The irritating jingle for India's tourism advertisements uses the slogan
"Incredible India". I for one tend to agree that the country is incredible, if
the literal meaning of the adjective may be employed to mean that various
aspects of the country's policy are simply not credible in today's global
economic context.
Just on Friday, the country announced wholesale price index inflation of
11.42%, an acceleration from the 11.05% of the previous week and worse than the
11.22% expected by economists. The jump from the trend rate of about 5% for
2007 to more than double is all too easily blamed on the rise in food and oil
prices, but in the case of India at least there are some pretty dumb policy
decisions at the heart of the whole mess.
The first major policy error was by the central bank (Reserve Bank
of India, or RBI) that tried to use a combination of moral suasion and reserve
ratio hikes at banks to curb economic overheating. In an economy that has
banking assets less than 50% of gross domestic product, the idea of using bank
reserve ratios to curb overall inflation is akin to using a motorcycle to pull
a truck along the highway.
RBI officials as recently as last month talked about "allowing" the rupee to
rise against the US dollar to combat inflation. Maybe it is just me, but the
idea of some ex-communists talking about "letting" or "guiding" any aspect of
financial markets always raises ones heckles. It is another matter that such
delusions of grandeur pervade the halls of all Asian central banks, but today's
subject happens to be India so let's stay on message.
On the other side of this fascination with "allowing" the markets to do
something is the question of interest rates. Both the central bank and the
government maintained until quite recently that keeping interest rates stable
was essential to disallow rapid appreciation of the rupee. In other words, the
government and the central bank refrained from using the most potent policy
tool available - namely interest rates - with the excuse of the currency.
The real reason is of course a profound misunderstanding of the
growth-inflation trade-off in policy. Keeping interest rates low creates an
incentive for investors to accumulate assets with leverage, thereby creating
inflationary spirals. The combination finally ends with a rapid tightening that
always causes economic hard landing.
This is precisely what India is headed for.
Reform malarkey
The second troubling aspect of the Indian policy apparatus is the government's
expense management, or more to the point, the complete lack of any discipline
and forethought in allocating expenses. Government expenses have the potential
to create the exact opposite effect of what is intended because of a
fundamental failure to understand demand-supply dynamics.
Much like the experience of China, keeping prices artificially low encourages
the wrong kind of consumption, while also limiting new investments. This is the
reason China this month agreed to massive fuel price hikes, as its government
realizes the importance of improving efficiency of fuel usage as a strategic
rather than tactical goal. The same process is all too politicized and,
incredibly, not even widely debated in the case of India.
Martin Wolf writing in the Financial Times last week made the valid point that
for India to spend more on fuel subsidies than education is scandalous. I agree
with that view, and indeed highlighted the wrong policy priorities in India in
articles such as The
jihadi ate my homework (Asia Times Online, February 24, 2007). Fuel
subsidies are meant to benefit the poor in India, but actually are designed to
keep political lobbyists from the transportation and manufacturing industries
happy enough to keep funding the current political parties. That no Indian
media highlights this unholy nexus is by itself a scandal.
A country with an average population age of 25 is actually quite a scary place
because a failure to provide youth with the right access to education and
opportunities would create the kind of downward spirals that are becoming all
too common in Arab countries. (See
Love your children, those little terrors Asia Times Online, November 4,
2006.)
This is what India faces, especially with respect to its urban populations,
whose access to schools is poor and even then they are confronted with a
quality of education that is questionable even for the middle classes. In turn,
this lack of government-mandated education has hit specific groups like Muslims
quite hard, effectively forcing their children into religious education that
creates people completely unsuited for a modernizing economy.
Another aspect of government spending that Indian financial media haven't quite
cottoned onto is the fertilizer subsidies that are seen as pro-poor (that is,
supporting subsistence farmers), but actually benefit only large farms in the
north of the country. Once again, the fear of food price inflation encourages
the government to maintain such subsidies, quite ignoring the effects on the
quality of fertilizers. In other words, neither producers nor consumers in that
industry have any incentive to demand quality or price improvements.
Nuclear power
The last bit of political football that needs a mention here is the goings on
in nuclear power. You would think that a country that faces acute power
shortages already and is over-dependent on polluting coal and gas-fired power
plants would get ready some options on the alternative energy side.
As I wrote previously (Who
gives a dam? Asia Times Online, January 6, 2007 ) , the plural
political culture of India has created extraordinary challenges to development.
Hydroelectric projects take too long to come to fruition while challenges with
nuclear power are already well known. The one strong initiative that India had
on the nuclear power side was the agreement with the United States that would
have opened up the route to accessing modern nuclear power plants with reduced
quality and safety concerns.
This deal has been opposed by the country's communist parties, who object to
anything involving the US, even if that comes at massive costs to India itself.
Then again, India's communists actually pledge their allegiance to Mao and
Stalin, and therefore aren't the ones to think of the country's national
interests in any event.
So what do you call a government that is running up massive deficits while
spending on all the wrong things, ignoring the most pressing strategic
priorities and that spends all its time wrangling on matters of little import
for the country's future? A few words do spring to mind, but seeing as this is
a family publication, I am forced to refrain from using any such language.
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