Joseph Heller’s Catch 22 remains one of the literary classics of the twentieth century. Set during the course of the Second World War, the book gave a new phrase to the English language. As a paragraph from the book goes:
There was only one catch and that was Catch-22, which specified that a concern for one’s safety in the face of dangers that were real and immediate was the process of a rational mind. Orrwas crazy and could be grounded. All he had to do was ask; and as soon as he did, he would no longer be crazy and would have to fly more missions. Orr would be crazy to fly more missions and sane if he didn’t, but if he were sane he had to fly them. If he flew them he was crazy and didn’t have to; but if he didn’t want to he was sane and had to.
Orr is a bomber pilot who keeps getting shot down. He has been shot down seventeen times, which is more than anyone else in his unit. Given that he is deemed crazy to still be flying. All he has to do to be grounded is to ask. But the catch is that the moment he asks he would no longer be be deemed to be crazy. He would be sane and being sane he would have to fly more missions.
This catch was the Catch 22. Over a period of time such a hopeless no win situation that Orr was in, came to be referred in the English language as a Catch 22.
The Indian economy is currently in a Catch 22 situation. The government of India had a total expenditure of Rs 7,12,671 crore, during the course of 2007-2008 (i.e. the period between April 1, 2007 and March 31, 2008). This grew by nearly 44% over the next two years and during the course of 2009-2010 (i.e. The period between April 1, 2009 and March 31,2010), the total expenditure stood at Rs 10,24,487 crore.
Increasing expenditure is not a problem if its met by increasing income. But that wasn’t the case here. Between 2007-2008 and 2009-2010, the revenue receipts of the government (or the income that the government hopes to earn every year) grew by a minuscule 5.7% to Rs 5,72,811 crore.
Some part of the increase in expenditure was met by selling shares that the government held in public sector companies. But a major part of the increase was met by simply borrowing more. The borrowings and other liabilities of the government shot up from Rs 1,26,912 crore to Rs 4,18,482 crore, a massive jump of nearly 230%, during the period.
The good part of this massive increase in government expenditure was that the Indian economy continued to grow at very high rates, even though economic growth in large parts of the world was slowing down in the aftermath of the financial crisis that had erupted after the investment bank Lehman Brother went bust in September 2008.
The Indian economy grew by 8.6% in 2009-2010 and 9.3% in 2010-2011. And the Indian politicians opened their champagne bottles and told us that India had decoupled from the global economy. As Sajjid Chinoy of JP Morgan writes in the Business Standard “The charitable (but incorrect) interpretation is that India successfully decoupled from the global economy, returned to its nine per cent growth path post-Lehman.”
The formula seemed to be working and so the government continued with it. For 2012-2013 (the period between April 1, 2012 and March 31, 2013), the government expenditure was expected to come in at Rs 14,30,825 crore. This meant that the government expenditure more than doubled between 2007-2008 and 2012-2013. This when the revenue receipts of the government went up by around 61% to Rs 8,71,828 crore, during the same period.
The borrowings and other liabilities of the government during the same period went up by 310% to Rs 5,20,925 crore. The government borrows money to make up for the difference between what it earns and what it spends. This difference is referred to as the fiscal deficit.
If the economic growth rate of 2009-2010 and 2010-2011 was anything to go by the Indian economy should have continued to grow at the same pace, given that the government was spending more and more money.
But that did not turn out to be the case. Numbers released on February 28,2013, suggested that the Indian economy grew by 4.5% during the three month period ending on December 31,2012. This was the lowest in fifteen quarters.
So what happened that led to the economic growth rate falling by half? Initially increased government expenditure translated into economic growth. As the government spent more money those who got that money benefited. They spent that money by goods and services, and this translated into higher economic growth. But two other things happened as well.
As the government went around spending more it led to a higher inflation. More money chased the same amount of goods and services leading to higher prices. Food inflation rose at a much faster pace than overall inflation.
Higher prices meant that people were spending more to meet their regular expenditure. And this meant lower savings. In the year 2009-2010 the household savings stood at 25.2% of the GDP. In the year 2011-2012 the household savings had fallen to 22.3% of the GDP. Even within household savings, the amount of money coming into financial savings (i.e. bank deposits, life insurance funds, pension and provident funds, shares and debentures) fell at a faster rate. As the Economic Survey that came out before the budget pointed out “Within households, the share of financial savings vis-à-vis physical savings has been declining in recent years…Financial savings accounted for around 55 per cent of total household savings during the 1990s. Their share declined to 47 per cent in the 2000-10 decade and it was 36 per cent in 2011-12. In fact, household financial savings were lower by nearly Rs 90,000 crore in 2011-12 vis-à-vis 2010-11.”
So we have a situation were the government has been borrowing more and the overall household financial savings have also come down. When the government borrows more it “crowds out” and leaves a lower amount of savings for the banks and other financial institutions to borrow from. This leads to higher interest rates on deposits and hence higher interest rates on loans.
Higher interest rates to some extent have killed economic growth as people have bought fewer homes, cars, consumer durables etc. Corporates have also postponed their expansion plans. So increased government which drove economic growth between 2009-2011, has pulled it down since then as interest rates as well inflation have remained high.
