Contrary to fiscal terrorists, India has a lot of room for fiscal expansion in infrastructure and low-cost housing.
I have always advocated that every policy maker, and economic analyst, should spend at least three months of her time in the financial markets. For two major reasons — financial markets incorporate and process a tremendous amount of information quickly, and efficiently; and second, and most importantly, trading in financial markets teaches one to be humble. The market teaches the same lesson every day — it is okay to be wrong, perhaps even human.
If one is outside of the financial world — say the academic or the bureaucratic or even the research analyst at an investment firm — one never has to admit, even to oneself let alone to others, that a mistake has been made. Especially among economists there is a tendency to use both hands, and all the fingers, to explain away why something happened (a bit too much like President Bush!). No accountability, no own pocketbook lost, and the arrogant beat goes on.
In this year of Black Swans, when everyone has been proven wrong, let us assess what some of the maestros have said, and done. Internationally, the clever people were baying for Bernanke's blood, stating that it was a huge mistake to not let Bear Stearns fail; a mistake because of the principle of moral hazard (didn't you know that Wall Street does not learn a lesson when 95 percent of its wealth is wiped out?) This "intellectual" non-market pressure was an important component in the US Fed making its first mistake through this financial crisis which started in August 2007 — and what a mistake it has been. It has brought not only the US but the international banking system down. Jobs, and not necessarily of those belonging to Wall Street, are being lost by the millions, and growth is negative. What price moral hazard? I can't help thinking, and believing, that a market participant would never have advocated the arrogant bureaucratic/academic demand for letting Lehman fail.
Closer to home, we have our own set of financial terrorists. It was less than two months ago that several non-market experts were claiming that the RBI was way behind the curve; eg Ajay Shah argued for more monetary tightening, in September, because the highest interest rates in the world were too low to combat imported inflation! (Wall Street Journal Online, Sept 2, 2008). Others echoed with similar sentiments. This was near universal conventional wisdom of leading investment firms, policy makers, pink paper experts, business TV anchor, academics — is there anyone left? If these gentlepersons were in the market, they would readily admit that they were horribly wrong. But since they have their egos involved (unlike market participants who can ill-afford an against-the-facts ego), they are loath to admit an error, even as horrendous an error as that of forecasting ever increasing inflation amidst ever declining world GDP growth. Incidentally, WPI seasonally adjusted inflation in September was running at a three-month annualized rate of only 3.6 percent; today, it is at a minus 2.3 percent rate. For the April to November period, the annualized inflation rate is only 4.6 percent.
An alternative to admitting a mistake is to morph oneself into one's twin; the conversion from a monetary to a fiscal terrorist is easy. Yesterday they argued that interest rates could not be reduced in India because of high inflation; today, the argument is that despite low and declining inflation, and below-potential and declining GDP growth, interest rates cannot be cut because of a high fiscal deficit. Over the last few years, off-budget items, in the form of fertilizer and oil subsidies, have become a source of concern to these fiscal jehadis. As of October ’08, the consensus was that India would have a double digit fiscal deficit, and that the oil deficit would account for 2 to 3 percent of GDP. But all of the fundamentalists (the moral hazard, monetary and fiscal, RBI/MoF and the IMF types!) were also forecasting a global growth slowdown of historic proportions. The fundamentalists forgot to note that low world growth, and WTI oil price below $65 for the Oct ’08-March ’09 period would mean an off-budget contribution of the oil deficit to be close to zero percent of GDP.
Analogous calculations with the fertilizer deficit show that it is likely to be lower than previously estimated — around 1 percent of GDP. Thus, off-budget items (oil, fertilizer, farm loan waiver, pay commission awards) which were thought to contribute 4 to 6 percent of GDP are likely to be around 2 percent of GDP (or Rs 100,000 crore). This will place the consolidated all inclusive fiscal deficit to be around 6.6 percent of GDP, which would make it the fifth best year since 1980, and except for 2007, the best for this low deficit decade. Slow growth will increase this estimate, but during slow growth years the fiscal deficit has averaged 8.5 percent plus.
An important conclusion of the oil and fertilizer price decline — India has a lot of fiscal space in which to operate. The need is for an expansionary additional fiscal stimulus of the order of 3 to 4 percent of GDP, with most of the expenditure going towards infrastructure and low-cost housing. In addition, the repo rate needs to decline to around 4 percent. This will make the real repo rate close to zero, a necessary condition to help arrest the slowdown in growth. Both policies will help the poor and middle class by enormous amounts, will help GDP growth, and not engineer inflation; the latter is determined mostly by international events. These growth policies may also be electorally correct. One additional gain — if the recommended policies are followed, the shrill, insensitive, and analytically wrong voices of the fiscal terrorists will be silenced.
The author is Chairman, Oxus Investments, a New Delhi-based asset management company. The views expressed are personal.
