The Current Economic Scenario

The Current Economic Scenario 

Arun Kumar

CESP, SSS, JNU

Rediff.com on September 12, 2013 

http://www.rediff.com/business/slide-show/slide-show-1-interview-why-indias-economy-is-in-such-a-mess/20130912.htm

1.      The rupee has fallen dramatically over the last few weeks. Any one particular reason that you’d say is the reason for this fall.

 The most obvious one is that foreign investors and Indian businessmen have lost confidence in the economy. This has led to the expectations of a declining value of the Re. Since the currency markets are notoriously speculative, there is speculation on the decline in the value of the Re. Often expectations are self fulfilling in a speculative market and that is why the Re has been falling rapidly since May 2013. Over the last two years it has fallen from its peak value of around Rs.44 to the dollar.

 The consequence of these self fulfilling expectations is that there is withdrawal of funds from India by say, the FIIs and NRIs. They feel it is better to withdraw funds before the value of the Re declines any more. Further, the exporters are delaying bringing back the proceeds of their sales abroad so as to make more money and the importers are importing more immediately so that they can take advantage of the cheaper Re at this point of time. Finally, to take capital out, there is greater under invoicing of exports and over invoicing of imports. All this is resulting in an increase in the trade and the current account deficits in the BOP which then justifies the fall in the value of the Rupee.

2.  The RBI has tried to stem the fall, but in vain. Was the RBI right in seeking to defend the rupee or should we let market forces decide the rupee’s value?

 The RBI’s steps may be characterized as `too little too late’. It should have defended the Rupee much earlier rather than when it has fallen below Rs.60 to the dollar. The market forces in a speculative situation are destabilizing so there is no market determined value of the Re. When the Re fell from Rs.47 to below Rs.50 then only the RBI should have intervened. This would have prevented expectations of a further fall from building. The RBI has had a kitty of $280 billion dollars in its reserves. It is true that this is based on borrowings of $ 380 billion. However, early intervention would have required small amounts of release while now it would require massive releases to correct the situation.

The RBI has been trying inflation control while in India inflation is not strictly a monetary phenomenon. It should have lowered interest rates to help spur growth. Inflation control in India requires supply side responses and a political will to stop speculative activities and to check the growing black economy. Black liquidity rushes in to speculate so any tightening of money supply by the RBI is undone by the funds from the black economy.

3.      Could the RBI and the government have done anything to stem the fall? Will the recent move at tightening capital account help the rupee?

 RBI by itself cannot control the value of the Re. Both fiscal and monetary policy instruments have to be used. The government has correctly set into motion steps to address the trade and current account deficits in BOP by curbing the inflow of inessentials like, gold.

While it is true that smuggling of gold may revive but overall the demand for gold would moderate and the outflow of foreign exchange on this account would moderate. It needs to be remembered that the inflow of gold increased from 160 tons per annum in 1992 to the current level of about 900 to a 1000 tons after liberalization of the import of gold in 1992. This has led to a massive out flow of foreign exchange.

Capital account restrictions are important since they stem the outflow of capital and foreign exchange. However, the government’s steps are half hearted and leave many channels for the outflow to continue. It needs to be remembered that in the 1997 Contagion in the SE Asian Tiger economies only Malayasia emerged unscathed because it imposed capital account controls. The IMF was critical of Malayasia at that time but later praised it for the management of the economy.

The government also needs to lower the fiscal deficit in its budget by raising more resources and investing more on the Plan account (rather than cutting it). It has been lowering Plan expenditures in the last few years by a whopping Rs.1 lakh crores each year. This has resulted in lower demand in the economy and a slowing economy. In a period when the private corporate sector is not investing enough, the cut in the plan expenditures has resulted in a fall in the investment rate of the economy from its peak in 2007-08 and that has adversely affected growth in the economy.

More resources can be raised by lowering the `tax expenditures’ in the budget which are running at about Rs.5.5 lakh crores (See Receipts Budget). Further, a moderate dent on the black economy of 50% of GDP can raise the additional funds required for maintaining the Plan expenditures budgeted for.

Finally, the investment model adopted by India is based on crony capitalism (more so after 1991) and this has collapsed since 2008 when major scams were unearthed and the public started reacting. Since then the politicians and the bureaucracy has become wary. The businessmen have also suffered with cancellation of licenses so they too are wary. Further, the public has lost trust in big projects that lead to massive displacement while the rich and the politicians make money. Thus resistance has built up to all major projects, like, power plants, SEZs, steel plants and mining projects. All these have stalled and there are cases of withdrawal of projects like, Arcelor Mittal and POSCO.

