Of 9% economic growth and Manmohan's pipedreams

Shashi Tharoor, before he decided to become a politician, was an excellent writer of fiction. It is rather sad that he hasn't written any fiction since he became a politician. A few lines that he wrote in his book Riot: A Love Story I particularly like. "There is not a thing as the wrong place, or the wrong time. We are where we are at the only time we have. Perhaps it's where we're meant to be," wrote Tharoor.

India's slowing economic growth is a good case in point of Tharoor's logic. It is where it is, despite what the politicians who run this country have to say, because that's where it is meant to be.


Prime Minister Manmohan Singh, in his Independence Day speech laid the blame for slowing economic growth in India on account of problems with the global economy as well as bad monsoons within the country. As he said, "You are aware that these days the global economy is passing through a difficult phase. The pace of economic growth has come down in all countries of the world. Our country has also been affected by these adverse external conditions.Also, there have been domestic developments which are hindering our economic growth.Last year our GDP grew by 6.5 percent. This year we hope to do a little better...While doing this, we must also control inflation. This would pose some difficulty because of a bad monsoon this year."

So basically what Manmohan Singh was saying is that I know economic growth is slowing down, but don't blame me or my government for it. Singh, like most politicians when trying to explain their bad performance, has resorted to what psychologists calls the fundamental attribution bias.

As Vivek Dehejia, an economics professor at Carleton University in Ottawa, Canada, told me in a recent interview I did for Daily News and Analysis (DNA): "Fundamentally attribution bias says that we are more likely to attribute to the other person a subjective basis for their behaviour and tend to neglect the situational factors. Looking at our own actions we look more at the situational factors and less at the idiosyncratic individual subjective factors."

In simple English, what this means is that when we are analysing the performance of others we tend to look at the mistakes that they made rather than the situational factors. On the flip side, when we are trying to explain our bad performance we tend to blame the situational factors more than the mistakes that we might have made.

So in Singh's case he has blamed the global economy and the deficient monsoon for slowing economic growth. He also blamed his coalition partners. "As far as creating an environment within the country for rapid economic growth is concerned, I believe that we are not being able to achieve this because of a lack of political consensus on many issues," Singh said.

Each of these reasons highlighted by Singh is a genuine reason but these are not the only reasons why economic growth in India is slowing down. A major reason for the slowdown is high interest rates and high inflation. With interest rates being high, it doesn't make sense for businesses to borrow and expand. It also doesn't make sense for you and me to take loans and buy homes, cars, motorcycles and other consumer durables.

The question that arises here is why are banks charging high interest rates on their loans? The primary reason is that they are paying high interest rates on their deposits.

And why are they paying more on deposits? The answer lies in the fact that banks have been giving out more loans than raising deposits. Between 30 December 2011 and 27 July 2012, a period of nearly seven months, banks have given loans worth Rs 4,16,050 crore. During the same period they were able to raise deposits worth Rs 3,24,080 crore. This means an incremental credit-deposit ratio of a whopping 128.4 percent - ie, for every Rs 100 raised as deposits, the banks have given out loans of Rs 128.4.

Thus banks have not been able to raise as much deposits as they are giving out as loans. The loans are thus being financed out of deposits raised in the past. What this also means is that there is a scarcity of money that can be raised as deposits and hence banks have had to offer higher interest rates than normal to raise this money.

So the next question ought to be this: why there is a scarcity of money that can be raised as deposits? This as I have said more than few times in the past, this is because the expenditure of the government is much more than its spending.

The fiscal deficit of the government, or the difference between what it earns and what it spends, has been going up, over the last few years. For the financial year 2007-2008, the fiscal deficit stood at Rs 1,26,912 crore. It went up to Rs 5,21,980 crore for financial year 2011-2012. In a timeframe of five years, the deficit has shot up by nearly 312 percent. During the same period the income earned by the government has gone up by only 36 percent to Rs 7,96,740 crore.

This difference is made up by borrowing. When the borrowing needs of the government go through the roof it obviously leaves very little on the table for banks and other private institutions to borrow, which in turn means that they have to offer higher interest rates to raise deposits. Once they offer higher interest rates on deposits, they have to charge higher interest rate on loans.

A higher interest rate scenario slows down economic growth as companies borrow less to expand their businesses and individuals also cut down on their loan-financed purchases. This impacts businesses and thus slows down economic growth.

The huge increase in fiscal deficit has primarily happened because ofthe subsidy on food, fertiliser and petroleum. One of the programmes that benefits from the government subsidy is the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA or just NREGA). The scheme guarantees 100 days of work to adults in any rural household. While this is a great short-term fix it really is not a long-term solution. If creating economic growth was as simple as giving away money to people and asking them to dig holes, every country in the world would have practiced it by now.

