Vivek Kaul
Raghuram Govind Rajan will take over as the governor of the Reserve Bank of India(RBI) on September 4, 2013. There are great expectations from him to turnaround the faltering Indian economy. His appointment has been welcomed by the media, business leaders as well as politicians. It is one of those rare occasions where almost everyone seems to be happy about the appointment.
But will Rajan be able to deliver? Will he able to control inflation, stop the rupee from falling further against the dollar and at same time engineer economic growth, as he is expected to. Or to ask a more pointed question, can any central banker really make a huge difference?
Before I get around to answering that question, let me deviate a little.
Inflation targeting has been a favourite policy of central banks all over the world. This strategy essentially involves a central bank estimating and projecting an inflation target and then using interest rates and other monetary tools to steer the economy towards the projected inflation target.
But recent analysis suggests that inflation targeting might have been one of the major reasons behind the current financial crisis. Stephen D King, Group Chief Economist of HSBC makes this point in his new book When the Money Runs Out. As he writes “the pursuit of inflation-targetting…may have contributed to the West’s financial downfall.”
He gives the example of United Kingdom to make his point. “Take, for example, inflation targeting in the UK. In the early years of the new millennium, inflation had a tendency to drop too low, thanks to the deflationary effects on manufactured goods prices of low-cost producers in China and elsewhere in the emerging world. To keep inflation close to target, the Bank of England loosened monetary policy with the intention of delivering higher ‘domestically generated’ inflation. In other words, credit conditions domestically became excessive loose…The inflation target was hit only by allowing domestic imbalances to arise: too much consumption, too much consumer indebtedness, too much leverage within the financial system and too little policy-making wisdom.”
In simple English what this basically means is that the Bank of England, the British central bank, kept interest rates too low for a very long time, so that people borrowed and spent money. This was done in the hope that prices would rise and the inflation target would thus be met.
With interest rates being low banks were falling over one another to lend money to anyone who was willing to borrow. And this gradually led to a fall in lending standards. People who did not have the ability to repay were also being given loans. As King writes “With the UK financial system now awash with liquidity, lending increased rapidly both within the financial system and to other parts of the economy that, frankly, didn’t need any refreshing. In particular, the property sector boomed thanks to an abundance of credit and a gradual reduction in lending standards.”
The Western central banks were focussed on just maintaining the inflation target that they had set. In fact, the ‘inflation only’ focus was a result of how economic theory had evolved over the years. As Felix Martin writes in the fascinating book Money – The Unauthorised Biography “The sole monetary ill that had been permitted into the New Keynesian theory was high or volatile inflation, which was deemed to retard the growth of GDP. The appropriate policy objective, therefore, was low and stable inflation, or ‘monetary stability’…On such grounds, the Bank of England was granted its independence and given a mandate to target inflation in 1997, and the European Central Bank was founded as an independent, inflation-targeting central bank in 1998.”
But this focus on ‘low inflation’ or ‘monetary stability’ as economists like to call it, turned out to be a very narrow policy objective. As Martin writes “The single minded pursuit of low and stable inflation not only drew attention away from the other monetary and financial factors that were to bring the global economy to its knees in 2008 – it exacerbated them…Disconcerting signs of impending disaster in the pre-crisis economy – booming housing prices, a drastic underpricing of liquidity in asset markets, the emergence of shadow banking system, the declines in lending standards, bank capital, and the liquidity ratios – were not given the priority they merited, because, unlike low and stable inflation, they were simply not identified as being relevant.”
And this ‘lack of focus’ led to a big real estate bubbles in large parts of the Western world, which was followed by biggest ‘macroeconomic’ crash in history.
Since then, central banks around the world have tried to concentrate on factors other than inflation as well. But it is not easy for a central bank, if I might use that phrase, to be all over the place.
Raghuram Rajan understands this very well. As he wrote in a 2008 article (along with Eswar Prasad) “The RBI already has a medium-term inflation objective of 5 per cent…But the central bank is also held responsible, in political and public circles, for a stable exchange rate. The RBI has gamely taken on this additional objective but with essentially one instrument, the interest rate, at its disposal, it performs a high-wire balancing act.”
