Four months ago Narendra Modi rode to power on a promise to revive the Indian economy and restore to the people of India the future they had lost. But tendrils of doubt had begun to surface well before he completed his first hundred days in office. In the last week these have hardened into certainty.
In normal circumstances four months would have been too soon start judging the performance of a new government. But the BJP came to power in a moment of crisis on a huge wave of anger against the UPA government. Economic growth had crashed, industrial production was contracting, and almost no new jobs had been created since 2008, leaving an estimated 40 million new job seekers stranded. None of those who voted for Modi had expected an instant miracle, but they had expected the new government to unveil a credible, well worked out plan to revive the economy.
They didn’t get one. There was no hint of any change in the macro-economic policies that the UPA had followed in Finance minister Jaitley’s budget speech and there was none in Mr. Modi’s Independence Day speech. Instead as the government’s 100th day approached it’s spokespersons plucked at straws to showcase its success – a 3.9 percent growth in Industry and, on its back, a one percent rise in GDP growth from 4.7 to 5.7 percent. July’s data for industrial production pricked this balloon. Not only had year-on-year industrial growth fallen to 0.5 percent and manufacturing contracted, but the 3.9 percent growth in the first quarter turned out to be a statistical illusion. To those on the ground for whom nothing had changed, this began to look like proof that nothing would change in the near future.
The policy change needed to restart growth is a simultaneous, very sharp lowering of interest rates and a firm containment of the fiscal deficit. The interest cut will revive consumer spending, especially on durables, start a rise in share prices, and bring down the cost of new investment. If synchronized with a reduction of the fiscal deficit it will bring about a non-inflationary transfer of resources from government consumption to corporate investment.
The time for making this shift of policy could not be more opportune. The balance of payments deficit has been brought down from an unsustainable 4.7 percent of GDP in 2012-13 to a healthy 0.8 percent in the last nine months of 2013-14. Exports are growing at 10.2 percent, and engineering goods exports at 22 percent. Foreign exchange reserves have crept up in the past 12 months from $ 279 billion to $ 320 billion. The threat that a sudden rise in investment and consumption will trigger a foreign exchange crisis has therefore receded. In his budget Mr. Jaitley made a determined bid to contain the fiscal deficit by increasing tax collections, and announcing plans to improve delivery and save money. But he made no mention of interest rates. His budget announcement therefore became a bird with a broken wing.
One has only to look as far as the Reserve Bank of India to see why. In his latest Policy Review the RBI governor, Raghuram Rajan, again did not lower interest rates, even by a fraction. Instead as one justification for keeping them high has dissolved, he has hurriedly replaced it with another. Today the wholesale price inflation is at a five year low of 3.7 percent, and consumer price inflation has fallen to 7.8 percent, but commercial bank lending rates (including bank charges) remain at 13 to 14 percent even for financially sound companies. This gives a real rate of interest for manufacturers of 10 percent — a figure unheard of in mature market economies even in good times and suicidal in times of recession. Even by the yardstick of CPI inflation the real rate is over five percent, a rate at which investment is not possible. Is it surprising then that bank lending has grown by less than ten percent this year against 23 percent five years ago; that there have been only six new share issues so far in 2014, against an average of 110 in the same nine months of 2006 and 2007, and that the sales of all consumer durables, from autos to TVs, computers and office equipment has fallen by eight to fourty percent in the last one year?
In his 14 months at the RBI, Rajan has not mentioned economic growth. This may be kosher in the West, which does not strictly need growth. It is not kosher in India, where people have to earn something before they can start worrying about how much their money will buy.
Prime Minister Modi has promised to give India world class roads and ports, high speed trains ‘smart’ cities, rural electrification and water supply. These are all infrastructure projects, and infrastructure devours capital. In the best planned and executed projects the ‘bare’ construction period, when the money has actually to be spent, stretches from five to 12 years. Where will Mr. Modi find Indian entrepreneurs willing to take up such projects when interest charges alone can add 25 to 100 percent to his costs?
The answer, of course, is nowhere. So Raghuram Rajan must give up his obsession with inflation, and his attempt to fight it single-handed by choking India’s economic growth, or he must leave. If the Modi government cannot persuade him, and has not the courage to fire him, then the people will fire it at the next elections.Read More