At the Delhi Economics Conclave earlier this week, RBI governor Raghuram Rajan warned his audience against complacency. “A stable gov-ernment post-election, while likely, cannot be taken for granted. This implies that all parties have to work together today to ensure that any government that emerges post-election has the time to come to terms with the challenges of managing the Indian economy ... More general-ly, it would be overly complacent and possibly dangerous for parties to postpone necessary legislation with the idea that they will pass bills post-election. Similarly, any slowdown in putting large stalled projects back on track before the elections or any fiscal slippage will only amplify the already large challenges the new government will have to face.”
Rajan went on to outline the challenges that the economy faces in the medium term: Better infrastructure, better job training, better busi-ness regulation, and a better financial system. But he did not have a word to say about its needs in the short term. Nor did he show any awareness that developments in the next few months can drastically change the choices the next government will face in the medium and long term.
The omission is strange because the “short term” is all the time we have left to save the Indian economy. The time limit for such action is the date of announcement of the next election. Rajan considers a stable post-election government “likely”, but after the announcement of the assembly election results last Sunday, he should know that a smooth transfer of power to another stable government in April or May is the least likely of several possible outcomes of the next election.
The sharp rise in voter turnout and the shift of votes away from the Congress in the four larger states shows that a strong anti-incumbency wave has built up against the UPA, and that its curling crest is made up of young and first time voters.
If there is anything certain about the next election, therefore, it is that the UPA will not come back to power. But the Delhi elections show that the protest vote will not necessarily go to the BJP, for while the Congress lost 15% of the votes, the BJP also lost 3.2%. It is therefore entirely possible that where the people are offered a third alternative, they may forsake the BJP too.
This lesson will not be lost upon the Left Front and the regional parties that want to side with neither the Congress nor a Modi-led BJP. Thus, a third front is almost certain to come into being. The next elections are therefore likely to see a three-way split of seats with no imme-diate prospect of a stable majority. The absence of a stable government, and the possibility that the next government will contain the left Front, will make foreign investors jittery.
If this coincides with the tapering off of the US fiscal stimulus (which, thanks to robust employment growth in the US during the past three months seems likely to start in March), foreign investors will take flight once more. The threat that this can precipitate a foreign exchange crisis will force the RBI to maintain high interest rates.
This will take the choice of policy out of the new government’s and the RBI’s hands. If interest rates remain high, the industrial stagnation and the rapid loss of non-agricultural jobs that the country is experiencing will continue into the indefinite future.
Dr Manmohan Singh therefore has one final duty to perform for the country. He must ensure that the economy is well on the way to re-covery before he relinquishes office. This will only be so if industrial growth has resumed, and share prices have begun a sustained rise. The single key that will turn both locks is a sharp reduction of interest rates. And the last chance for doing so is the RBI’s mid-quarter policy review at the end of this month.
In a recent article, I had made an impassioned plea to lower interest rates sharply now to start an economic recovery. I had shown that if one excluded April and May 2013, when there had been a $15 billion speculative surge in gold imports, the monthly trade deficit from June onwards showed that the current account balance of payments deficit was set to fall to less than 1% of the GDP in a full year. The country, therefore, had a golden opportunity to lower interest rates and to restart an industrial recovery without re-igniting the fear of a foreign ex-change crisis.
On Monday, December 3, the RBI confirmed these projections. Unable to hide its relief, it announced, almost a month ahead of sched-ule, that the CAD had fallen to a mere 1.25% of GDP in the July to September quarter of the fiscal year. With strengthening exports, this could easily come down further in the remaining half of the year. The time is therefore ripe for the long-prayed-for lowering of interest rates.
But Rajan is still unconvinced. On November 15, he said: “We can spend a long time debating the sources of this inflation. But ultimately, inflation comes from demand exceeding supply, and it can be curtailed only by bringing both in balance.” And in a talk this week, he esti-mated that it would take another eight months to bring inflation under control.
Rajan is a dyed–in-the wool Chicago School economist, so refusing to distinguish between demand–pull and cost-push inflation is a matter of faith with him. But the price of his, and his predecessors’ monetarism, is going to be paid by the Congress party whose very sur-vival, let alone return to power after the next election, is no longer assured.