Focus on multiple things makes the RBI run the risk of not doing any of them well. “What is wrong with this? Simple that by trying to do too many things at once, the RBI risks doing none of them well,” wrote Rajan and Prasad.
Hence it made sense for the RBI to concentrate on one thing instead of being all over the place. As Rajan wrote in the 2008 Report of the Committeeon Financial Sector Reforms “ The RBI can best serve the cause of growth by focusing on controlling inflation, and intervening in currency markets only to limit excessive volatility. This focus can also best serve the cause of inclusion because the poorer sections are least hedged against inflation.”
Rajan might have revised his beliefs in the last five years. But as we have seen over the period, the strategy of central banks being all over the place hasn’t really worked either. Given this, we shouldn’t have very high expectations from what Rajan will be able to do as the governor of the RBI, even though he maybe the best man for the job.
To conclude, it is worth remembering what Sunil Gavaskar said in 1994, after he was appointed the manager of a floundering Indian cricket team. “Results can’t be produced overnight. I’m not instant coffee,” said the cricket legend.
Rajan probably realises this more than anyone else. As he wrote recently in his globally syndicated column “The bottom line is that if there is one myth that recent developments have exploded it is probably the one that sees central bankers as technocrats, hovering independently over the politics and ideologies of their time. Their feet, too, have touched the ground.”
This article originally appeared in the Wealth Insight Magazine for September 2013
(Vivek Kaul is the author of the soon to be published Easy Money. He tweets @kaul_vivek)
Raghuram Rajan
Will Rajan fight inflation, leave rupee to market?
Vivek Kaul
Milton Friedman was the most famous economist of the second half of the twentieth century. He believed that inflation is a monetary phenomenon. As he wrote in Money Mischief – Episodes in Monetary History: “The recognition that substantial inflation is always and everywhere a monetary phenomenon is only the beginning of an understanding of the cause and cure of inflation.”
This line of thinking has influenced many economists over the years ‘particularly’ those who work and teach at the University of Chicago, where Friedman was based for 31 years between 1946 and 1977.
Raghuram Rajan, who teaches at the University of Chicago and is scheduled to takeover as the next governor of the Reserve Bank of India (RBI), is one such economist. In fact Rajan has clearly pointed out in his earlier writings that RBI should simply concentrate on managing inflation.
As Rajan wrote in a 2008 article (along with Eswar Prasad) “The RBI already has a medium-term inflation objective of 5 per cent…But the central bank is also held responsible, in political and public circles, for a stable exchange rate. The RBI has gamely taken on this additional objective but with essentially one instrument, the interest rate, at its disposal, it performs a high-wire balancing act.”
And given this the RBI ends up being neither here nor there. As Rajan put it “What is wrong with this? Simple that by trying to do too many things at once, the RBI risks doing none of them well.”
Hence, Rajan felt that the RBI should ‘just’focus on controlling inflation. As he wrote in the 2008 Report of the Committee on Financial Sector Reforms “The RBI can best serve the cause of growth by focusing on controlling inflation and intervening in currency markets only to limit excessive volatility…an exchange rate that reflects fundamentals tends not to move sharply, and serves the cause of stability.”
The trouble is that the RBI has moved on from a single minded focus on inflation, since the days of Bimal Jalan and tends to follow what experts refer to as the ‘multiple indicator approach’. The central bank now looks at a range of indicators from inflation to capital flows and even the exchange rate. Though at times the objectives the RBI is trying to achieve, are at odds.
This is what is happening currently. The RBI is trying to control inflation, accelerate economic growth and stabilise the value of the rupee, all at the same time. Something which is not possible. Rajan understands this well enough. “The RBI’s objective could be restated as low inflation, and growth consistent with the economy’s potential. They amount to essentially the same thing! But it would let the RBI off the hook for targeting the exchange rate. And that is the key point,” Rajan wrote in the 2008 article cited earlier.
Rajan’s writing suggests that he believes in letting the currency finding its right value. This puts him at odds with the current RBI policy of defending the rupee at around 60-61 to a dollar. If he allows the rupee to fall and find its right value against the dollar, it would make him terribly unpopular with the political class. Also, do nothing might be a good theoretical strategy, but an RBI governor needs to be seen doing something to defend the rupee.
