Pranab Mukherjee is leaving a better finance ministry to the next finance minister than what he inherited when he took over in February 2009. In fact, for a non-economist FM he did a good job in handling one of the worst periods in the Indian economy since reforms began in early 1990s.
It is unfair to say that Pranab was responsible for the so-called mess India is in. In fact, the current economic situation India is facing was created by the previous FM, P Chidambaram. Chidambaram, despite being a highly acclaimed economist, failed to read a bubble and pursued policies that inflated rather than pricked an economic bubble. And poor Pranab got the pieces of the burst economic bubble.
The incoming FM, whether it is the PM himself or a non-politician economist, central banker or a bureaucrat, is receiving an economy that Pranab has been trying to set right. Pranab has laid the ground for the new FM to formulate the right policies required to take the country back on an even keel. The right policies include cutting down subsidies, reducing fiscal and current account deficits, improving governance, keeping down inflation and giving enough leeway to the RBI to act independently. Unfortunately, Chidambaram failed to adopt the right policies, leading to India going back into time rather than going forward.
Chidambaram’s policies were not reformist, it was only pro-market. Chidambaram encouraged capital flows at a time when the world was being flooded with leveraged liquidity emanating from a mortgage bubble in the US. India received over USD 10 billion of inflows every year since Chidambaram took office in 2004. The huge portfolio flows drove up equities with the Sensex rising five-fold and drove up the rupee that gained over 15 percent against the USD. The strong capital flows pushed up economic growth that averaged close to 9 percent in the 2004-08 period.
The policies adopted by Chidambaram included floating of oil bonds to absorb oil subsidies that were rising as higher global oil prices were not being passed through to consumers. He also announced a farm loan waiver of around Rs 70,000 crore. Then there was a sixth pay commission implementation costing around Rs 30,000 crore to the exchequer.
Chidambaram tussled with then RBI Governor YV Reddy on capital controls as the governor saw all signs of a bubble forming. There was lack of governance, leading to the huge telecom 2G scam and the countless land scams. There were no tax reforms to increase the tax-GDP ratio. Chidambaram’s policies were given a thumbs up by corporate India that again failed to see a bubble leading to the accumulation of debt both in rupees and US dollars.
Pranab took over as FM just when the credit bubble burst. He inherited an economy that was riding on a bubble. His first action was to provide stimulus to the economy that floundered to below 7 percent growth in 2008-09. However, that stimulus cost the government Rs 1,80,000 crore. Pranab took up the fiscal deficit by 350 bps (3.5 percent) in 2008-09 to flood the country with borrowed money. He was urged by corporate India to provide stimulus as they saw a threat to their profits due to an economic bubble bursting.
The result of the fiscal stimulus of 2008-09 is being felt now with inflation that trended at over 9 percent levels for almost two years, interest rates rising by 400 bps from lows seen in 2008, the rupee down over 20 percent from the highs seen in 2011, record levels of government borrowing and economic growth at below 7 percent levels.
Pranab, when he leaves the finance ministry, must be thinking that if he had received a economy that was built to withstand bubbles, he may not have come in for such criticism from the same corporate India that urged the government to encourage capital flows and provide stimulus.
To be sure, Chidambaram’s actions may have been prompted partly by pressures from the party’s populist chief, but then the same holds for Pranab as well. There’s no doubt the rot began in Chidu’s watch.
Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors.