The pitfalls of economic brinkmanship

As it approaches the general elections next year, the economic management skills of Congress-led UPA-II have gone offtrack in more ways than one, prompting a series of measures that do not seem to be targeting the desired results.

For, the flip side is there to see. Running a current account deficit that stood menacingly high at $87.8 billion as on March 31, 2013, or 4.8 per cent of the gross domestic product (GDP), and showing little signs of abatement, it would have been fiscally prudent for the government to embark on course correction to put its macroeconomic management back on track. However, in blatant defiance of logic and economic sense, the Centre came up with yet another social security scheme, the Food Security Bill (FSB), estimated to cost about Rs 1,25,000 crore annually. At a time when its finances are already strained, it is inexplicable how the government thought of it; the only plausible explanation could be to ride the hype of such a legislation to retain power for another five years.

FSB has already faced flak from many quarters. Last week, president of trade body Federation of Indian Chambers of Commerce and Industry (Ficci) Naina Lal Kidwai called it “troublesome”; she slapped on another Rs 75,000 crore as the cost of administering FSB.

A simple question that economists and plebeians alike ask the government is: Where will the money come from to implement FSB? Surely, raising taxes is not an option when the economy has lost its growth momentum after growing at 5 per cent last fiscal, the lowest in a decade?

Things are not going to change markedly this fiscal, with Prime Minister Manmohan Singh tacitly conveying a few days ago that the 6.4 per cent growth target would be difficult to achieve. Not to mention that former Reserve Bank of India governor and currently Chairman of the Prime Minister's Economic Advisory Council, R Rangarajan said in May at a session organised by the Bangalore Chamber of Industry and Commerce: “It's a sad day when 6.4 per cent is called optimistic.”

This leaves the government with no option but to go on a borrowing spree to bankroll rising expenses, which unfortunately raise the spectre of hardening interest rates. Of course, it's not that corporates are queuing up to borrow, for there are no fresh investments; at least, not the big ticket ones. As the Managing Director of State Bank of Mysore Sharad Sharma put it rather succinctly in a recent interview to Deccan Herald: “There is no major demand for credit, and therefore, we shed our bulk deposits in a big way.”

If the domestic situation is bad, the external is worse. After falling short of the fiscal 2013 target for exports and managing to reach $300.6 billion, the target for the current fiscal is $325 billion. However, in the first quarter this fiscal, exports at $72.45 billion registered decline of 1.41 per cent year-on-year, clearly pointing to an encore of last year.

This raises the spectre of rising trade deficit this year which stood at an elevated $195.7 billion in 2012-13. Proof is evident in the trade deficit figures in the first quarter this fiscal at $50.18 billion, up from $42.21 billion in the corresponding period last fiscal. To add to the woes, a falling rupee will only push up India's average monthly import bill of $42 billion, leading to an inescapable domino effect on inflation.
And, if these are not enough, the country's external debt at $390 billion as on March 31, 2013 is bound to exert more pressure on the rupee, when demand for dollars to repay external commercial borrowings and non-resident deposits rises further.
The debt was up 12.9 per cent over the previous fiscal.

In the context of the classic economic equation Y = C + I +G + NX, where Y as GDP is explained as a function of consumption (C), investment (I), government purchases of goods and services (G) and net exports (NX), the Centre has more or less reached a stage where it has almost exhausted all its options to prop up Y. Investments are not happening, consumption is stagnant or falling, government is keen on doles and subsidies, and the scope to raise exports looks minimal.

Faced with such a predicament that it obviously did not foresee, the government embarked on a series of missteps in the past few months, each indicative of either desperation or misplaced optimism. The former marked by measures to stem the rupee's free fall and the latter in the form of foreign direct investment (FDI) norms being relaxed in many sectors in the hope that dollars will automatically flowing in. But both have already revealed their flip sides; the credit squeeze to prop up the rupee is sure to push up lending rates, while the FDI relaxation has triggered an intra-party war within the Congress, especially over FDI norms in the defence sector. Either way, the dollars are not flowing in.