A weaker rupee would mean higher oil prices for one. These higher prices would have to be passed onto the consumers in the form of higher price of petrol, diesel, cooking gas etc. With the Lok Sabha elections due in mid 2014, this would be politically disastrous for the Congress led UPA.
Also it is worth remembering that there is not much a central bank governor can do about high consumer price inflation in India, given that most of it has come about from increased government expenditure, which more than doubled(gone up by 133%) to Rs 16,65,297 crore between 2007-2008 and 2013-2014. In fact, inflation might only go up once the food security scheme is on full swing.
In short, a tough test lies ahead for Raghuram Rajan. But given his impeccable credentials he might just be the best man for the job. As Turkish-American economist Dani Rodrik put it“In Rajan, India gets a superb economist as its central bank governor.”
Rajan himself realises the challenges he has to face and the fact that there are no “magic wands” to cure India’s economic problems. He also realises the limited power of a central banker. As he wrote in an October 2012 column for Project Syndicate “Central bankers nowadays enjoy the popularity of rock stars, and deservedly so…But they must be able to admit when they are out of bullets. After all, the transformation from hero to zero can be swift.”
The article originally appeared in the Daily News and Analysis on August 8,2013
(Vivek Kaul is a writer. He can be reached at [email protected])
What to expect from Raghuram Rajan as RBI governor
Vivek Kaul
Even the worst governments make some right decisions. The appointment of Raghuram Govind Rajan as the next governor of the Reserve Bank of India(RBI) is one of the few correct decisions that the Congress led United Progressive Alliance(UPA) government has made in the last few years. Rajan, an alumnus of IIT Delhi, IIM Ahmedabad and Massachusetts Institute of Technology, is currently the Chief Economic Advisor of the government of India.
Rajan was the Chief Economist of the International Monetary Fund(IMF) between October 2003 and December 2006. In 2003, he also won the first Fischer Black Prize, which is awarded to the most promising economist under the age of 40, by the American Finance Association. He is also a Professor of Finance at the Chicago University’s Booth School of Business.
So what can we expect from Rajan as the RBI governor? In order to understand we first need to understand what are Rajan’s views on various factors impacting the Indian economy right now, and which he will have to deal with as the governor of the RBI.
Rajan is a firm believer in the fact that high government spending in doling out various subsidies has been a major cause behind India’s high inflation. This clearly comes out in the Economic Survey for the year 2012-2013, which he was in-charge of as the Chief Economic Advisor.
A part of the summary to the first chapter State of the Economy and Prospects reads “With the subsidies bill, particularly that of petroleum products, increasing, the danger that fiscal targets would be breached substantially became very real in the current year. The situation warranted urgent steps to reduce government spending so as to contain inflation.”
This is something that he reiterated in a recent column as well, where he wrote “India needs less consumption and higher savings. The government has taken a first step by tightening its own budget and spending less, especially on distortionary subsidies.”
The RBI under D Subbarao has been very critical of the high government expenditure distorting the Indian economy. Rajan’s thinking on that front doesn’t seem to be much different from that of his predecessor.
Also Rajan firmly believes that Indian households need stronger incentives in the form of lower inflation to increase financial savings, which have been declining for a while. As the recent RBI financial stability report points out “Financial savings of households…have declined from 11.6 per cent of GDP to 8 per cent of GDP over the corresponding period (i.e. between 2007-08 to 2011-12.”
Financial savings are essentially in the form of bank deposits, life insurance, pension and provision funds, shares and debentures etc. In fact between 2010-2011 and 2011-2012, the household financial savings fell by a massive Rs 90,000 crore. This has largely been on account of high inflation. Savings have been diverted into real estate and gold in the hope of earnings returns higher than the prevailing inflation.
Also people have been saving lesser as their expenditure has gone up due to high inflation. And the financial savings will only go up, if inflation comes down, pushing up the real returns on bank fixed deposits.
“Households also need stronger incentives to increase financial savings. New fixed-income instruments, such as inflation-indexed bonds, will help. So will lower inflation, which raises real returns on bank deposits. Lower government spending, together with tight monetary policy, are contributing to greater price stability,” wrote Rajan in his column.
