The Government announced a slew of economic policies this week, including the decisions to increase FDI in multi-brand retail and aviation to 51%, and to increase diesel prices by Rs.5/litre. In response, Mamata Bannerjee, the Chief Minister of West Bengal, declared that she will pull her party’s 20 MPs out of the Government’s UPA coalition, leaving it in a large minority and dependent on outside support from the SP and BSP. There were widespread protests against the Government’s anti-aam-admi policies, but it seems to be pulling through on its decision, much to investors’s relief.
To understand these upheavals, resignations and bandhs, some economic context is necessary. India’s GDP growth has fallen to a level not seen since the current global economic recession began in 2008. However, as the graph below shows, this fall coincides with the fall of GDP growth of other BRIC nations, indicating that the global forces may be at work. Still, the main cause remains inflation, especially that of food prices. High inflation hurts GDP growth, while high growth can reduce inflation.
Note that GDP growth figures vary from source to source, depending on which factors are taken into account.
The fiscal deficit has become a major cause for worry. The dangers of a high fiscal deficit and how to reduce it are expounded in this illuminating talk given at the RBI in 2004. As it explains, the deficit is caused when Government spending is more than the revenue it collects, for example, from taxes. A recurring fiscal deficit increases the national debt, eventually to unsustainable levels. When the debt is too high, the rupee is devalued, leading to higher inflation and rising costs for banks and businesses, and can eventually lead to a financial crash. It becomes risky for business to invest and run in India, and this drives away future and current investors, worsening the crisis, and the deficit, in a vicious cycle. To avoid this, it is imperative for the government to revive both domestic and international investor confidence, for example, by creating a conducive environment for foreign companies to invest in India. However, the Government, rocked by massive corruption scandals, and facing ideological opposition from its left leaning allies, has been stuck in a policy paralysis, worsening investor outlook about India. That is why this week’s policies being pushed through is so important: it shows investors that the Government has the will to use its political clout and implement sound fiscal decisions, even if it means taking flak from parties looking to make proverbial hay off a populist sun. In this light, Ms. Bannerjee’s accusations can be better examined.
The most trivial of these is that she was kept in the dark. This particular complaint is easy to pass off as egotistical posturing, which probably also influenced her decision to withdraw her MPs from the centre. Technically, fiscal policy is an executive decision that doesn’t require the support of the Parliament. Even so, it seems that she simply chose to ignore attempts to involve her in the decision making process, something she denies in a somewhat contradictory manner on her Facebook page, and it’s perfectly understandable that the Government chose to wait no longer. She has proven herself to be an irresponsible, at times despotic, leader, prone to whimsical accusations and dramatic flurries of anger. Her party’s record in the state has been better than that of the 40-year incumbent Left, but hasn’t yet lived up to election expectations, something glossed over in the many self-congratulatory pamphlets and advertisments her party prints. Its official website is disturbingly Orwellian.
Her personal record notwithstanding, it is still unclear what her real opposition to the move is, apart from the vague rhetoric of being ‘anti-people’. She says it is undemocratic for a ‘minority government’ to implement unpopular policies, which is really an indefensible stance to take. But let’s assume that she made rational arguments against two real issues. First, the issue of FDI in retail. On the face of it, it is hard for the common man to understand why inviting big businesses into retail will help improve his life, and leaders like her prey on their fears and inherent mistrust of corporations. But these businesses create jobs, both direct and indirect. Given that India has such a large ‘bottom-of-the-pyramid’ market segment, business have and will continue to discover innovative ways to engage with them, and the benefits percolate throughout the socio-economic strata. They will offer competitive prices, that reduce inflation, and ultimately benefits the middle and lower-middle classes, who will be their largest consumer base. As per the rules of the policy, they will have to invest in transport and warehouses, creating more jobs and helping to build the nation’s infrastructure. The most widely cited harm is that kirana stores will disappear, but many think this won’t happen. The policy also leaves it up to the states to decide whether they want to implement these decisions. It is hard to see how the poorest of the poor will be adversely affected; indeed the reduction of the budget deficit this way will help fund the massive social welfare schemes that really impact their lives.
Second, the steep hike in fuel prices, which is more complicated. The Government pays for a two lakh crore fuel subsidy, according to the Prime Minister. Even conservatively, this accounts for more than 2% of GDP, which is more than the amount spent on national health-care. Experts have long called for a correction of diesel subsidy to match global prices, which have remained low even as petrol prices are hiked. This is because Indian policy makers tend to view diesel as a poor man’s fuel; millions of bus and tractor owners are dependent on it. But the low prices have made buying diesel guzzling SUVs in cities attractive, prompting the PM to say that half the diesel subsidies go to those who don’t need it. Even so, the fact is that raising diesel prices will further push up food prices, and hence inflation. Despite this, this move is necessary to reduce the national debt. By simultaneously increasing FDI in retail and aviation, the Government hopes it will boost the economy, create enough jobs, and reduce fiscal deficit, all of which will reign in runaway inflation. The arguments for capping the number of LPG cylinders per family to six are similar, with the PM also saying that half of the country uses six or less cylinders, and will remain unaffected. The unsaid part of that argument is that the Government cannot afford to continue subsidising LPG for the other half, who should be able to pay for it themselves.
The debate about what to do to revive the economy is tough, and one that many pundits have gotten wrong in the past. But the point here is that doing nothing in the name of protecting the common man cannot work, a policy decision must be taken. As history has shown, large unmanageable national debts eventually lead to hyperinflation or insolvency in the long term, and prolonged periods of inflation and low growth in the short term. This is a problem that is plaguing countries all over the world today, from the EU zone, to America. India is more protectionist about its economy than most countries, and this has served to somewhat shield it from the global recession. However, as expected, the current hullabaloo has emerged to become only a political debate about an unpopular decision. If India’s economy is to improve, its citizens must engage in a rational policy debate, and not one based on misplaced socialist and populist agendas with no real economic backing. The Government, for all of its faults, will survive this round of policy reform, and no one will really miss Mamata Di much in New Delhi. Whether she will be content to paint only Kolkata blue is another matter entirely.