There is a need for transparent and market based investment in which the public can have confidence and where these projects appear to be in the national interest and not just to fill the pockets of the rich and the powerful. Such a model of investment has not emerged and that is why investment is suffering in the country.

Unfortunately, given the political uncertainty due to the weakness of the present government and the impending state and national elections and the uncertainty of who will come to power, private investors are holding back investments. This is not likely to change any time soon.

4.      Where do you see the rupee vis-à-vis the dollar at the end of the year?

 There is no way to predict the value of the Re even a few months down the line. If the government can successfully reverse expectations, the Re can strengthen and go back to Rs.55 to the dollar but if not it could breach the Rs.70 mark. The latter appears more likely at present given the uncertainties and the lack of confidence in the economy.

5.      How will the rupee fall impact the economy? For example, petrol prices will go up, and this might push up inflation even as growth remains stagnant. Are we back to the “stagflation” days?

 The fall in the value of the Rupee will result in the prices of all goods with import content to rise in price. Immediately the price of energy (petroleum products and coal) would rise and since this is used in all production all prices would tend to rise. Electricity, petrol, diesel, gas prices will rise. Energy is required for transportation so all goods will rise in price due to higher transport costs. All electronics goods, automobiles, etc., with high import component will see a price rise. Internal tourism will be adversely affected because of its import intensive character but foreign visitors may increase in number with the weakening Rupee.

In India, growth is not stagnant but it is still at around 5% per annum which is better than what the IMF prediction for the world economy is. Thus, Indian economy’s rate of growth remains better than the world average and this cannot be called stagnation. The rate of growth will fall as inflation rate rises. Employment generation which is a big concern for India will fall further and lead to persistence of poverty and more crime amongst the unemployed youth.

Exports will do better over time as the prices of Indian goods decline and this would help the growth of some sectors like, software, call centres, textiles and leather goods. However, the rise in exports will not be able to compensate for the decline in internal demand due to inflation. Hencve the rate of growth would tend to fall unless other steps are taken.

6.      What do you think should be done on a priority basis to stem the rupee’s fall?

 Answered as part of Question 3.

7.      Moving to the general economy, how much of the blame for the economic downturn can be blamed on external factors, and how much with the current government’s ineptitude?

 We are facing major macro economic imbalances in the economy.

On the external front, the Current Account Deficit in BOP is also a result of the slow growth in the major world economies – USA, Eurozone, China and so on. That is why the growth rate in exports has fallen while imports continued to surge due to import of energy and gold (prices of both of which rose or remained high). Now with the improvement in growth in US and Euro sone while Indian economy is weakening, capital has begun to go out leading to a decline in the value of the Rupee. Finally, the fear of tapering off of the Quantitative Easing (QE) by the Federal Reserve has made many believe that days of easy money are numbered and capital flows to emerging markets are set to fall. This has created the expectation that the currencies of emerging markets will decline in value and that is what is happening.

On the internal front, the high rate of persisting inflation, high fiscal deficit (kept in control by cutting plan expenditures) and falling rate of growth (especially in industry) reflect deep macro imbalances.

The internal and external factors have dented the confidence in the Indian economy and led to credit rating agencies repeatedly threatening a downgrade. Even though the performance of these agencies was not creditable during the crisis starting 2007, their actions are still influential with investors.

Along with these factors one can add the `policy paralysis’ of the present government since 2009 due to the surfacing of the various scams. The government has been busy warding off pressures due to these exposes rather than setting new directions in policy. Now with elections round the corner, investors will wait and watch and the government will have to get more proactive in encouraging growth through its actions.

8.      You have written that the problems we face is because are following a “borrowed development model”? But many would argue that 22 years of liberalisation has helped India far more than 44 years of state control policies ever did?

 We borrowed a development model in 1947 and another one in 1991 – both have been based on the notion of western modernity and not what India needed. Both have been based on a top down approach and not a bottom up one.  Both have depended on trickle down to the poor. The post 1991 path has not increased growth rates as much as the pre 1991 path did. Our average rate of growth in the period between 1950 and 1980 jumped by a factor of 5 as compared to that in the 50 years before independence. After 1991, the rate of growth has barely increased by 50% over the average growth rate in the 1980s and that too over a few years between 2003 and 2008. We are now back to around 5% rate of growth.