Given this, the focus of the RBI on controlling ‘inflation’ which continues to be close to double digits (consumer price inflation was at 9.87% in the month of June, 2013) is likely to continue under Rajan as well. Hence, the repo rate, which is the rate at which RBI lends to banks, is unlikely to come down dramatically any time soon.
Lower inflation leading to higher savings will also help in bringing down the high current account, deficit feels Rajan. During the period of twelve months ending December 31, 2012, the current account deficit of India had stood at $93 billion. In absolute terms this was only second to the United States.
The current account deficit(CAD) is the difference between total value of imports and the sum of the total value of its exports and net foreign remittances. Since imports are higher than exports and foreign remittances, the country is spending more than saving.
As Rajan told the India Brand Equity Foundation in an interview “CAD essentially reflects the fact that you are spending more than you are saving. That’s technically the definition of the CAD, which means that you need to borrow from abroad to finance your investment. Ideally, the way you would reduce your current account deficit is by saving more, which means consuming less, buying fewer goods from abroad and importing less. Or, the other way is by investing less, because that would allow you to bridge the CAD. Now we don’t want to invest less. We have enormous investment needs. So ideally, what we want to do is save more.”
And to achieve this “the first way is for the government to cut its under-saving or its deficit and that is part of what we are doing” “The second way is when the public decides to save more rather than spend. We need to encourage financial saving,” Rajan said in the interview.
Given this, Rajan has never been a great fan of subsidies and he looks at them as a short term necessity. In an interview I did with him after the release of his book Fault Lines – How Hidden Fractures Still Threaten the World Economy, for the Daily News and Analysis(DNA), I had asked him whether India could afford to be a welfare state, to which he had replied “Not at the level that politicians want it to. For example, the National Rural Employment Guarantee Scheme (NREGS), if appropriately done, is a short term insurance fix and reduces some of the pressure on the system, which is not a bad thing. But if it comes in the way of the creation of long term capabilities, and if we think NREGS is the answer to the problem of rural stagnation, we have a problem. It’s a short-term necessity in some areas. But the longer term fix has to be to open up the rural areas, connect them, education, capacity building, that is the key.”
This commitment came out in the Economic Survey as well. “The crucial lesson that emerges from the fiscal outcome in 2011-12 and 2012-13 is that in times of heightened uncertainties, there is need for continued risk assessment through close monitoring and for taking appropriate measures for achieving better fiscal marksmanship. Open ended commitments such as uncapped subsidies are particularly problematic for fiscal credibility because they expose fiscal marksmanship to the vagaries of prices,” the Survey authored under the guidance of Rajan pointed out.
So what this clearly tells us that Rajan is clearly not a jhollawallah. The last thing this country needs at this point of time is an RBI governor who is a jhollawallah.
Another important issue that Rajan will have to tackle is the rapidly depreciating rupee against the dollar. RBI’s attempts to control the value of the rupee against the dollar haven’t had much of an impact in the recent past. On this Rajan has an interesting view. As he said in an interview to the television channel ET Now “When we have capital either coming in or flowing out, sometimes it is very costly standing in the way. We would rather wait till our actions have the most impact. It would wait till the moment of maximum advantage and then use all the firepower that it has to pushback.”
What this means is that under Rajan the RBI won’t try to defend the rupee all the time. Given this, the rupee might even be allowed to fall further. What Rajan does on this front will become clear in the months to come, but this will be his biggest immediate challenge.
Another factor working in Rajan’s favour is that this is clearly not Rajan’s last job. He is still not 50. Also, he has a job at the University of Chicago, which he can always go back to.
Given this, it is unlikely that he will make any compromises to help the politicians who have appointed him and is likely to make decisions that are best suited for the Indian economy, rather than help him win brownie points with politicians.
For anyone who has any doubts on this front it is worth repeating something that happened in 2005. Every year the Federal Reserve Bank of Kansas City, one of the twelve Federal Reserve Banks in the United States, organises a symposium at Jackson Hole in the state of Wyoming.
The conference of 2005 was to be the last conference attended by Alan Greenspan, the then Chairman of the Federal Reserve of United States, the American central bank.
Hence, the theme for the conference was the legacy of the Greenspan era. Rajan was attending the conference and presenting a paper titled “Has Financial Development Made the World Riskier?”
