An Economic Disease

After World War I, the Allied Powers were all but broke. Article 231 of the Treaty of Versailles – the War Guilt Clause – declared Germany and its allies responsible for all ‘loss and damage’ suffered by the Allies during the war and provided the basis for reparations. An Inter-Allied Reparations Commissions decided the total sum of reparations as 269 billion gold marks – equivalent to 100,000 tonnes of pure gold. Clearly, Germany couldn’t pay it and hence it was asked to pay back through devalued Gold Marks, which ultimately led to hyperinflation.

Inflation reached such magnitudes that in just 2 years since 1921 value of the Mark decreased from 60 Marks per Dollar to 4.2 Trillion Marks per Dollar. By 1923, the rate of inflation hit 3250000 per cent per month – doubling every two days. There were two theories to explain this effect – either the Weimer Republic was too incompetent to control it or it was a deliberate attempt to avoid paying reparations.

India today is standing at a similar stage. The inflation is becoming chronic day by day. The usual deadlines for controlling it and wildly “guessed” reasons by both PM, FM and RBI are just becoming irritating. Sometimes government blames “progress” of nation and sometimes its global fuel-prices. Both are valid reasons for inflation but not for its chronic state.

Explanation for Germany’s inflation was an either or question. But inflation in India is a result of both answers working together – its part Deliberate part Incompetence.

UPA-2 government is working under what John Stuart Mill called “Tyranny of the Masses.” In such a system, decisions made by a majority places that majority’s interests so far above a dissenting individual’s interest that the individual would be actively oppressed, just like the oppression by tyrants and despots.

India being an agrarian society provides the majority vote bank as farmers. With almost 75% voters from the Agricultural Sector, the math is simple – appease them and stay in power. Consider this – when RBI announced the last interest rate hike, government increased the price of wheat for farmers by 10% on the very same day. Now, through the RBI directive, government “tried” to look as if they were serious about controlling inflation. But the Congress Whip’s Office wanted a better Election result in the upcoming U.P Elections.

With the speed of modern communications, the availability of non-inflating money substitutes, free exchange of currency, and the efficiency of world markets, the potential for governments to benefit from deliberate inflationary policies is very limited. But still they are pursuing, only because of vote bank politics. India’s fiscal deficit is reaching unmanageable levels. This year’s deficit has doubled even when the government expected less income as there won’t be any sources like 3G auction. Finance Ministry recently sold cash-management bills of about $ 2.5 billion dollars in just 2 days, a clear sign of economic panic in the government. Government is faking to be Monetarist but is actually implementing Fiscal theory of the price level; pretending to keep money demand in check but letting budget deficit create over-inflation.

In all this, government is still subsiding, not for Middle Class but only for the Rich and the poor. Of course the poor need subsidised food and kerosene. But free TV sets, free laptops, free mixers? It’s not immediately apparent how a family surviving on Rs. 3 per kg rice will use mixers. If India is not able to provide 24 hour electricity to even its metropolis, what use are TV sets and Laptops? Surely fiscal deficit is going to increase if political
parties want to implement their Election Manifestos.

Another area where the farmer vote bank is nurtured is Diesel subsidy. Petrol prices have been raised at will since the de-regulation “scam” was implemented by the Government. There aren’t any Scooters or Motorcycles that run on Diesel. Diesel cars are also on the expensive side. Tractors are the target of Diesel subsidy. Mamta Banerjee will definitely issue empty threats on Petrol Rise but will definitely pull out if Diesel prices are deregulated.

No one is against farmers but all this expenditure through subsidy in not translating into growth of Agriculture. It’s still growing at 2.2%, while its costs to exchequer are only increasing. Irrigation, rural infrastructure, rural electrification etc. is not on the agenda. Government buys huge amount of grains from farmers every year at market prices but most of it rots due to poor storage systems.

To me, the plan looks like this. Give free lunches, more subsidies to the voters but don’t let them actually grow. If the farmer actually develops, he might not actually want subsidy. Moreover, the Indian farmer is not poor; it’s the Farm Labour, which starves. Increased wheat prices or increased production is no guarantee that farmers will increase labour wages. Surely, government know this but don’t want to disrupt farmer-labour relationship. It is the same reason why the government doesn’t want to deal with Khap-Panchayats.

Secondly, inflation is a result of zero governance by UPA-2. All the sides of the political pyramid have raised this point, from BJP to Team Anna to Industrialist like Premji. When Congress returned to power in 2004, they had many ideas – NREGA, Right to Information, etc. In the UPA-2 term, there haven’t been any. There are two reasons to it – No pressure from Left parties to remain “Aam-Aadmi” oriented and actual dearth of ideas. More than 8 years of gap from power gave Congress leaders enough time to think of new ideas. Unfortunately, the number was sufficient only for UPA-1’s duration.

UPA-2 has been a symbol of mismanagement and failed authority since 2009. The nuclear deal on which the government almost fell hasn’t made an iota of progress, while the price of Coal has increased by $50 per tonne. This is causing tremendous pressure of Power Generating entities. The continuous downfall of Rupee is hurting imports badly, especially oil imports.

India is sitting on foreign reserves worth $330 billion, which is mainly used to invest in foreign treasuries. The returns average around 5% only. In the normal course, the abundant dollar supply should appreciate the Rupee but it’s not true in India’s case. Steiner (2009) suggests that the accumulation of reserves might result in inflationary pressures if the resulting monetary expansion is not fully sterilized and exceeds the growth of money demand. Moreover, only 10% are in Gold Reserves and rest in US Dollars, which is subject to volatility. Also, import growth outpacing export growth is shrinking the reserve base. Combined together they are leading to depreciated Rupee and high Oil Prices.

Dimensionless International Diplomacy is also letting us down.  France during the last peak of Oil singed a 100 yr treaty to get oil at fixed price. They again jumped in and signed a treaty with Libya just 2 weeks into NATO war. Iran-Pakistan-India pipeline was decreased only to Iran-Pakistan because of India’s inability with diplomacy.

Since inflation is a rise in the general price level, direct control over wages and price can stablise prices and thereby prevent the evils of inflation. Dr. Manmohan Singh’s idea of “let markets find their correct levels” cannot work in a mismanaged economy. Not all ideas have to be big-ticket and huge. Small steps here and there can make a lot of improvement.
Government needs a taser-gun to wake up from its deep slumber.

Abhay Nidhi