An election-year syndrome

India’s macroeconomic fundamentals have a tendency to get worse about a year before the general elections. This may be a recent trend and there is also no causal connection between the holding of the elections and the macroeconomy coming under stress. But the coincidence is too stark to be ignored.

The Centre’s fiscal deficit in 2007-08 had declined to just 2.54 per cent of gross domestic product (GDP). Economic growth, measured by GDP at factor cost, was estimated at 9.3 per cent for that year. The current account deficit was 1.3 per cent of GDP. And retail inflation (measured by the rise in the consumer price index for industrial workers) was 6.2 per cent. Barring the inflation number, all other data points indicated a relatively healthy state of the economy.

A year later in 2008-09, the Centre’s fiscal deficit widened to 5.99 per cent of GDP, economic growth slumped to 6.7 per cent, the current account deficit widened to 2.3 per cent of GDP and retail inflation spurted to 9.1 per cent. The deterioration in the country’s economic health was sharp and disturbing.

Of course, a major factor contributing to the worsening numbers was the Great Recession. The global financial crisis of September 2008 took a toll on the Indian economy and the government was forced to increase spending and provide fiscal stimulus to manage the fallout.

But what cannot be ignored is the election-year syndrome of the Indian economy. Note that the deterioration in India’s macroeconomic fundamentals and the government response took place just before the general elections were held in May 2009.

Something similar happened before the general elections in May 2014. The Centre’s fiscal deficit in 2012-13 stayed at an uncomfortably elevated level of 4.93 per cent of GDP and declined marginally to 4.48 per cent in 2013-14. Economic growth dropped to 5.4 per cent in 2012-13 and staged only a small recovery to 6.1 per cent a year later.

The current account deficit rose to an alarmingly high level of 4.8 per cent of GDP in 2012-13. Though it declined sharply to 1.7 per cent in the following year, thanks to some tough measures taken by the government, the danger signals had rattled the managers of the economy. Retail inflation, too, rose to 10 per cent in 2012-13 and declined only marginally to 9.4 per cent in 2013-14.

Here also, the deterioration in India’s economic health was attributed to the US Fed Reserve’s announcement of paring down its liquidity infusion programme and to international crude oil prices that remained elevated at above $100 a barrel.

Quite remarkably, a similar trend is evident now as the country prepares for the next general elections that are due to be held in May 2019. The Centre’s fiscal deficit in 2017-18 missed its Budget target and stayed at 3.5 per cent of GDP, pausing the steady correction seen every year since 2012-13. Economic growth decelerated to 6.7 per cent in 2017-18, compared to 7.1 per cent recorded in the previous year. Growth in the current year may pick up and may cross the 7 per cent mark, but it would be nowhere near the highs seen before the financial crisis of 2008.

Equally disconcerting has been the rise in the current account deficit that inched up from 0.7 per cent in 2016-17 to 1.9 per cent of GDP in 2017-18. There is now a danger of the deficit touching the 3 per cent-mark. Retail inflation remained moderate at 3.6 per cent in 2017-18 but is projected to touch 4.7 per cent in 2018-19, thanks to a combination of factors including crude oil price increases and the rise in minimum support prices for agricultural crops.

In sync with what happened in the previous two periods prior to the general elections, this time also the factor largely responsible for the deterioration in India’s economic health is an uncertain global trade environment and rising crude oil prices. India's foreign exchange reserves now are more healthy than they used to be on the two previous occasions, but what is complicating its problems further is its poor showing on the exports front, which in turn has affected its current account balance.

The Indian currency, too, depreciated significantly about a year before the general elections were held. The Indian rupee depreciated by around 27 per cent from April 2008 to March 2009 (down from about Rs 40 a dollar to Rs 50.61 in that period). The depreciation was lower in the April-March 2013-14 period at just about 10 per cent -- from Rs 54.41 to Rs 60. And now, the Indian currency has already depreciated by 11 per cent from April 2018 and it is still not clear how the rupee will behave in the coming months. Such depreciation needs to be managed well by the authorities, but its electoral fallout could be adverse for a government that mistakenly believes that a strong currency is always beneficial for the economy.

There is no doubt that meeting a widening current account deficit will be a challenge for the government, particularly in the run-up to the general elections. Even though the extent of the deficit is not as large as the one that was seen in 2012-13, a widening gap in the current account tends to push up the inflation rate and impose checks on the economy’s growth potential — factors that could harm the ruling party’s electoral prospects in 2019.

Complicating the scenario now are rising crude oil prices and the spread of protectionism triggered by the trade war, affecting global trade in general and undermining India’s exports recovery prospects. It must be noted that in similar situations in 2009 and 2014, the government did not have to contend with the menace of protectionism. But in 2018-19,  rising trade tariffs are likely to deal a blow to India’s exports and dampen prospects of bridging the current account deficit. And if the global economy remains troubled, India may not receive steady inflows of foreign capital that could have cushioned the adverse impact of a wider current account deficit.

In such a situation, the government will be called upon not only to manage the external shocks by overseeing the currency's depreciation without undue volatility but also to prevent any further deterioration in the government’s fiscal situation. The government can hardly afford any slippage in meeting its fiscal consolidation targets. It must also avoid the dangerous temptation of falling into the trap of protectionism and raise duties on imports in the mistaken belief that such a step alone can help the country bridge its current account deficit and prevent the rupee from further depreciation.

But because the deterioration in the economy is an election-year syndrome, the government may face stiff political resistance to take tough corrective measures just before the polls . On the other hand, it will be relatively easy to take populist steps like allowing the deficit to widen through higher and mindless spending on poorly monitored schemes, cutting excise duty on petroleum products to prevent their prices from going up and raising import duties in general. The irony is that the latter course could cost the economy dearly.