The growth in the last two decades is based on the achievements of the earlier four decades. Also, the growth rate has accelerated due to structural changes where the services sector has become dominant and the slow growing agricultural sector has become marginal to the growth story. Further, the present path is leading to massive disparities since the growth is concentrated in a narrow section of the population. Finally, poverty is changing its characteristics so that in spite of increase in incomes of the poor, poverty is persisting in its changed forms.

We are pursuing a policy of `growth at any cost’ with all costs falling on the workers and the environment. The cost of a deteriorating environment is borne disproportionately by the poor who live in poor conditions. Studies show that the health cost of the poor have risen sharply so that their increased incomes cannot compensate for the increase in the cost of living for them.

The new policy paradigm which has led to increased consumption by the middle classes and the well off hides a massive rise in social and political instability in the country. This has its hidden costs. Further, consumerism is the means used by the ruling class to divert the attention of the people from the real problems faced by them. But rather than provide the solution it is creating additional problems due to the rising expectations amongst the youth which is bombarded with images of high consumption in TV ads, serials, films, etc. However, there is no way that these expectations can be fulfilled since the organized sector jobs paying well are only 6% of the total jobs. 96% of the 12 million children joining the work force every year will have to take up low paying jobs in the unorganized sectors and they cannot fulfil their expectations. This is leading to terrorism and crime all around.

9.      If the current development model is flawed, then what is the development model best suited for India?

One has to go for an indigenous path based on social justice and equity. This does not mean a closed economy. Development has to be from below as suggested by Gandhi. That is what the government also now wants when it talks of inclusive growth but it lacks the will to implement such a path. Its flagship programmes are mere safety devices to take care of the problems its policies are creating. The alternative path would target productive full employment and not just investment. It would be based on an appropriate mix of various levels of technologies. It would create conditions for decentralized urbanization and decentralized development with autonomy devolved from the Centre to the States to the local bodies. It would curb the black economy to release resources from the present unproductive sectors and channel them to productive activities. It would be based on protecting the environment and making everyone not only literate but also creative through high quality education to all. Such a path was spelt out in the alternative budget presented in 1994 which also showed `how to make the desirable feasible’.

arunkumar1000@hotmail.com.

A Macroeconomic View of the National Food Security Bill

A Macroeconomic View of the National Food Security Bill

Arun Kumar

CESP,SSS,JNU

Mainstream, Vol Li, No 37, August 31, 2013

The National Food Security Bill (NFSB) has been contentious. Economic arguments have been presented against it confusing the public. The rich farmers are worried that farm prices would fall because cheap food would find its way into the markets. Businessmen argue that the economy would further slow down with an increase in the burden on the Budget. The elite say that subsidies and inflation would rise sharply due to profligacy. Unfortunately, most of these arguments are based on a partial economic perspective which ignores the full impact of the economic processes that the scheme would set into motion.

There is legitimate concern about corruption, diversion of food and the problems associated with the implementation of the provisions of the Bill. No doubt, given the state of governance in large parts of the country, the full implementation of the provisions of the Bill would take many years. Given that the Congress party may lose politically by bringing in the scheme so close to the next general elections, those whose expectations would remain unfulfilled by the time the elections are held would be disappointed. The moot question is: should corruption be the reason for not implementing what may be a good policy? Should the allotment of spectrum or of coal mines be stopped because there has been corruption in these cases? Can the baby be thrown out with the bathwater?

The case for the NFSB is a macroeconomic one. The nation has the responsibility to feed its citizens. However, due to a lack of incomes and the choices sometimes made by the individuals because of the social pressures, many are unable to buy enough food for their family and that is why there is hunger and malnourishment. Thus, hunger is not an individual problem but has its roots in the country’s macroeconomics. For instance, it depends on the nature of employment generation, the distribution of incomes, investment policies, global factors in an increasingly open economy (including consumerism), production technology encouraged by policies, position of agriculture in the economy and the related issue of terms of trade between agriculture and the other sectors. None of these factors can be changed by individual efforts.

The government, through its policies, deter-mines these macroeconomic factors. Since the launch of the New Economic Policies in 1991, the problem of unemployment, distribution of incomes and so on has got aggravated and worsened the situation of the marginalised in society. Hence in spite of growth, hunger persists. The government is the only entity that can provide the correctives and ameliorate hunger. In this sense, the NFSB is only a corrective to the market-oriented policies currently being pursued and does not resolve the fundamental economic problem of lack of adequate incomes of the poor.

