Chidu-nomics - the threat within
Preventing managed rupee depreciation is a key internal inconsistency in the finance minister's economic prescription
Mr Chidambaram’s term as finance minister with UPA-II was born in difficult circumstances, thanks to money-does-grow-on-trees approach of the Congress party. More than an ideological reformer, he comes across as a pro-equity market finance minister. More worryingly, economic vulnerabilities have increased, but the fault lines are masked by the easy global liquidity.
Mr Chidambaram has a challenging task ahead of him. Fiscal contraction in the run-up to a general election is hardly a recipe for electoral success. What makes the challenge more daunting is that part of reducing government expenditure requires unpleasant political decisions about cutting non-food subsidies. Fuel subsidies also need to be cut to make some room for the potential hit from the food security Bill, often characterised as UPA-II’s political trump card ahead of the next general election.
The UPA-II is now trying to fix a system it broke with a risky approach and it could still backfire. Mr Chidambaram is attempting to doctor an economy that has become a low growth-high inflation economy, thanks to his government. The twin deficits are unsustainably large, investment is frozen, consumer spending cannot be unaffected by the cuts in subsidies, and the economy is exposed to volatile risk-driven capital flows like never before in India’s history. The rupee has had one bout of the currency flu, but is showing the symptoms of more serious suffering for which policy makers are ill-prepared.
Policies have ironically made the supply-constrained Indian economy less competitive. The cost of capital in India was never low and it has become more expensive in recent years because of much-needed monetary tightening. Land has essentially been all about rent-seeking behaviour, which was not addressed in a timely manner and subsequently contributed to crippling investment. India’s labour market has been off-limits, and the employment guarantee legislation, directly and indirectly, raised wages. But, and this is an important point the government is uncomfortable to confess, without any gain in productivity.
The way to address this erosion of competitiveness is a combination of domestic cost deflation and currency depreciation. The land acquisition Bill will further worsen the cost structure of the economy. That leaves rupee depreciation. But Chidu-nomics favours rupee appreciation even if the underlying economic situation doesn’t support it. Therein is the biggest internal inconsistency in Chidu-nomics, not to mention the increased vulnerability to an unexpected reversal in global capital flows.
The mood was worse than the reality on the ground before last September. The reverse is true now, thanks to the re-rating of the equity market. Given the idiosyncratic factors responsible for crippling investment, fiscal correction in India’s case is a necessary but not a sufficient condition for investment revival.
The only reason Chidu-nomics has not already resulted in a more serious crisis is the exceptional easy global liquidity. All of us want India to do better. The question to be asked about Chidu-nomics is not what if it works, but what if it doesn’t work, as we are not prepared for the consequences of that. As global events of recent years have shown, economic fault lines eventually assert themselves, even if delayed. Policy makers are risk managers, not risk takers. Worryingly, that distinction has lost its relevance in India.
