Normally, both high growth and low inflation are the two most important objectives of macroeconomic policy for any Government. The problem – and paradox – is that for the six months remaining before the general elections, the outcomes on both these yardsticks are largely “baked in the cake” already. They will reflect mainly the wisdom (or folly) of policies undertaken in the preceding months and years… Macroeconomic policy aimed at short-term political gains does not augur well for a poorly performing economy…
The national elections are hardly six months away and a series of state elections will span the next few weeks. In the best of circumstances, this would be a challenging period for economic management, as the political executive focuses increasingly on trying to win the elections and the “professional economic managers” (senior civil servants, the central banking elite and their advisors) try to insulate the economy from some of the worst excesses of political “short-termism”. These tensions are amplified greatly in the present situation when the Indian economy is performing poorly: growth is low, inflation is high, employment is stagnant and both domestic and external finances are under serious stress.
Both groups, the “politicos” and the “professionals”, would like to see the economy perform better in the short run, but the former are much more inclined to undertake measures (or postpone desirable “bullet-biting” steps) for politically visible short-term gains at the expense of longer-term costs. One can readily imagine some of the short-run political priorities (not necessarily consistent): no more administrative price increases; inflation in widely consumed goods and services should be reduced, or, at least, contained to a minimum; spending on welfarist programmes must be maintained or increased; the rupee must not depreciate (further); private investment and employment should be stimulated … and so forth.
The subtexts, often unstated, include: don’t worry about the fiscal deficit, nobody knows what that is; and don’t worry about economic reforms (or even economic growth) in the months ahead, they will not affect the election outcome. Just ensure there are no critical shortages or currency collapses.
Inflation and growth
Normally, both high growth and low inflation are the two most important objectives of macroeconomic policy for any Government. The problem – and paradox – is that for the six months remaining before the general elections, the outcomes on both these yardsticks are largely “baked in the cake” already. They will reflect mainly the wisdom (or folly) of policies undertaken in the preceding months and years.
Not much can be done through policies to affect outcomes in the brief time remaining. Thus, the projections outlined a fortnight ago in the Reserve Bank of India’s (RBI’s) monetary policy statement are good approximations of what will be recorded by the end of the financial year 2013-14: gross domestic product (GDP) growth of five per cent, wholesale price index (WPI)-based inflation of six per cent plus and consumer price index (CPI)-based
inflation of nine per cent plus.
Possibly, economic growth may turn out to be a little lower, closer to 4.5 per cent.
These are not happy economic numbers with which to enter the national electoral contest. But there they are. It is true that more energetic and effective efforts by the Cabinet Committee on investments to break logjams with stalled projects may affect growth, but the rewards are likely to come later, beyond the six-month horizon.
This assessment may reduce the incentives to work hard and effectively to relieve the present constraints, but the negative consequences of inactivity will be incurred later too. Nor will a burst of loose monetary policy achieve a ramping up of growth in the
short run, though it will certainly worsen current high levels of inflation soon enough.
Indeed, in these pre-election months, the RBI may have a freer mandate to pursue a tighter monetary policy without the usual pressures and pleas from the Government side for lower interest rates. Within the range of realistic options, higher policy rates may help contain inflationary pressures in the short run without significant damage to growth.
What about the temptation to ramp up pre-election spending in a last-mile dash to win nationwide votes? The truth is, fortunately, it is too late for that. No new populist programme can be launched and made effective in the remaining few months. Of course, higher-than-budgeted spending on subsidies and welfarist programmes is certainly possible. Here there are real choices and dilemmas. Despite the Finance Minister’s – and the Ministry’s – oft-repeated pronouncements of a “red line” commitment to honour the fiscal deficit target of 4.8 per cent of GDP, the likelihood of overshooting is high. In the first half of 2013-14, the fiscal deficit has been running at about eight per cent of GDP, thanks mainly to major shortfalls in budgeted tax and non-tax revenues as well as disinvestment receipts.
Compressing this run rate down to 4.8 per cent by year end will require fairly draconian expenditure restraints, or substantial creative accounting (such as the postponement of subsidy payment obligations and tax refunds into the following year), or a combination of both. Substantial postponement of Government payment obligations is almost certain since they will be seen to be relatively costless in the short run. However, sharp expenditure cuts could have some negative political fallout. They would not be undertaken if our external finances were in better shape. But they are not.
So a major, transparent overshooting of fiscal targets could heighten the risks of a credit rating downgrade, leading to additional downward pressure on the rupee during a politically sensitive period. Thus, the Government is likely to be somewhat serious about expenditure restraint, though perhaps not enough to credibly achieve the 4.8 per cent of GDP budget target. Let us see.
Rupee and external finances
That brings us to the principal vulnerability in pre-election economic management: the continuing precariousness of our external finances. If there was any doubt on this score, it has surely been dispelled by the rupee’s three per cent recent depreciation after a lull of several weeks’ stability. The main proximate cause appears to have been the publication of strong employment figures and other recent signs of strength in the US recovery, which, in turn, has triggered speculation about an early start to the famous “tapering” of the US Federal Reserve’s $85 billion a month quantitative easing programme.
What must worry the Government the most is that the rupee’s wobble occurred despite continuing, extraordinary inflows under the new (since September) foreign currency non-resident (bank), or FCNR (B), swap facility and the end-August arrangements to keep the bulk of oil import bills of the petroleum refiners off the spot foreign exchange market. One likely response may be to announce a continuation of the FCNR (B) swap facilities beyond November 30 (the earlier date for cessation of the facility). That may well be the political preference of a pre-election Government. But it comes with the heavy costs of a continuing exchange guarantee (which is what the RBI’s swap facilities amount to), which will surely impose a substantial fiscal burden in the future. A better response would be to accept the rupee depreciation catalysed
by a change in tapering expectations. Tapering will happen sooner or later, and we have to adjust to that hard fact.
Clearly, the next few months are going to test the mettle and wisdom of both the “politicos” and the “professionals”.
(The writer is honorary professor at Icrier and former chief economic adviser to the Government of India. Views are personal.)