governance in Bihar almost coming to a standstill. Muslims form 16-17% of the population in Bihar which is much more than 9.9% nationally.
What is interesting here is that even though Lalu Yadav successfully wooed the Muslims, when it came to distributing goodies he concentrated on the upper caste Muslims i.e. the 
Manjur Ali studies this phenomenon in a research paper titled 
Politics of ‘Pasmanda’ Muslims : A Case Study of BiharAs he writes “Lalu Prasad Yadav in the name of M-Y (Muslim-Yadav) alliance has promoted the FM-Y (Forward Muslim-Yadav) alliance, where major benefits were cornered by Ashraf Muslims in the name of the community… Unemployment, poverty and apathy of the state towards their problems were never raised by the Bihar Ashraf political elites ..The RJD made fourteen Muslims MLCs, out of which twelve were upper-caste Muslims. Again, there were seven appointments made for the post of Vice Chancellor, all from upper castes. Similarly, appointment to government posts like teachers, posts in the police department and in minority institutions were allotted to the sharif people. In turn, Lalu received blessings from religious leaders belonging to the upper castes for his electoral victory.”
Nitish Kumar was sympathetic to the cause of the backward caste Muslims while Lalu Yadav took the Muslim support for granted. On October 8, 2005, seven 
pasmanda political parties issued a clarion call to defeat Lalu Yadav’s Rashtriya Janata Dal (RJD) in the state assembly elections. Slogans like ‘Vote hamara fatwa tumhara, nahi chalega’ (your dictate on our vote will not work) and ‘jo pasmanda ki baat karega, wahi Bihar pe raaj karega’ (those who concede the demand of Pasmanda will rule Bihar) became the order of the day.
This split in the Muslim vote along with other caste alliances that had been built, helped Nitish Kumar become the Chief Minister of Bihar in November 2005. In fact he first realised the power of the Muslim vote in 2004. The BJP-JD(U) alliance won just 11 out of the 40 Lok Sabha seats in the state. This despite the fact that people of the state were fed up with the misrule of Lalu Yadav and Rabri Devi. But the Muslims had not been voting for the BJP-JD(U) alliance and punishing it for the Gujarat riots of 2002.
In the state assembly elections of 2005, Nitish Kumar wooed the 
pasmanda Muslims and did not allow Narendra Modi to campaign in Bihar. The JD(U)-BJP alliance did very well winning 143 out of the 243 seats in the state assembly. This anti Modi stand continued and the alliance did very well in the state in the 2009 Lok Sabha elections and 2010 state assembly elections as well. He also ensured that Modi did not campaign in these elections as well. So Nitish Kumar has found his anti-Modi stand reap electoral benefits in the past.
Hence, any direct association with the BJP which has Narendra Modi at the top would clearly have cost Kumar the 
pasmanda votes and helped his bete noire Lalu Yadav resurrect his MY formula. In fact, in the recently concluded Lok Sabha by election in Mahrajganj, the RJD candidate won by 1.37 lakh votes. The worrying thing here for Kumar was that Muslims seem to have voted for the RJD enmasse. This was the final nail in the coffin for the BJP-JD(U) alliance.
Critics of Nitish Kumar have repeatedly asked that why did he continue in the NDA government in Delhi after the 2002 Gujarat riots. If he had a problem, he should have quit then. Why wait for 11 years? While this seems like a valid point that is not how things work in politics.
In 2002, and till very recently, Modi was nowhere in the national scheme of things for the BJP. Hence, there was no direct association between Nitish Kumar and Modi. But now with Modi being BJP’s prime ministerial candidate the Muslim vote would have moved enmasse to RJD, which is something that Kumar could ill-afford. In the past Nitish managed to keep Modi away from Bihar, but now with Modi being the prime ministerial candidate for the BJP that would not have been possible.
That’s one part of the story. The caste alliances that Nitish Kumar built were one reason behind the success of the BJP-JD(U) alliance. Nevertheless the alliance was also helped by the upper caste vote that the BJP brought with it. The Brahmins, Rajputs, Bhumihars and Kayasthas, form the upper castes and account for around 16% of votes in Bihar.
The upper castes formed the icing on the cake. In fact, the JD(U) leader and former convener of NDA, Sharad Yadav, admitted to as much when he said after the 2005 win: “We had the masses with us but I am not sure we would have won such a landslide without the BJP. Although some JD(U) members wanted to break from BJP, we realised that it was the BJP which had the support system – the upper-caste dominated press, bureaucracy and judiciary. Though Nitish led from the front, the BJP played its part in this win.”
Manish K Jha and Pushpendra summarise the situation very well in their 2012 research paper 
Governing Caste and Managing Conflicts Bihar, 1990-2011 “Nitish Kumar had assiduously worked to bring together a coalition of Kurmis, Koeris, EBCs, lower Muslims (Pasmanda) and Mahadalits. and the upper-caste and business-community support-base of his party’s coalition partner, BJP. Finally, in November 2005 assembly elections, EBCs consolidated their votes in alliance with lower caste Muslims and upper castes and RJD regime was replaced by the JD(U)-BJP coalition.”
In a state as feudal as Bihar is, for any party the support of the upper castes is a huge help. What the BJP also brings with itself is the RSS cadre, which is a huge help during 
the election process, from campaigning to manning booths to having the right electoral agents at the right booths. This is something that Nitish would have realised during the recent Maharajganj Lok Sabha poll.
One possibility for Nitish is to align with the Congress to make up for the loss of the votes that BJP brought in. The Congress has already started sending feelers regarding an alliance. There are two problems with this approach. The first problem is that the Congress is more or less dead in the state. Hence, any alliance between the two parties is going to benefit the Congress more than the JD(U).
And the second problem is that the Congress already has an alliance with Lalu Yadav’s RJD. And aligning with Lalu won’t go well with the political plank of development that Nitish has built and also delivered on. Any political leader who stands for economic development can’t be seen aligning with Lalu Yadav, the very antithesis of development. But as they say funnier things have happened in politics.
Given these reasons, Nitish Kumar and JD(U) will be worse off after the split with the BJP, but only slightly. Nitish’s bigger interest here seems to hold back Lalu Yadav from resurrecting his MY alliance and from the way things stand here, he should be successful at that.
As far as the BJP is concerned it will continue to get the support of the upper castes in the state. But that in itself will not be enough to win a substantial number of the 40 Lok Sabha seats. In the current Lok Sabha, the BJP-JD(U) alliance had 32 seats from the state.
Also, it is worth remembering that Hindutva was never really a big issue in Bihar. Even after Lalu Yadav arrested Lal Krishna Advani during the course of his 1990 
Rath Yatra, the state continued to remain peaceful. So BJP’s attempts to resurrect this issue (as it is plans to in Uttar Pradesh by appointing Modi’s lieutenant Amit Shah as in-charge of the party in the state) won’t really work in Bihar. Given these reasons, it will be difficult for the party to win more than 10 Lok Sabha seats from the state, on its own. Hence, Modi will have to work more magic in other states so as to ensure that the party wins enough seats on its own so that potential allies are attracted to it at least after the elections.
The article originally appeared on on June 17,2013 

(Vivek Kaul is a writer. He tweets @kaul_vivek)