In these columns last week, I had made an impassioned plea to the United Progressive Alliance (UPA) government to lower interest rates very sharply and kickstart an economic recovery now, before the onset of the election season made it lose the chance, possibly forever. I presented detailed statistics to show that the Current Account Deficit (CAD) was shrinking far more rapidly than the government had realised; that if one excluded the speculative surge in gold imports in April and May last year, and took the monthly trade deficit from June onwards, the CAD would fall in a full year to less than 1 percent of the Gross Domestic Product (GDP). Therefore, the country had a final, golden opportunity to kickstart an industrial recovery without igniting the fear that it could create an unsustainable balance of payments deficit.
On 3 December, the Reserve Bank of India (RBI) confirmed these projections. Unable to hide its relief, it announced almost a month ahead of schedule that the CAD had fallen to a mere $5.2 billion — 1.25 percent of the GDP in the second quarter of the fiscal year (July to September). If this rate is sustained — and there is every reason to expect that it will be — my prediction will be vindicated.
In the coming weeks, this realisation will percolate through the foreign and NRI investors’ communities and the last vestiges of the panic that had seized them in July and August will begin to subside. The only thing that can reignite it is more bad news from the economy, such as a further contraction in manufacturing output or fall in corporate profits and share prices. By contrast, a revival of consumer spending and construction activity, and a firming up of share prices, will do the opposite. A lowering of interest rates will achieve both, and the comfortable balance of payments position that is now developing will enable it to do so without running the risk of a foreign exchange crisis
So, why is RBI Governor Raghuram Rajan still harping on the imperative need to control inflation first? His answer is simple: consumer price inflation is among the highest in the world. So, interest rates must remain “positive”, i.e. higher than the inflation rate.
In a speech given as recently as 15 November (when the decline in the CAD was already apparent), Rajan’s exact words were profoundly revealing: “We can spend a long time debating the sources of this inflation. But, ultimately, inflation comes from demand exceeding supply, and it can be curtailed only by bringing both in balance… The weak state of the economy, as well as the good kharif and rabi harvest, will generate disinflationary forces that will help, and we await data to see how these forces are playing out.”
In short, it does not matter to him why demand is exceeding supply. The distinction between demand-pull and cost-push inflation is irrelevant. In the end, both have the same effect: more money chasing fewer goods. So, the only way to bring inflation down is to shrink demand until it is once more in line with supply.
But what is the cost Rajan is prepared to pay? To him, this question is irrelevant. Inflation must be taken care of first, no matter what that does to economic growth. But whom does lowering inflation help? To him and the UPA government, this is a silly question. “Why, income earners, of course, especially those without the bargaining power to increase their money incomes in the face of rising prices.” But how does controlling inflation help someone who does not have an income. Isn’t it necessary to have a job in order to benefit from price stability? How does a breadwinner who loses his job, or a family where the son or daughter is unable to find a job, benefit from inflation? Rajan has never had to answer this question because the stable of journalists who regularly attend the RBI briefings have never asked it. But his attitude suggests that it is better for a few to suffer in the short run so that many may benefit in the long.
There is a strange heartlessness about Rajan’s prescription. Saying that it does not matter whether inflation is “demand-pulled” or “cost-pushed” takes ethics out of economics. It punishes human beings irrespective of whether they caused the price rise, for instance, through hoarding, overambitious investment or irresponsible trade union action (the original springboard of Milton Friedman’s monetarism), or are its victims as happens when nature unleashes an inconvenient drought or thunderstorm. It abolishes the distinction between perpetrator and victim; worse, it treats the victim as perpetrator. Therefore, it deprives human beings of their humanity and allows policymakers to be indifferent to their suffering and ultimate fate.
This goes far beyond the cruelty of the Market Economy. It amounts to intervening in the Market Economy to make it more cruel than it needs to be. Rajan must be familiar with Karl Polanyi’s immortal classic, The Great Transition. He may even have skimmed it. But it is exceedingly unlikely that he has read it from cover to cover as great books deserve to be read. Polanyi pointed out in 1944 that a Market Economy yields the most efficient organisation of production. But it does so by turning human labour into a commodity, to be bought and sold like any other. For the human beings who supply the labour, this creates “a stark utopia” in which they find it impossible to live because it is a world of total insecurity. So, they begin to band themselves together to regain a modicum of control. That is what gave birth to the Political Economy in Europe in the 19th century.