Those were the days when the United States was in the midst of a huge real estate bubble. The prevailing economic view was that the US had entered an era of unmatched economic prosperity and Alan Greenspan was largely responsible for it.
In a sense the conference was supposed to be a farewell for Greenspan and people were meant to say nice things about him. And that’s what almost every economist who attended the conference did, except for Rajan.
In his speech Rajan said that the era of easy money would get over soon and would not last forever as the conventional wisdom expected it to. “The bottom line is that banks are certainly not any less risky than the past despite their better capitalization, and may well be riskier. Moreover, banks now bear only the tip of the iceberg of financial sector risks…the interbank market could freeze up, and one could well have a full-blown financial crisis,” said Rajan.
In the last paragraph of his speech Rajan said it is at such times that “excesses typically build up. One source of concern is housing prices that are at elevated levels around the globe.”
Rajan’s speech did not go down well with people at the conference. This is not what they wanted to hear. He was essentially saying that the Greenspan era was hardly what it was being made out to be.
Given this, Rajan came in for heavy criticism. As he recounts in his book Fault Lines – How Hidden Fractures Still Threaten the World Economy: “Forecasting at that time did not require tremendous prescience: all I did was connect the dots… I did not, however, foresee the reaction from the normally polite conference audience. I exaggerate only a bit when I say I felt like an early Christian who had wandered into a convention of half-starved lions. As I walked away from the podium after being roundly criticized by a number of luminaries (with a few notable exceptions), I felt some unease. It was not caused by the criticism itself…Rather it was because the critics seemed to be ignoring what going on before their eyes.”
The criticism notwithstanding Rajan turned out right in the end. And what was interesting that he called it as he saw it. India needs the same honesty from Rajan, as and when he takes over as the next RBI governor.
The article originally appeared on www.firstpost.com on August 6, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Dear PM, those who live in glass houses don't throw stones at others
The nation came to the realisation yesterday that the Prime Minister Manmohan Singh actually has a voice. And then we all came to the conclusion that just because he decided to speak, he spoke well. One commentator even went onto christen the event as “Manmohan on steroids”.
The part that the media loved the most was when Singh told the Parliament ‘Jo garajte hain, woh baraste nahi(Thunderous clouds do not bring showers)’, a clichéd statement which was supposed to put the Bhartiya Janata Party (BJP), the main opposition party, in its place.
As far as clichés go, I would take this opportunity, to bring to your notice, dear readers, a dialogue written by Akhtar-Ul-Iman and delivered with great panache by Raj Kumar in the Yash Chopra directed Waqt. The line goes like this: “Chinoi Seth…jinke apne ghar sheeshe ke hon, wo dusron par pathar nahi feka karte (Chinoi Seth…those who live in glass houses don’t throw stones at others).”
Now Singh may not have time to sit through a movie which runs into 206 minutes, given that he is the Prime Minister of the nation, and probably has decisions to make and things to do. But he would be well-advised to watch this 18-second YouTube clip and hopefully come to the realisation that those who live in glass houses, like Singh and his government, do not throw stones at others.
In fact, Singh’s speech to the Parliament yesterday was riddled with many inconsistent and wrong claims. It is a real surprise that the BJP has not caught onto rubbishing the arguments presented by Singh. Let us examine a few claims made by Singh:
Even BIMARU states have also done much better in UPA period than previous period: BIMARU is an acronym used for the states of Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh. These are states which have lagged in economic growth for a long period of time. There has been a recent spurt in their economic growth and this claims Singh has been because of the UPA government.
Three out of the four states (except Rajasthan) have had a non Congress-non UPA government for the entire duration of the UPA rule in Delhi. Rajasthan has had a Congress government since December 2008.
So trying to claim that the growth in these states has been only because of the UPA government is misleading to say the least. The argument is along similar lines where Congress politicians and some experts have tried to claim over and over again that Bihar has grown faster than Gujarat. Yes it has in percentage terms. But what they forget to tell us is that Gujarat is growing on a much higher base, meaning the absolute growth in Gujarat is higher. In fact, it is three times higher than that of Bihar (The entire argument is explained here).
