The looming crisis in India

A political override over economic common sense is likely to push India’s tottering economy over the edge.

India’s politics, economy and social fabric are unravelling. Its politics are dysfunctional. Its economy is tanking. Uncivil society is rebelling. The ‘street’ is challenging the ‘state’. Government of India cannot respond coherently. Probity and ethics in public, corporate and professional life are conspicuous by their absence. Devastation in Uttarakhand aggravates India’s traumas. The armed forces and NGOs respond with skill and compassion, in contrast to the serial failures of civilian government. The tragedy highlights again the incapacity of government in India to govern effectively/efficiently or regulate activity sensibly.


India bleeds; yet its politics are stalemated. Parliament is dysfunctional with 165 Bills pending. The BJP opposes all that the government proposes. It demands resignations and blocks legislative activity. That might be justified if it provided a credible alternative. It does not. It has elevated a dangerous, divisive autocrat to lead it into general elections, triggering internal dissonance and fracturing the NDA alliance.

Given UPA’s record, the BJP’s travails may not guarantee a third UPA victory. That might prove disastrous anyway if a post-2014 UPA-3 repeats the record of UPA-2. State elections confirm a public desire to oust corrupt governments coupled with incapacity to install cleaner ones. They do not exist in the Indian political space. So a Federal Front may emerge comprising regional parties most of which are led by mercurial and unstable personalities. Such a coalition may cobble together a majority of votes in the Parliament. But it would have no credibility, national agenda or durability. No third front has survived in India for more than 18 months. With the fragility of the economy, a third front might set India back by decades.

 Unexpectedly, UPA-2 has mismanaged the Indian economy; in contrast to UPA-1 Agreed that it had a global recession to contend with, but that should have depressed growth from 9 percent to 7 percent. Instead growth has fallen below 5 percent because of economic mismanagement, falling investment, infrastructure bottlenecks and corruption. India has high inflation and twin deficits that have spiked to unsustainable levels, causing the INR to collapse. The fiscal deficit is 5 percent of the GDP. The CAD is 4 to 6 percent of GDP. Declining capital inflows (resulting from collapsed confidence) mean the CAD cannot be financed. India’s large short-term external debt is pushing it into a corner. Reserves of USD 280 billion will not protect against external unwinding or an oil price shock.

The INR has depreciated by 12 percent in June and 40 percent since 2008. That worsens inflation by increasing the INR cost of essential imports. Devaluation should make India more competitive. But India is ill placed to benefit. It has not reformed its absurd labour policies, nor its infrastructure and other structural policies, to become globally competitive. Its hostility to FDI, and aversion to multinationals constrains its competitiveness. A continually declining INR puts off potential FDI that sees value being eroded by ever-materialising currency risk.

Given its economic characteristics and debt dynamics, growth of 5 percent in India is equivalent to 0 percent in the developed world. It accentuates the country’s incapacity to generate sufficient revenue, create sufficient employment, and ensure competitiveness. India has to run faster than others on the global treadmill to stand still. Instead it is running slower and falling behind.

Clearly, UPA-2 appointed the wrong Finance Minister in 2009. His 3-year tenure showed a lack of judgement, hostility to FDI/FII, and an obsession with maximising revenue that dented investor confidence irreparably. The present FM faces a herculean challenge in turning India’s economy around. Yet GoI keeps sending out confused, contrary signals. Ministers talk up the attractiveness of India to investors but they turn them off by actions contrary to words. The external situation demands that GoI does everything possible to attract FDI and FII. But the government is dilatory in passing the amended Insurance and Pensions Bills. These would bring in direct immediate investments of  $1-2 billion, more via associated indirect FDI and FII. Yet the signals are that GoI will not accommodate the legitimate interests and concerns of the foreign investors.

Despite economic turbulence UPA-2 has increased fiscal burdens. It has introduced large income subsidies before reducing sufficiently misdirected price subsidies for energy, fertilisers and food. Just before the 2009 elections UPA-1 introduced a National Rural Employment Guarantee Act (NREGA) that is now fiscally unaffordable, though it has propped up rural incomes and increased aggregate demand. But it has distorted and overpriced agricultural labour thus raising farm costs and fuelling food inflation. Given the failures of state governments, 40-50 percent of the resources allocated under NREGA do not reach intended beneficiaries.

UPA-2 has reduced fuel subsidies that were misdirected yet supported by an opposition unversed in economics. But it has not gone far enough to eliminate their market-distortions. Again, just before the 2014 election, UPA-2 now wants a Food Security Bill (FSB) that guarantees cereal supply at egregiously subsidised rates to 75 percent of India’s rural population and 50 percent of its urban population; when it claims to have reduced poverty to 28 percent of the population. FSB opens the door to more graft by relying on a dysfunctional Public Distribution System, which will divert even more resources from intended beneficiaries. GoI argues that it will increase the fiscal burden by ‘only’ INR 270 billion. This is an astonishing move, given that the government is bankrupt. The actual burden may be twice or thrice that. If monsoons fail, FSB will increase food imports and widen the CAD.

GoI and the leadership of UPA-2 are gambling on getting a damaging FSB passed at the expense of more urgent reforms. Flawed political reasoning drives such distorted priorities. Congress’ leadership believes that the electorate must be bribed to vote for it. But that detracts from the credibility of GoI at a time when India confronts an economic debacle.

If India’s policy-makers do not correct course and moderate their hostility to foreign investment, thus compromising India’s long-term interests, then India will never be a force in the global economy. Instead of keeping foreign investors at bay, India should be attracting as much FDI and as many multinationals as it can, by providing the most user-and-tax friendly environment it can. Instead it is doing the opposite. India now needs a harsh reality check about what a political override over economic reason will do to push its disintegrating economy over the edge. It may take decades to recover, with another generation being sacrificed.

Photos: Katy Ereira