How Manmohan's omelette came out as scrambled egg
Despite the sudden rush of blood to the head on reforms last Friday, Manmohanomics in UPA-2 has been a story of messing things up.
Around half way through Manu Joseph's new book The Illicit Happiness of Other People, Ousep Chacko, one of the main characters in the book, says "Don't hate me, son. There are people in this world who set out to make an omelette but end up with scrambled eggs. I am one of them."
I just couldn't help comparing this statement to Manmohan Singh, the Prime Minister of the country. When he started out in 2004 he had all the economic ingredients that could be used to make a good omelette but what he has given us instead is burnt bhurji (the closest Indian representation of scrambled eggs, and with due apologies to all the vegetarians out there).
What the UPA did was assume that the growth it did nothing to create would provide money to finance all its populist indulgences. This is how the omelette planned by the PM was converted to bhurji when other spending cooks from the Congress party stirred the pot.
Here's the story from the beginning.
When Manmohan Singh took over as Prime Minister on 22 May 2004, things were looking good on the economic front. Consumer price index (CPI) inflation was at a rather benign 2.83 percent in May 2004. Interest rates were low.
The fiscal deficit projected by the government for 2004-2005 was at 4.4 percent of GDP. The fiscal deficit is the difference between what the government earns and what it spends.
The interest payments that the government had to make on previous debt formed around 94 percent of the fiscal deficit. Interest payments stood at Rs 1,29,500 crore whereas the fiscal deficit was at Rs 1,37,407 crore. Thus the primary deficit, or the difference between expenditure and income, after leaving out the interest payments, came to just 0.3 percent of the GDP.
What this meant was that the government was more or less meeting its expenditure from the income that it was earning during the course of the year. Thus the deficit was on account of past debt. It also meant that the government did not have to borrow much, which in turn kept interest rates low, encouraging both businesses and consumers to borrow and spend, and thus helping the Indian economy grow at a fast rate.
The subsidy bill for the year stood at Rs 43,516 crore, or a little over 9 percent of the total government expenditure.
Cut to now. The CPI inflation for July 2012 was at 9.86 percent, and could cross over to double-digits in August. The interest rate on most retail loans is greater than 10 percent. And the fiscal deficit has gone through the roof. The projected fiscal deficit for the year is Rs 5,13,590 crore, or around 5.1 percent of GDP. The primary deficit is at 1.9 percent of GDP.
Even these numbers, as I showed in a recent piece, will turn out to be way off the mark. (You can read the piece here). The way things are going currently, the fiscal deficit might touch 7 percent of GDP, or thereabouts, by the end of this year. This is a situation which hasn't been experienced since 1990-91, just before India liberalised and opened up the economy.
In his speech as Finance Minister of India in July 1991, Manmohan Singh had said "The crisis of the fiscal system is a cause for serious concern. The fiscal deficit of the Central Government...is estimated at more than 8 percent of GDP in 1990-91, as compared with 6 percent at the beginning of the 1980s and 4 percent in the mid-1970s."
So the question that arises is what went wrong between 2004 and 2012?
The answer is that the subsidy budget of the government went through the roof. Things started changing in 2007-08. The projected subsidy bill for the year was Rs 54,330 crore. By the end of the year the government had spent Rs 69,742 crore, or 28 percent more. This was in preparation for the 2009 Lok Sabha elections.
The same thing happened the next year -2008-09. The government budgeted Rs 71,431 crore as subsidies and ended up spending Rs 1,29,243 crore, a whopping 81 percent more. The subsidies were primarily on account of fertiliser, oil and food.
The budgeted subsidies for the current financial year (2012-13) are at Rs 1,90,015 crore, or around 12.7 percent of the total government expenditure. But as has been the case earlier, the government will end up spending much more than this. Even after the Rs 5 increase in diesel price, the oil marketing companies (OMCs) will lose more than Rs 1 lakh crore on selling diesel this year. The total loss on account of selling diesel, kerosene and cooking gas at a loss is estimated to come to Rs 1,67,000 crore.
Just this will push up the subsidy bill close to Rs 3,00,000 crore. The government is expected to cross the budgeted amount for food and fertiliser subsidy as well. All in all, it's safe to say that subsidies will account for more than 20 percent of the government expenditure during the course of the year, leading to greater borrowing by the government and thus higher interest rates for everybody else.