If we look at the MSP across various commodities, they have increased by 50 to 200% since 2004-05: The government offers a minimum support price on various commodities including rice and wheat. At this price, the Food Corporation of India (FCI), or a state agency acting on its behalf, purchase primarily rice and wheat, grown by Indian farmers. The theory behind setting the MSP is that the farmer will have some idea the price he would get when he sells his produce after harvest. What it has led to is that more and more farmers are selling to the government because they have an assured buyer at an assured price. The government now has nearly Rs 60,000 crore of rice and wheat in excess of what it needs to maintain a buffer stock. While the government is hoarding onto more rice and wheat than it needs, there is a shortage of wheat and rice in the open market pushing up their prices and in turn food inflation and consumer price inflation. It has also pushed up food subsidies and fiscal deficit. Fiscal deficit is the difference between what the government earns and what it spends. And if the government continues with this policy there are likely to be other negative consequences as well. (The entire argument is explained here)
The current slowdown in industrial growth is a concern: This was the most tepid statement in the entire speech. Is it just a concern? Some of the biggest Indian industrialists have gone on record to say that they would rather invest abroad than in India. As Kumar Manglam Birla recently said in an interview “Country risk for India just now is pretty elevated and chances are that for deployment of capital, you would look to see if there is an asset overseas rather than in India…We are in 36 countries around the world. We haven’t seen such uncertainty and lack of transparency in policy anywhere.” The Birlas have known to be very close to the Congress party for a very long time.
And numbers bear this story. Indian corporates are investing abroad rather than India. In 2001-2002 this number was less than 1% of the gross domestic product (GDP) and currently it stands at 6% of the GDP (Source: This discussion featuring Morgan Stanley’s Ruchir Sharma and the Chief Economic Advisor to the government Raghuram Rajan on the news channel NDTV). So the situation is clearly more than just a concern. If Indian industrialists don’t want to invest in India who else will? Is it time to say good bye to industrial growth? Maybe the Prime Minister has an answer for that.
The economic growth has slowed down in 2012-13, because of the difficult global situation: This is something which the finance minister P Chidambaram also alluded to in his budget speech. What it tells us is that there is very little acknowledgement of mistakes that have been made by this government led by Manmohan Singh over the years.
When India was growing at growth rates of 8% and greater, there was a lot of chest thumping by various constituents of the government, that look we are growing at such a high rate. Now that we are not growing at the same speed its because of a difficult global situation.
Ruchir Sharma in a post budget discussion on the news channel NDTV made a very interesting point. India has consistently been at around 24-26th position among 150 emerging market countries when it comes to economic growth over the last three decades.
We thought we were growing at a very fast rate over the last few years, but so was everyone else. As Sharma put it “The last decade we thought we had moved to a higher normal and it was all about us. Every single emerging market in the world boomed and the rising tide lifted all boats including us.”
But now that we are not growing as fast as we were it is because the global economy has slowed down. Sharma nicely summarised this disconnect when he said “When the downturn happens it is about the global economy. When we do well its about us.” India currently has fallen to the 40th position when it comes to economic growth.
Will bring the country back to 8% growth rate: This is kite flying of the worst kind. As Sharma of Morgan Stanley told NDTV “I see people in government today including the Prime Minister talking about 8% GDP growth rate as if that is the level we should be. There is nothing to suggest that is our potential.”
Singh said that the government was committed to achieving a 8% growth rate for the period of the 12th five year plan period of 2012-2017. In the first year of this plan i.e. the financial year 2012-2013 (the period between April 1, 2012 and March 31, 2013), the Indian economy is expected to grow at around 5%(numbers projected by the Central Statistical Organisation).
What that means is that if the 8% target is to be achieved, the economy has to consistently grow at 9% per year for the remaining four years of the plan. And India has never experienced such consistent high growth ever in the past.
Given that Singh’s statement needs to be taken with a pinch of salt. It is essentially rhetoric of the worst kind. As Nate Silver writes in The Signal and the Noise “Sometimes economic forecasts have expressively political purposes too. It turns out that economic forecasts produced by the White House , for instance, have historically been among the least accurate of all, regardless of whether it’s a Democrat or Republican in charge. When it comes to economic forecasting, however, the stakes are higher than for political punditry. As Robert Lucas pointed out, the line between economic forecasting and economic policy is very blurry: a bad forecast can make the real economy worse.” Singh’s 8% growth statement needs to be viewed along similar lines.