Those who would benefit from the cheap foodgrain provided under the NFSB will get an additional income since they will buy a given amount of food for less. This would leave some money for buying other goods and services including more protein and vegetables. This amount could be substantial since 50 per cent-60 per cent of the budget of the poor is spent on food. If it is assumed that 50 crore people were already benefiting from various State level schemes under which they were getting cheap food, an additional 30 crore people would get the cheaper food and buy not only more food but more of other items of consumption. This would help reduce poverty in the country.

In the present situation of a demand slow-down and a falling rate of economic growth, there would be a stimulus to the economy. This boost would be strong since little of the additional demand would leak out of the economy as happens with the additional incomes of the well-off. Further, there could be additional requirements of infrastructure for storage and distribution of the additional food and this would result in more investment and, therefore, spur growth.

The implication also would be that the rate of inflation for the poor would fall. The total consumption of food would rise leading to an increase in the free market price of foodgrains. That would hurt those not covered by the NFSB and for them the rate of inflation would rise. The lower middle classes would be hurt but the others with inflation indexation can adjust to it. However, the immediate rise in inflation would be small since the government already has huge stocks of foodgrains which, when released in the market, would moderate the price rise. As of March 1, the food stocks were 62.8 million tonnes and with the procurement in the new season these would have increased to above 80 million tonnes while the buffer stock norm for July 1 is only 27 million tonnes. Thus, there is a lot of cushion to keep prices in check. But, as the extra stocks above the statutory requirement get exhausted in a few years, the prices would rise. To check this, the government would have to pursue policies to encourage an increase in output rather than resort to fire-fighting later on.

The higher free market price would lead to a higher price for the farmers and this could lead to an increase in supply. This would also mean that the government would have to give a higher support price to the farmers to be able to procure additional amount for expanded distribution. This would further incentivise the farmers to produce more.

Some argue that the poor do not need more foodgrains but require other items of food. This is only partially correct. Foodgrain availability (proxy for consumption) in India peaked in 1991 at 510 gm per person per day and declined after that (in 2001 by 18 per cent). This has been attributed to a shift in the consumption pattern. However, whenever the monsoons have been bountiful and food prices have dropped, consumption has gone back to around 500 gm.

This suggests that the consumption pattern may have shifted some but a lot of people are unable to buy adequate amount of foodgrains when the prices rise. The well-off consume more of foodgrains indirectly through consumption of animal protein but their consumption is hardly sensitive to prices since they have enough income. Thus, the fall in availability of foodgrains when the prices rise is a reflection of the squeeze of the consumption of the poor. The NFSB would help the poor by making their consumption independent of inflation. The implication also is that the current high foodgrain stocks are not an indication of food self-sufficiency in the country but of inadequate purchasing power of the poor. Further, as the NFSB gets implemented, India may have to import foodgrains unless the production rises.

It is estimated that the subsidy bill on food would rise to more than Rs 1,24,000 crores (around one per cent of the GDP). The additional amount over and above what is being currently spent may be around Rs 35,000 crores. This is insignificant compared to the Rs 5.5 lakh crores of tax expenditures (a kind of subsidy) given to the well-off in society or the revenue loss of Rs 20 lakh crores due to the black economy. The question then is: who should be subsidised? The choice should clearly be in favour of the poor. There will be additional expenditures on storage and other infrastructure. But, the total requirement of storage could decline since foodgrains would be distributed rather than held in the open where they rot adding to the subsidy burden. The losses of the FCI should decline since the food distributed would get some revenue, even if small, as opposed to its complete write-off when it rots and correspondingly the subsidy element could fall.

The real problem would be corruption and identification and delivery to the additional families to be covered. That is why some suggest cash transfer using the UIDAI cards. Examples of Brazil and other countries are mentioned but the recent public demonstrations in Brazil point to the prevailing corruption there. It is not obvious that the UIDAI would be free of corruption. Ingenuity of the Indian elite has fostered corruption in whatever scheme is launched. There is much corruption in transfer of money through banks and post offices. Already corruption cases are surfacing with regard to fictitious cards, etc. even when the scheme is not yet operational. Further, cash transfer may not lead to expenditure on food but diversion to other wasteful expenditures. That danger exists even when cheap food is given but it would be less than with cash transfer.

It is unfortunate that the NFSB was initially brought through an Ordinance rather than being implemented after approval in Parliament. This deprived the scheme of a political consensus which would have helped its implementation. However the politics plays out, in macro-economic terms the NFSB is highly desirable and reflects the nation’s commitment to its citizens and that would help in nation building.

arunkumar1000@hotmail.com

[This is an enlarged version of the article on the subject in Hindustan Times on August 21, 2013. —A.K.]