The idea behind the subsidies (or inclusive growth, as the government likes to call it) is to help the poor and ensure that they are not left out of the growth process. The question is where is the money to fund these subsidies going to come from? As Ila Patnaik writes in The Indian Express, "Anyone looking at the rising subsidy bill, at the size of the welfare programmes, and contrasting it with the limited tax base, can only wonder why India will not have a fiscal crisis. A continuation of the present policies cannot but land the country into a huge problem. Either before a crisis or after it, there is little doubt that the current expenditure path has to change."
The programme at the heart of the so-called inclusive growth is the National Rural Employment Guarantee Act (NREGA), under which there is a legal guarantee of 100 days of employment during the course of the financial year to adults of any rural household. The daily wage is set at Rs 120 in 2009 prices (but varies state by state), which means it is indexed for inflation. Now only if economic and social development was as easy as getting people to dig holes and fill them up.
Also, as is usual with most such schemes in India, there are huge leakages in this scheme as well. Estimates suggest that leakages are as high as 70 percent, which means only around Rs 30 of the Rs 100 reaches those it should, while the rest is being siphoned off. This is done by fudging muster rolls, which are essentially supposed to contain the number of days a labourer has worked and the wages he or she has been paid for it.
Also, these subsidy and welfare programmes were initiated when the Indian economy was growing faster than 9 percent. Now the economic growth has slowed down to 5 percent levels. As Patnaik puts it, "Implicit was also the argument that NREGA will be paid for by the high tax collection that the fast growing sectors of the economy would yield. Growth was to be made inclusive through a redistribution of incomes. This was the scenario when India was growing at 10 percent and leaving some people behind. It was a scenario that might stand the test of time if India continued to grow at a long-run steady state of 10 percent growth. This plan did not appear to evaluate the fiscal path of such a programme when growth halved."
Slow growth also implies a slowdown in tax collections for the government, which might lead to the government needing to borrow more to finance the subsidies and welfare programmes.
A lot of the expenditure on account of subsidies could have been met if the government had been less corrupt and not sold off the assets of the nation at rock-bottom prices. The loss on account of the telecom scandal was estimated to be at Rs 1.76 lakh crore. The loss on account of the coal blocks scandal was estimated to be at Rs 1.86 lakh crore.
While these scams were happening all around him, Manmohan Singh chose to look the other way. As TN Ninan wrote in the Business Standard: "Corruption silenced telecom, it froze orders for defence equipment, it flared up over gas, and now it might black out the mining and power sectors. Manmohan Singh's fatal flaw - his willingness to tolerate corruption all around him while keeping his own hands clean - has led us into a cul de sac , with the country able to neither tolerate rampant corruption nor root it out."
Singh has tried to re-establish his reformist credentials recently by announcing a spate of economic reforms over Friday and Saturday. But none of these reforms look to control the expenditure of the government and thus bring down the fiscal deficit. If the government continues down this path the future is doomed. As Ruchir Sharma writes in Breakout Nations: "If the government continues down this path, India might meet the same path as Brazil in the late 1970s, when excessive government spending set off hyperinflation, ending the country's economic boom."
Higher expenditure also means inflation will continue to remain high. "NREGA pushed rural wage inflation up to 15% in 2011," writes Sharma. The fear of high inflation continues, despite the reforms announced by the government. "The government undertook long anticipated measures towards fiscal consolidation by reducing fuel subsidies and selling stakes in public enterprises. Further, steps taken to increase foreign direct investment (FDI) should contribute to both greater capital inflows and, over the long run, higher productivity, particularly in the food supply chain. Importantly, however, for the moment, inflationary pressures, both at wholesale and retail levels, are still strong," the Reserve Bank of India said in a statement today, keeping the repo rate (or the rate at which it lends to banks) constant at 8 percent. This, despite the fact that there was great pressure on the central bank to cut the repo rate. It is unfair to expect the RBI to make up for the mistakes of the government.
The bottomline is that if the government has to get its act right it needs to reign in its expenditure. I started this piece with eggs, and so let me end it with chickens. As economist Bibek Debroy wrote in The Economic Times: "Since 2009, UPA-2 has behaved like a headless chicken. It is still headless, but the chicken at least wants to cross the road. We still don't know whether it will be run over or cross the road and lay an egg."
And even if eggs are laid, we might still end up with burnt bhurji rather than omelettes.
Vivek Kaul is a writer. He can be reached at email@example.com
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