There were many things that Singh did not talk about. Among 150 emerging markets, the fiscal deficit of the Indian government is currently at the 148th number. When it comes to inflation, India is currently at the 118-119th position. The current account deficit (which Singh did talk about) will touch an all time high during the course of the financial year 2012-2013. Interest rates have stubbornly refused to come down. And so on.
To conclude, Manmohan Singh was in poetic mood yesterday. “Humko hai unse wafa ki umeed, jo nahi jaante wafa kya hai (We hope for loyalty from those who do not know the meaning of the word),” the prime minister said quoting the Urdu poet Mirza Ghalib, while taking pot-shots at the BJP.
It’s time the BJP got back to him with what are the most famous lines of the poet Akbar Allahabadi.
“Hum aah bhi karte hain to ho jaate hain badnam,
wo qatl bhi karte hain to charcha nahi hota.”
(badnam = infamous. Qatl = murder. Charcha = discussion)
This article originally appeared on www.firstpsost.com on March 7, 2013, with a different headline.
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Why the foreigners are not impressed with Budget 2013
The foreigners aren’t impressed with the budget presented by Finance Minister P Chidambaram yesterday. These include the rating agencies as well as investors who pour money into the Indian stock market.
As Ruchir Sharma, head of the Emerging Markets Equity team at Morgan Stanley Investment Management and the author of Breakout Nations told NDTV in a discussion yesterday: “On the fiscal side..a lot of the assumptions are being torn apart when people are analysing this budget.”
Government income is essentially categorised into two parts. Revenue receipts and capital receipts. Revenue receipts include regular forms of income which the government earns every year like income tax, corporate tax, excise duty, customs duty, service tax and so on.
Capital receipts include money earned through sale of shares in government-owned companies, telecom spectrum, etc. Capital receipts are essentially earned by selling things that the government owns. Once something is sold it can’t be sold again and that is an important point to remember. Borrowing by the government, which is not an income, is also comes under capital receipts.
Revenue receipts for the year 2013-2014 are expected to be at Rs 10,56,331 crore. For the year 2012-2013 revenue receipts were budgeted to be at Rs 9,35,685 crore when the last budget was presented. This number has now been revised to Rs 8,71,828 crore. Hence, the government expects the revenue receipts to grow by 21.2 percent in 2013-2014. This projection has been made in an environment where the government is unlikely to meet its original revenue receipts target for the year. Also the revenue receipts this year will grow by 16 percent in comparison to last year.
So a 21 percent growth in revenue receipts is a fairly optimistic assumption to make. So if revenues collected are lower during the course of the year and the expenditure continues at the same rate, the fiscal deficit will be higher than it has been projected to be. Or expenditure will have to be cut, like it has been done this year. And that is not always a good sign.
Another point that this writer made yesterday was on the side of subsidies. For the year 2012-2013 subsidies were expected to be at Rs 1,90,015 crore. This has been revised to Rs 2,57,654 crore, which is almost 36 percent higher. This makes it very difficult to believe next year’s subsidy target of Rs 2,31,084 crore, especially when more subsidies/sops are likely to be announced during the course of the next financial year in view of the 2014 Lok Sabha elections.
As I said in the piece, the understating of subsidies has not been a one-off thing and has happened every year during the second term of the Congress-led United Progressive Alliance (UPA) government. So higher subsidies than budgeted might again mean a higher fiscal deficit or a cut in expenditure.
Amay Hattangadi and Swanand Kelkar of Morgan Stanley Investment Management, in a report titled The Art of Balancing, make an interesting point. They feel that the finance minister by projecting a fiscal deficit of 5.2 percent of GDP for this financial year and 4.8% of GDP might be giving an impression of fiscal prudence, but a closer look at the math reveals a different story.
As they write: “As trained accountants, we have learnt that sale of assets from the balance-sheet are one-off or non-recurring items. It is interesting that if we add back the estimates from sale of (telecom) spectrum and divestment of government companies (both non-recurring in our view), the ‘real’ fiscal deficit/GDP ratio for financial year 2014 shows no improvement over financial year 2013.”
