Is Chidambaram our next Muhammad bin Tughlaq?
Muhammad bin Tughlaq went down in history as the Sultan who debased his own currency. Will Finance Minister P Chidambaram be following in his footsteps?
By R Jagannathan
Every schoolboy has heard of Muhammad bin Tughlaq's early exploits with debased coinage. Our history texts tell us that the Delhi Sultan (reign: 1325-51AD) issued brass and copper coins to people against gold and silver in the treasury in what was one of the world's first experiments with fiat currency. The idea was to enable easier commerce with cheaper coins representing underlying gold and silver.
But the new copper coins were so easy to forge that the sultanate saw a deluge of counterfeit tokens that Tughlaq's treasury had to exchange for gold and silver. He almost ruined the sultanate's finances with this experiment.
Now, cut to the world as it now exists. There are Tughlaqs all over, from Ben Bernanke of the US Fed to Mario Draghi of the European Central Bank to our own Reserve Bank and finance ministry led by P Chidambaram.
The US is about to embark on QE-2 - quantitative easing, round three - which will mean further unlimited printing of money. And this even when the US is rolling in trillions of dollar of unfunded liabilities. That's the world's Tughlaq-in-chief.
The European Central Bank has already announced it will buy eurobonds with a tenure of upto three years (with no particular limits set) with a view to bringing down interest rates. Draghi is Tughlaq No 2, despite the frowns of Angela Merkel's Germany.
The Indian government, given its complete inability to meet the budget deficit, is planning to print even more money this year. As this writer noted earlier this month, if oil prices are not raised quickly, the government's borrowing requirement (the fiscal deficit) will bloat to over Rs 6,50,000 crore in 2012-13, which is nearly Rs 1,40,000 crore more than what the budget indicated. A lot of this could be mere note-printing.
Palaniappan Chidambaram will go down, along with a reluctant RBI chief Duvvuri Subbarao, as the joint holders of the Tughlaq No 3 title.
Under pressure from a worsening fiscal deficit, Chidambaram will not only be printing more money than ever, but even the money he collects as revenue from disinvestment may be really be little more than an IOU for money to be printed in future. He will be committing the government to remain a Tughlaq well into the future.
Two dubious ways in which the finance minister hopes to raise money (or not spend more) are these.
One, he wants to get banks' cash reserve ratio (CRR) reduced, so that they can lower interest rates and also earn more on this freed money (no interest is paid on the CRR deposits banks maintain with the Reserve Bank). This helps the finance ministry in two ways: first, it brings down rates, and second it helps banks make higher profits from freed money - which reduces the ministry's need to inject capital into nationalised banks.
A one percentage point cut in CRR frees Rs 64,000 crore, but as this money flows into the system, its multiplier effect effectively releases over Rs 2,50,000 crore of funds (read Latha Venkatesh's article on this here). Easing CRR is thus not unlike printing money - and works against the monetary policy of bringing down inflation.
Two, the other way in which the government hopes to fool itself and all of us that it is not printing money is by pretending it is earning revenue through disinvestment - by, for example, getting the Life Insurance Corporation (LIC) to buy its public sector shares, in case nobody else is willing it.
According to The Economic Times, the ministry is leaning on the Insurance Regulatory and Development Authority (Irda), the industry regulator, to allow insurance companies to invest more than 10 percent (the current equity limit) in companies.
Quoting unnamed sources, the newspaper said: "Officials from the ministry have been lobbying the regulator to raise the stake an insurance firm can own in a company to 20 percent from 10 percent...While LIC itself has been demanding such an increase, the regulator had in the past turned it down, citing risk."
The regulator, J Hari Narayan, is quoted as saying that he has his doubts on this course of action. "In my view, 20 percent is just asking for trouble. Risk is to be looked at and LIC is ultimately an important financial institution. The focus of the insurer is not to expose it to risk, but provide stable return. If policyholders are looking for only equity-linked return, they will go to mutual funds."
But, Jab mian-biwi raazi, kya karega kaazi? Both the government and LIC seem keen on this folly. A Business Line report says that LIC Chairman DK Mehrotra wants the right to invest upto 20-25 percent in a company. He said: "My only concern is that this 10 percent includes historic holdings which we have (had) since 1956. So, for good scrips, I should have some headroom. Otherwise, what will happen is with the amount of equity we sit upon, we will not have good opportunities in the market."
This is dubious logic. The regulator cannot up the limit only for good scrips, and what is a good scrip today may be a flop scrip tomorrow - as we have seen with various telecom stocks and even banks in a downturn. The 10 percent prudential limit thus makes sense.
In any case, we know what the limit increase really is for: disinvestment. In March, the government forced LIC (the latter claims was its own decision) to buy ONGC shares that went abegging. Then it asked LIC to subscribe to the rights issues of many public sector banks (which breached the 10 percent limit) since it didn't have the money itself.
Leaving the risk for LIC alone for a moment, the moot point is this: if LIC money is the same as government money, as the government seems to think, is it really disinvestment? And if it is not, can the reduction in the fiscal deficit through this ruse be considered valid?
The insurance ploy effectively means that the fiscal deficit is being hidden in the folds of the LIC. Hari Narayan may fret about the risks, but the government obviously believes that if the LIC gets into trouble, it can any give it a bailout by printing more currency.
A fiscal deficit hidden in the LIC's books is really a promise to print notes later - a Tughlaqish act scheduled for the future.
Chidambaram has two options: one is to put his foot down and force the government to take up difficult reforms and cut the budget deficit. The easier option, of course, the one Tughlaq took. The choice is his.
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