As Raghuram Rajan, who is taking over as the next Chief Economic Advisor of the government of India, told me in an interview to DNA a couple of years back, "The National Rural Employment Guarantee Scheme (NREGS, another name for MGNREGA), if appropriately done, is a short-term insurance fix and reduces some of the pressure on the system, which is not a bad thing. But if it comes in the way of the creation of long-term capabilities, and if we think NREGS is the answer to the problem of rural stagnation, we have a problem. It's a short-term necessity in some areas. But the longer term fix has to be to open up the rural areas, connect them, education, capacity building, that is the key."

But the Manmohan Singh-led United Progressive Alliance seems to be looking at the employment guarantee scheme as a long-term solution rather than a short-term fix. This has led to burgeoning wage inflation over the last few years in rural areas.

As Ruchir Sharma writes in Breakout Nations - In Pursuit of the Next Economic Miracles, "The wages guaranteed by MGNREGA pushed rural wage inflation up to 15 percent in 2011".

Also, as more money in the hands of rural India chases the same number of goods, it has led to increased price inflation as well. Consumer price inflation currently remains over 10 percent. The most recent wholesale price index inflation number fell to 6.87 percent for the month of July 2012, from 7.25 percent in June. But this, experts believe, is a short-term phenomenon and inflation is expected to go up again in the months to come.

As Ruchir Sharma wrote in a column that appeared on Wednesday in The Times of India: "For decades India's place in the rankings of nations by inflation rates also held steady, somewhere between 78 and 98 out of 180. But over the past couple of years India's inflation rate is so out of whack that its ranking has fallen to 151. No nation has ever managed to sustain rapid growth for several decades in the face of high inflation. It is no coincidence that India is increasingly an outlier on the fiscal front as well with the combined central and state government deficits now running four times higher than the emerging market average of 2%." (You can read the complete column here).

So, to get economic growth back on track, India has to control inflation. The Reserve Bank of India (RBI) has been trying to control inflation by keeping the repo rate, or the rate at which it lends to banks, at a high level. One school of thought is that once the RBI starts cutting the repo rate, interest rates will fall and economic growth will bounce back.

That is specious argument at best. Interest rates are not high because the RBI has been keeping the repo rate high. The repo rate at best acts as an indicator. Even if the RBI were to cut the repo rate the question is will it translate into interest rates on loans being cut by banks? I don't see that happening unless the government clamps down on its borrowing. And that will only happen if it's able to control the subsidies.

The fiscal deficit for the current financial year 2012-2013 has been estimated at Rs Rs Rs5,13,590 crore. I wouldn't be surprised if the number even touches Rs 6,00,000 crore. The oil subsidy for the year was set at Rs 43,580 crore. This has already been exhausted. Oil prices are on their way up and Brent crude, as I write this, is around $115 per barrel. The government continues to force the oil marketing companies to sell diesel, LPG and kerosene at a loss. The diesel subsidy is likely to continue given that with the bad monsoon farmers are now likely to use diesel generators to pump water to irrigate their fields. With food inflation remaining high, the food subsidy is also likely to go up.

The heart of India's problem is the huge fiscal deficit of the government and its inability to control it. As Sharma points out in Breakout Nations: "It was easy enough for India to increase spending in the midst of a global boom, but the spending has continued to rise in the post-crisis period...If the government continues down this path India, may meet the same fate as Brazil in the late 1970s, when excessive government spending set off hyperinflation and crowded out private investment, ending the country's economic boom."

These details Manmohan Singh couldn't have mentioned in his speech. But he tried to project a positive picture by talking about the Planning Commission laying down measures to ensure a 9 percent rate of growth. The one measure that the government needs to start with is to cut down the fiscal deficit. And the probability of that happening is as much as my writing having more readers than that of Chetan Bhagat. Hence India's economic growth is at a level where it is meant to be irrespective for all the explanations that Manmohan Singh gave us and the hope he tried to project in his independence-day speech.

But then you can't stop people from dreaming in broad daylight. Even Manmohan Singh! As the great Mirza Ghalib, who had a couplet for almost every situation in life, once said "hui muddat ke ghalib mar gaya par yaad aata hai wo har ek baat par kehna ke yun hota to kya hota?"

Vivek Kaul is a writer and can be reached at vivek.kaul@gmail.com

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Updated Date: Dec 20, 2014 12:16:26 IST

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