The table below sourced from the Morgan Stanley report gives the complete story.
Table from Morgan Stanley
Once we take away capital receipts like divestment of shares and sale of telecom spectrum, which are essentially one-off sources of income from the equation, the real fiscal deficit to GDP ratio comes in at a more realistic 5.6 percent of the GDP and not 4.8 percent or 5.2 percent that it has been projected to be. The point is that people aren’t buying the numbers put out in Chidambaram’s budget.
There is also very little acknowledgement of the mistakes that have made by the government over the past few years.
Ruchir Sharma, in his discussion on NDTV, put up a very interesting slide. The slide shows that India has consistently held rank 24-26 among 150 emerging market countries when it comes to economic growth over the last three decades. We thought we were growing at a very fast rate over the last few years, but so was everyone else. As Sharma put it: “The last decade we thought we had moved to a higher normal and it was all about us. Every single emerging market in the world boomed and the rising tide lifted all boats, including us.”
India’s growth has remained consistent in the last three decades
But now that we are not growing as fast as we were in the past, it is because of the slowing down of the global economy. As Chidambaram put it in his budget speech “We are not unaffected by what happens in the rest of the world and our economy too has slowed after 2010-11.”
Sharma pointed out the self-serving nature of this argument thus: “When the downturn happens it is about the global economy. When we do well it’s about us.” This is a disconnect that still persists, as is evident from Chidambaram’s statement.
India in the last four years was fed with artificial fiscal stimulas, which led to high inflation
Another slide put up by Sharma makes for a very interesting reading. “Between 2008 and 2010 we implemented a massive stimulus, both fiscal and monetary, and that artificially inflated our growth rate to 13th in emerging market (as is evident from the slide). We were thrilled about it. It led to a massive increase in inflation and now this is payback time. Between 2010-2012, we fell to the 40th position,” said Sharma. So as more money was pumped into the economy, it chased the same number of goods and services, which led to higher prices or inflation.
So the massive spending by the government came back to haunt us. Inflation went through the roof. India’s rank among emerging markets when it came to inflation used to be around 60th. In the last few years it has fallen to the 118-119th position.
As Sharma puts it: “This is the problem that India has today. India does not have an explicit inflation target. Most emerging markets and central banks work with explicit inflation targets. We have gotten away with it. I think the time is coming now for a more rules-based system. If we had an inflation target I doubt if we would have allowed inflation to increase at such a rapid pace”
Nations which have grown in the past at rapid rates have never had consistently high inflation. “And whenever inflation persisted over a period of time it always meant that the economy was headed for a major slowdown,” said Sharma. High inflation continues to be a major reason for worry in India.
Inflation in India has been a manifestation of a rapid increase in government spending. The total expenditure of the government in 2006-2007 was at Rs 5,81,637 crore. For the year 2013-2014, the total expenditure is expected to be at Rs 16,65,297 crore. The expenditure thus has nearly tripled (actually it’s gone up 2.9 times). During the same period the revenue receipts of the government have gone up only 2.5 times. The difference, as we all know, has been made up by borrowing leading to a burgeoning fiscal deficit. The next slide tells you how hopeless the situation really is.
So India is really at the bottom when it comes to the fiscal deficit.
The point is very basic. We don’t earn all the money that we want to spend. As Chidambaram admitted to in the budget speech: “In 2011-12, the tax GDP ratio was 5.5 percent for direct taxes and 4.4 percent for indirect taxes. These ratios are one of the lowest for any large developing country and will not garner adequate resources for inclusive and sustainable development. I may recall that in 2007-08, the tax GDP ratio touched a peak of 11.9 percent.”
And this budget highlighted very little on how the government plans to increase its revenue receipts. In fact, Chidambaram even admitted that only 42,800 individuals admitted to having taxable incomes of greater than Rs 1 crore in India. This is a situation that needs to be set right. More Indians need to be made to pay income tax.
To conclude, let me say that the foreigners are worried and so should we.
The aritcle originally appeared on www.firstpost.com on March 1, 2013.
Vivek Kaul is a writer. He tweets @kaul_vivek