Tuesday, July 26, 2011

Politics killing economic growth.....

The RBI yesterday increased benchmark repo rates (the rates at which RBI lends money to banks....and which set the benchmark for all rates in the country) for a record 11th time in the last year and a half or so. It has been shouting from the rooftop for a long time now that the economy is starting to sputter. Corporate head honchos have been similarly repeating ad nauseum that the economy is slowing down. It is quite clear that the policy freeze in the government – arising from an environment of extreme politics – is responsible at least partly for the current situation we find ourselves in.

The RBI is mandated to keep inflation rates low. It considers rightly inflation to be the worst type of taxation.....affecting the poorest the most as it does. It controls inflation by shaping the Monetary Policy of the country. In other words, it looks at “money supply” – basically any movement of money from banks to those who need money. By increasing rates, the RBI squeezes supply of money, thus clamping down on demand. If demand drops, pricing should drop, thus easing pressures on inflation. That’s why RBI has been constantly increasing prices. RBI controls prices by controlling demand and often this is the only way to control demand in the short run. However, inflation by demand management has limited utility in curbing prices in the long run. Clamping down on demand is akin to a company cutting costs to manage profitability in an environment when revenues are not growing. Cost management may yield results in the short run, but in the long run, revenues have to rise, if profitability has to be sustained. In the same way, in a country, raising rates may moderate demand and inflation in the short run, but in the long run, it is increasing production and supply of goods and services that is the right way to manage inflation. That brings us squarely into the domain of the Government in general and the Finance Ministry in particular.

The Finance Ministry uses the Fiscal Policy to incentivize higher production in sectors that are suffering from under-supply. For eg., if import duties on oilseeds are reduced, it will increase supply of oilseeds and lower prices. If there is inflation in real estate, there must be a policy to free up land, make credit cheaper, lower cement and steel prices and so on and so forth, so that supply can increase. Over the last 20 years since economic liberalization began, the fiscal policy of the country has been made more liberal – customs duty, excise duty etc have all been pruned to encourage more industrial production. That has stood us in good stead till now. But now the challenges have increased. We need to relook at industrial policy, at agricultural policy and at fuels separately. This is where politics is starting to hurt the economy.

Just one more point on inflation components before we go to the politics involved. Inflation has three major components – Primary articles (20% weight – mainly made up of food and non-food items), manufactured products (65% weight....which has several components) and Fuels/power etc (15% weight). Everyone knows that controlling fuel inflation is not in our hands in the short run. India still imports 85% of its crude oil and though natural gas production has increased, it is no where close to substituting crude. With the rise in global crude prices, there is precious little that India can do. In the very long run, India has to depend more on nuclear fuel and must move its transport industry more towards electric modes of transport (with the electricity generated from hydro and nuclear power plants). Hence the government must invest in more metro networks in all our bigger towns, significantly improve the inter-city train network, encourage electric cars, plan for more unconventional power sources (sun, wind, biogas mainly) etc etc.

When it comes to food inflation, this is where successive governments have repeatedly failed. There has been nothing substantial achieved in agricultural productivity since the Green Revolution in the mid-sixties. We need to embrace more bio technology. We need more irrigation facilities. We need better food storage facilities so that so much food doesn’t get wasted. We need a better cold chain system. We need more mechanisation in farms and for that we need to develop a system of credit flow to the farmers. We need more power supply at affordable rates. We need a better fertilizers policy......Clearly, a lot needs to be done on this side.

And finally when it comes to manufactured products, we need a far more aggressive industrial policy. We need flexible labor laws so that industries can use labor supply as required and not have to rely on contract labor. The Left blocks any labor reforms.....but like many things that the Left used to believe in, this one also has got outdated. Industries are using contract labor to fill the vacancies that should have actually gone to full-time labor. The plight of contract laborers is quite shocking.....so the Left must ask itself what it has achieved by its rigid stand on labor reforms. Likewise, we need a better mining policy which encourages more exploitation of minerals without exploitation of the environment or the people who own the land. We need better environmental laws.....but those that are realistic, not extremist. We need a new land acquisition policy which rewards people who have to surrender the land. We need more fiscal incentives in smaller states where industrialization has barely been seen. We need tax reforms – the GST being the primary one of them all. We need a better educational policy which focuses on vocational training. There is so much to be done. And if we get distracted from this, there is no chance of us achieving our destiny.

This is where politics starts to hurt. Just think about it. For the last year now, all that this country has been talking about is corruption. We have had one scam after another. In most cases, the truth is far from what is projected. The 2G scam for instance is an example of hyperbole. There is local corruption but the CAG has confused matters by mixing its comments on policy with actual acts of corruption. The CWG scam was touted as being Rs 70,000 crores – of course no one owes anyone any explanation of where this number first came from. The Adarsh scam? It’s one building for god’s sakes.....and sometimes we must ask if our protestations are justifiable for scale. The BJP’s own woes in Karnataka have given rise to a feeling of there being corruption all around in all parties. Of course, most people in the country (and that’s true of all countries really) don’t understand the reasons which cause corruption and hence have no solutions to offer. Even readers of this blog offer emotional responses, not commensurate with expected levels of intelligence. Many attack me personally (doesn’t bother me really!). It would appear that the solution to all problems is the enactment of Anna’s Lokpal Bill. And while we are at it, please.....don’t even think of suggesting changes to it. And of course, there is this other hint in all responses.....throw out the UPA....no, no, throw out all the politicians. So who runs the country if we throw out the politicians? Maybe we need a Pakistan style military dictator? Or maybe a half century of old-style communism? Or maybe Anna should become the PM!

Poltics is essential in our country, but when it starts to distract from economic growth, we must pause and review where we are headed. If every decision the government makes (BJP or Congress) is to be seen as an act of corruption, then we are actually incentivizing the government to take no decisions. If every bureaucrat is assumed to be corrupt, then only the scum will join that service. If every media channel will don the role of the judiciary, then we will be adopting a primeval form of judicial system akin to what prevails in Afghanistan or worse. Sure we need lots of reforms. We need to take erring politicians to task. But we must have the maturity to balance this with identifying, rewarding and applauding good work. The mood in the country today is such as if everything was wrong in India. All the good work has been done by the people.....all the bad work by the government. This is political jingoism. And it harms the country to no end.

The real truth is for people to realize what they are doing. For media to play a far more responsible role – even if some people will call them as having “sold out to the politicians”. The fourth estate has a critical role in nation building and this is needed more than ever now in the country. There has to be a limit to politics.....else the poor RBI will have no options but to keep increasing rates again. And again.....

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