Surjit S Bhalla: History repeats - Congress loses?

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The Opposition knows that the Congress- and RBI-led monetarist battle against food and energy inflation is foolish - it hurts economic growth, and the chances of a Congress win.

There is buzz around town "" the recent economic polices of the UPA government, as announced via the Budget 2008, would lead them to electoral victory in Oct-Nov 2008. The Opposition is not really worried for at least two reasons. First, Budgets per se have little effect on elections; second, and more importantly, the reason for hidden complacency in the Opposition is because it has not one but at least two Trojan horses in the Congress camp!

There is an unfortunate myth about economic and political reality in India "" low inflation is an electoral winner. There is precious little evidence to substantiate this claim, and it is therefore unfortunate that even as good an economist as Dr Manmohan Singh keeps repeating this (false) mantra. Even more unfortunately, this mantra has led to misguided monetary policy in the mid 1990s, and today.

A major puzzle about the Indian economy is the constancy of the GDP growth rate post the economic reforms of the early 1990s (1991-93). These reforms have been politically popular; accepted by all parties, including most elected Left MPs. Only post 2003 did the Indian economy experience a significant growth acceleration "" from 5.5 per cent (1980s and 1990s) to 8.5 per cent, 2003-2008. Congress leaders somewhat embarrassingly take refuge in long and variable lags, but such long lags only exist in virtual reality. So what really happened in the 1990s? Why did the GDP growth rate not accelerate? It did, for three years 1993-94 to 1995-96 "" average GDP growth of 7.5 per cent. But "in the name of inflation" monetary sledgehammer made interest rates go sky high starting in 1995; investment declined subsequently, and GDP growth decelerated to a pre-reform level. One policy messed up the total effect of the mother of all reforms.

The political consequences of this strict monetarist (SM) policies were felt by the Congress in the 1996 elections. Except for 1991, inflation had been running at an 8 to 9 per cent rate. In the last year of Congress rule (1995-96), the inflation rate began to decline and reached a rate of 6.5 per cent in 1996-97, a rate close to then historical lows. Despite this low-lowest inflation rate achievement, the Congress lost massively "" down from 220-odd seats before the elections to only 140 seats in 1996. Anyone for lower inflation getting you extra votes?

This extremist monetary policy is defended by the RBI, and its then governor, Dr Rangarajan (now the Chairman of the National Advisory Council to Manmohan Singh; the first Trojan horse). While electorally the Congress lost, India gained; inflation expectations got killed, and inflation was reduced permanently in India to an acceptable 3-5 per cent level. How true is this belief? Quite false, actually. The table reports the identical pattern of Indian and developing economies' inflation rates; the other countries did not experience the Rangarajan SM sledgehammer. Yet inflation also collapsed elsewhere, and by somewhat more, 3 percentage points, compared to the 2.5 percentage point Indian decline. The deeper one examines the inflation picture in India and the world, the less does the claim of extreme monetarist victory in India post 1996 hold true. 
 

DECLINE IN WORLD INFLATION "" AND GDP GROWTH IN INDIA
Year	GDP Growth India	Inflation
		India	Developing  Countries
1981	6.3	10.4	10.3
1982	4	7.4	9.8
1983	7.1	8.8	10.4
1984	3.8	7.9	11.9
1985	5.8	7	10.5
1986	5	6.7	9.6
1987	4.2	9.2	9.3
1988	9.7	8.1	11.6
1989	6.6	9	11.9
1990	5.7	10.2	12
1991	1	13.8	12.9
1992	5.3	9.1	9.5
1993	4.9	9.6	10
1994	7.7	9.3	12.5
1995	7.2	9.4	11
1996	7.7	6.8	8
1997	5	6.4	7
1998	5.2	8.2	7.5
1999	7.4	4.6	4.3
2000	3.9	3.4	5.2
2001	4.4	3	5
2002	3.8	4	4.9
2003	8.6	4.2	5.1
2004	7.4	5.3	6.2
2005	9.2	4.8	5.5
2006	9.7	5.6	5.8
2007	8.6	4.5	5.5
Notes: Inflation is measured by the GDP deflator; developing countries are non-oil non OECD non Eastern European economies with population greater than 1 million.

Sadly, history may be on the verge of repeating itself in 2008-09. Sadly for India that is, not necessarily for the political opposition. There has been an investment and savings boom in India, yet the present RBI governor, Dr Reddy (the second Trojan horse), believes that we have mostly been "overheating" these last few years. And overheating begets inflation "" and inflation requires high interest rates. The RBI concern for inflation is touching, but in reality the RBI SM policy is geared towards the ideological belief that whenever the Indian economy grows faster than 6 to 7 per cent per annum, it most likely is overheating. This belief is logically and empirically inconsistent with the 14 percentage point jump in savings and investment rates that India has experienced over the last five years.

But what about gains against inflation? Again, the table shows that the RBI SM policy has produced a worse outcome than the average developing country. This average has stayed near constant for the last two years, as it has in India. So no gains in inflation declines for India "" and losses in terms of much lower GDP growth. While China, Korea, Euroland and Australia have yet to slow down, Indian GDP growth has slowed considerably. From 9.6 to 8.5 per cent, and forecasts of 7 % GDP growth in 2008-09. Industrial growth is down considerably (data for Jan. 2008, at 5.6 per cent y-o-y growth, is half the growth observed in Jan. 2007). Why this lower growth? Misguided inflation fighting has meant a large increase in real borrowing rates for corporates "" real rates of 10 per cent and above, while our competitors pay less than half this magnitude.

In the recent discussion about high food and energy inflation around the world, I have not understood the following. Agreed that food inflation hurts the poor the most and oil inflation hurts the middle class the most. But can any of the so-called experts please tell me as to how raising interest rates in India to double-digit real levels is going to affect the probability of an Australian drought, which has driven food (wheat) prices to record levels? Or how does obstinate SM policy in India affect the prospects for the price of OPEC oil? These questions deserve answers rather than homilies about the need to fight inflation. The more these questions are not asked and not answered, the greater the likelihood of an electoral defeat for the Congress in 2008, as it happened in 1996. Those who do not learn from history are condemned to repeat it. In the US, the Republicans are hoping for a Hillary Clinton win; in India, the Opposition is privately cheering Dr Rangarajan and Dr Reddy's strict monetarist tendencies.

The author is Chairman, Oxus Investments, a New Delhi-based asset management company. The views expressed are those of the author and not those of the institution he belongs.

surjit.bhalla@oxusinvestments.com