So does this mean that the government expenditure needs to be cut? Yes and no. If interest rates and inflation have to come down, the government expenditure and hence borrowing need to come down. But with the private sector and households going slow on spending money, if the government expenditure is also cut, it will slowdown economic growth even further. So that’s the Catch 22 situation that the Indian economy has been put in.
As Chinoy puts it “A tightening fisc and slowing growth are seen as coincidental. Markets applaud fiscal discipline, but bemoan weak growth. But these are not independent phenomena. Instead, they are inextricably linked. Fiscal austerity impinges upon growth. A reduction in the deficit has a contractionary impact on activity.”
In fact this can already be seen in the Indian context. During the second half of 2012-2013, the government cut down on expenditure as it feared a downgrade by international rating agencies. The targeted expenditure for the year stood at Rs 14,90,925 crore. It was revised to a Rs 14,30,825 crore, which was 4% lower. And this has had an impact of economic growth. “On a cyclically adjusted basis, India’s deficit was reduced by a whopping 1.5 per cent of GDP in 2012-13 – largely by squeezing expenditures. No wonder the slowdown was accentuated further,” writes Chinoy.
Getting out of this Catch 22 situation is difficult. It makes immense sense for the government to cut down on expenditure. Only that can drive down interest rates and inflation and thus revive genuine economic growth. But that of course will take time to happen and meanwhile the economic growth will slowdown further. Given that Lok Sabha elections are due next year, it is not hard to figure out what the government is likely to do.
The government’s targeted expenditure for the year 2013-2014 (i.e. the period between April 1, 2013 and March 31, 2014) is at Rs 16,65,297 crore, which is 16.4% higher than the last financial year. Given this a scenario of high inflation and high interest rates is likely to continue in this financial year as well. And that is no April Fool’s joke.
The article originally appeared on www.firstpost.com on April 1, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
There are no free lunches in life, though at times its not obvious who is footing the bill. Take the case of the right to food security bill which guarantees 80 crore Indians or two thirds of the population, subsidised rice, wheat and cereals.
The bill proposes to provide 5 kg of food grains to an individual every month at the rate of Rs 3 per kg of rice, Rs 2 per kg of wheat and Rs 1 per kg of cereals. The food minister KV Thomas expects that the extra burden on food subsidy will be about Rs 20,000 crore. Also 61.23 million tonnes of food grain would be needed.
Prima facie this is a very noble idea. But the question is who will be footing the bill for this? The answer is the tax paying salaried middle class. Allow me to explain.
In the financial year 2011-2012 (i.e. the period between April 1, 2011 and March 31,2012) the Indian government through the Food Corporation of India(FCI) and other agencies procured 63 million tonnes of grains (primarily rice and wheat).
If the right to food security bill is passed by the Parliament (as it is likely to be, why would any political party in their right sense oppose it?), the government will have to procure a greater amount of grains. The government estimates suggest that 61.23 million tonnes of food grain will be needed just to meet the requirements of the right to food security. There are other government food programmes running as well, and hence the 63 million tonnes of grain that the government currently procures may not be enough.
So the government will have to buy a greater amount of grain in the coming years. In order to do that it will have to keep offering a higher price. The government sets a minimum support price(MSP) for wheat and rice (and other agricultural commodities as well) every year and this has been going up over the last few years.
FCI and other state agencies acting on the government’s behalf buy grains produced by the farmer at the MSP. In the years to come the government is likely to buy more rice and wheat at a higher MSP. This means a lesser amount of rice and wheat will land up in the open market and thus push up prices. This argument does not work only if the amount of rice and wheat being produced goes up significantly and that cannot happen immediately in the short run.
Who does this hurt the most? The tax paying salaried middle class is the answer as they will have to pay more and more for the food that they buy.
There are other problems as well. The total storage capacity of FCI as on April 1, 2012, stood at 33.6 million tonnes. The Central Warehousing Corporation has 466 warehouses with a total capacity of 10.56 million tonnes. This brings the total storage capacity of the central government to a little over 44 million tonnes. Then there is the storage capacities of various state warehousing corporations which are also used to store grains. But even with that the government does not have enough storage capacity to store the amount of grain that it currently procures and will have to procure from the farmers in the years to come.
This means more grains will be dumped in the open and will rot as a result. As The Indian Express wrote in an editorial yesterday “The government will be required to procure more foodgrain at a huge cost, which would require pushing procurement prices even higher, creating storage facilities, and distributing the partly rotted foodgrain through a dysfunctional public distribution system.”
So more rotten food grain will be distributed in the years to come.
The major reasoning behind right to food security is that if subsidised food is offered to people, their nutrition will improve. This is not always the case. Abhijit Banerjee, professor of economics at the Massachusetts Institute of Technology explains this through an example. “We carried out a nice experiment in China. We gave some people a voucher to buy cheap rice. Instead of buying rice lets say for Rs 10, they could buy it for Rs 2, using the vouchers. The presumption was that this would improve nutrition. This was done as an experiment and hence some people were randomly given vouchers and others were not. When people went back and looked at it, they were astounded. People with vouchers had were worse off in nutrition. They felt that now that they have the vouchers, they are rich and no longer need to eat rice. They could eat pork, shrimps etc. They went and bought pork and shrimps and as a result their net calories went down. This is perfectly rational. These people were waiting for pleasure.”
