by SANDEEP TALWAR
Director, Banyan Tree Advisors
January 14, 2013
There is much talk these days about the US fiscal cliff and the debt ceiling debate in that country. The truth is that after the years of excesses in the ten years from 1997 to 2007, government finances in most countries across the globe are in shambles. The crisis of 2008 brought this to the fore as private demand collapsed and with it, government revenues from taxes. In true Keynesian fashion, governments stepped into the breach and stepped up government spending in an effort to stimulate the economy. While this did have a temporary salutary effect on aggregate demand, the net result of this has been widening fiscal deficits across the globe. Many of the countries in Southern Europe and the US are facing huge deficits and economists are scratching their heads as to how these are likely to be reduced.
India has not remained untouched from these issues. Government finances in India have not been great at the best of times. Coalition governments over the past 2 decades have increasingly turned to populist measures to woo the electorate and this has meant large fiscal deficits. These populist measures have included loan waivers, entitlement programmes such as the National Rural Employment Guarantee Program, free power (however unreliable the supply), subsidised fuel, besides freebies like TVs, mixer-grinders and the like at the time of elections. This fiscal largesse has brought to knot all the benefits of an expanding tax base and high GDP growth that India witnessed through the mid-2000s. The crisis of 2008 exacerbated the problem because the government was forced to offer indirect tax cuts and step up government spending to stimulate demand. This was further compounded by the various corruption scandals that erupted in the country which have kept the government busy fire-fighting and have undermined investor confidence. As a result, the growth rate of the economy is hitting decade lows.
Besides the issues with government finances, India faces another problem in the form of a high current account deficit. In essence, we import much more than we export, largely due to our huge imports of oil and gold. The twin deficits (fiscal and current account) have resulted in a huge depreciation of the rupee (more than 20% over a 12 month period from Sep 2011 to Sep 2012) as credit rating agencies have threatened to bring India’s credit rating below the investment grade.
In essence, India’s predicament is analogous to that of the good old Hindi film heroine, who is hanging by a thin rope from a cliff, screaming in anguish for the hero to come and save her. Politicians are known to act only after the situation is almost beyond repair, much like the fate of the 1980s Hindi film heroine. Dr. Manmohan Singh is not unfamiliar to this movie script as he has been there before as India’s finance minister in 1991 when India adopted bold policy reform to stave off an even worse economic situation when the county did not have foreign reserves enough to pay for a month of imports and had to pledge its gold holdings to tide over the situation. It appears that he has re-read that script because the Indian government has over the last few months launched a number of reform measures – foreign direct investment has been relaxed in multi brand retail and aviation; the Banking Amendment Bill has been passed in parliament which will allow issue of new bank licenses; last week the government raised railway passenger fares by 25% after almost a decade of keeping rail fares stagnant; there is now talk of raising diesel and kerosene prices by a small quantum every month to bring the subsidies down. This last measure, not only very sensible, could prove very important because it could make a huge dent in the government’s fiscal deficit.
The heroine is hanging by the proverbial thread and the hero seems to have heard her call and started his car. Will he arrive at the cliff in time to save the lovely lady? And will he encounter some good old Hindi film villains on his path?