Prime Minister Manmohan Singh and his advisers may have taken ethics and humanity out of economics, but they are beginning to learn that they cannot take politics out of it. The ‘Modi wave’ is, without doubt, smaller than the media are making it out to be, but to the extent that it exists at all, it is a protest against the way in which, under the UPA, seven years of relentlessly high interest rates, declining industrial and economic growth, and vanishing jobs has robbed the people of urban India — workers and manufacturers — of their dreams and their future. Shining India, they are now convinced, is dead.
Behind the ‘wave’, therefore, is not only a rising desperation but a profound sense of betrayal. For four of the past seven years, the UPA was telling them how fortunate they were to have had a government that saved them from the worldwide recession. Then, in 2011, it began telling them that all their problems — dwindling orders, declining profit margins and vanishing jobs — were caused by the global recession. In 2012, the UPA changed its tune again and told them that their problems sprang from reckless overspending in the past. It confessed, without a blush of shame, that the reckless spender was the government itself.
But mea culpa — mistakes were mistakes: they belonged in the past. It was time to ensure that they did not blight the future. So the government asked them to tighten their belts one last time as it reduced subsidies to make space for non-inflationary investment. The people did so — expectations brightened and the share markets made another brief rally. Only for the RBI to dash their hopes yet again.
The reason it gave then was precisely the one Rajan is giving now: in September, October and again in December, Rajan’s predecessor D Subbarao ignored a 2 percent fall in the consumer price index over the previous year and instead cited a tiny spike in the previous weeks to refuse to bring interest rates down. By March, when he did start to bring them down, it was too late. Investors were convinced that the government did not know what it was doing, and panic had set in.
The golden moment we are in now, when it is still possible to revive growth without risking a foreign exchange crisis, will last for only another few weeks. The RBI’s mid-quarter policy review at the end of this month will be the last opportunity for the government to change tack and revive growth. If it shirks making any changes, if it allows Rajan to continue harping upon controlling inflation through ‘positive’ interest rates, this moment will pass.
If Rajan believes that he can afford to wait until after the 2014 General Election, he is politically naïve. The only certainty in the next election is that it will not yield an unambiguous result. The resulting instability, and the possibility of a Third Front government that includes the Left parties, will make foreign investment take flight once more. The threat of a foreign exchange crisis will once again loom large, and with it the last opportunity to lower interest rates and restart growth will vanish.
When historians write the epitaph on the UPA-2, they will conclude that it consciously and deliberately destroyed the Indian dream. They may be forced to go even further and conclude that it destroyed India’s last chance to make a success of its grand experiment of building a modern nation through democracy, and doomed it to living perpetually in the twilight zone of near failure.
The roots of its failure go back to its ideological, neo-liberal refusal to distinguish between cost-push and demand-pull inflation. This refusal drove it to raising interest rates relentlessly at the merest whisper of a rise in prices — from December 2006 to August 2008 and again from March 2010 until March this year. Its ideology blinded it to the utter absence of any effect of its interest rate hikes upon inflation. In fact, from 2006 until today, prices and interest rates have always moved in the same direction.
As far back as July 2008, even first-year economics students could see that there was no correlation between interest rates and prices. But the RBI, and Manmohan Singh and his dream team, remained blind to this and continued to raise interest rates. In October 2011, the industry finally collapsed. Since then, its growth has remained stuck at 1 percent. But no one in the government evinced even the slightest sign of distress.
Instead, it has simply ignored the statistics that will shatter its remaining illusions. It does not wish to know that in the past four years, non-agricultural employment has fallen by 5.2 million against a rise of 37 million in the previous five years. It does not want to know that 9.1 million women have lost their jobs in rural areas because their men have been forced back to the villages due to the absence of jobs in the towns. It doesn’t seem to care that investment has fallen by 70 percent in the past three years. It doesn’t seem to care that the collapse of the share markets threatens 225 blue-chip companies that have issued convertible debentures abroad and are now unable to redeem them. It would rather not think of the way in which the 40 percent fall in the rupee has jeopardised the future of scores of other companies that borrowed heavily abroad and now face the fate that overtook Kingfisher Airlines and Suzlon.
When Rajan took over as RBI governor, the industry rejoiced because he was a ‘real’ economist. Unfortunately, he is turning out to be the wrong kind of ‘real’ economist: one who has had less than a year’s experience of the Indian economy, but is steeped in the experience of postindustrial economies where 85 percent of the GDP comes from services, and the distinction between demand pull and cost push has lost most of its salience.