A similar thing might play out in India as well. The money people will save on buying subsidised rice/wheat, might get channelised onto other unhealthy alternatives. But then that’s an individual decision that people might make and hence needs to be left at that.
The broader point is there hasn’t been enough discussion/debate/trials to figure out the unintended consequences of the right to food bill. One unintended consequence that is visible straight away is the rise in prices of non cereal food.
The money people save on buying rice/wheat can get channelised into buying fruit, vegetable, pulses, fish, meat, eggs etc. But the production for this may not go up at the same pace leading to higher price. As The Indian Express points out “The production of fruit, vegetable, pulses, fish, meat and eggs will continue to stagnate, however, as more resources will need to be allocated to push up the production of foodgrain. Instead of land, labour, capital, fertilisers and infrastructure being devoted towards meeting the needs of the population as determined by households that choose what they wish to eat, the country will be diverting resources to producing what the state decides the population must consume.”
As the government offers higher MSPs on rice and wheat, the farmers are more likely to produce that than non cereal food. This for the simple reason that the MSP is set in advance and it gives the farmer a good idea of how much he should expect to earn when he sells his produce a few months later. The same is not true for something like pulses where the government does set an MSP, but does not have the required infrastructure for procurement.
The “nutrition” problem will also continue. As Howarth Bouis , director of HarvestPlus, International Food Policy Research Institute (IFPRI), Washington, pointed out in a recent interview to Mint “If you look at all the other food groups such as fruits, vegetables, lentils, and animal products other than milk, you will find a steady increase in prices over the past 40 years. So it has become more difficult for the poor to afford food that is dense in minerals and vitamins. That probably explains the poor nutritional outcomes .” The right to food security will ensure that the poor will find it even more difficult to buy non cereal food which is high on nutrition as it becomes more expensive.
The nutrient deficit of India will continue to remain unaddressed. The right to food security works with the assumption that most of India’s poor may not have access to even the most basic food. That is really not correct as the government’s own data shows. As The Mint points out in a recent news report “Apart from the extremely poor, who form a small fraction of the population, nearly everyone else can afford the rice and wheat they require… A February report of the National Sample Survey Office shows the proportion of people not getting two square meals a day dropped to about 1% in rural India and 0.4% in urban India in 2009-10. Interestingly, the average cereal consumption of families who reported that they went hungry in some months of the year (in the month preceding the survey) was roughly equal to the average cereal consumption of those who reported receiving adequate meals throughout the year. The stark difference across income-classes lies in the level of spending on non-cereal food items, the survey points out.”
So what India needs to eat is more of eggs, vegetables and fruits, and not rice and wheat, as the government seems to have decided to. “Most of the poor can afford as much of rice, or wheat, as they can eat. And if you look at consumption patterns of these items across income groups, it does not change very much. The huge difference between low-income and high-income groups is in the consumption of non-staple foods—fruits, vegetables and pulses. I think that’s what is limiting better nutrition, not just in India but in much of the developing world,” Bouis told Mint.
What all this means is that the right to food security will drive up food prices higher than what they already are. Hence, food inflation will continue to remain high, which in turn will push up consumer price inflation as well. The right to food security will not only hurt those it is intended to benefit, but it will also hurt the tax paying salaried middle class, as they will continue to face higher prices on food.
The passing of right to food also signals that the Congress led UPA government remains committed to higher expenditure, without really figuring out where the revenue to finance that expenditure is going to come from. In simple English that means the government is going to continue to borrow more. Banks will thus have a lower pool of savings to borrow from, which means higher interest rates and higher EMIs will continue. Now who does this hurt the most? The tax paying middle class again.
Estimates made by Global Financial Integrity suggest that between 2001 and 2010, nearly $123 billion of illicit financial flows went out of India. This means around $12 billion per year on an average. At current conversion rate of one dollar being worth around Rs 54, this is around Rs 65,000 crore per year. So Rs 65,000 crore of black money is leaving the country every year. The black money being generated within the country would be many times over.
Of course people who have this black money are better placed to bear inflation because they don’t pay tax. That is clearly not the case with the salaried middle class, who pay tax and also have to bear higher food inflation. The government should be looking at ways of taxing this black money.
Over and above this agricultural income in this country continues to remain untaxed. This is totally bizarre. As Andy Mukherjee of Reuters Breaking Views writes in a slightly different context “No government today can muster the political courage to tax the incomes of even very large farmers. But to keep the section of the economy that accounts for 60 percent of employment out of tax undermines the system’s legitimacy…It’s ironic that villagers should have political representation without taxation, while the urban middle class finds itself heavily taxed but politically alienated.”
Taxing agricultural income remains out of question. Meanwhile, the salaried tax paying middle class will continue to be screwed.
The article originally appeared on www.firstpost.com on March 20, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)