Swamy’s Vaidyam

Friday evening, good friend Chandran Dharmarajan in Singapore sent me the link to Dr. Subramanian Swamy’s article in THE HINDU with a concerned (I am guessing) face. His subsequent questions gave me that impression. I read it. I winced at first and applauded later. I had it in mind to blog on it. But, I was postponing it due to other writing commitments. For example, I had also read Dr. Raghuram Rajan’s speech in Mumbai, where he counselled patience, against stimulus and against jugaad. My mind was made up at this late hour to blog on it because my friend Nitin Pai had sent me a mail asking what I thought of Dr. Swamy’s article.

First and foremost, the hypothesis that India appears headed for a crash and crisis in 2016 does seem far-fetched. It is such a serious prognosis that one would have expected him to substantiate it first before moving on. He does not. India could be doing a lot more to grow its economy, create jobs, etc. But, it is hard to see India crashing and entering a crisis, unless he is also predicting a trebling of the crude oil price from here, China devaluing the yuan substantially and Indians living in the Gulf being sent back in millions due to political unrest or whatever. If these happen simultaneously, then Indian economy could be in big trouble.

The good parts:

Dr. Swamy posed six questions at the beginning. Except for (a) and (b), the other questions were the right ones to ask. On (a), the fact is that the global US$ GDP is going be down 5% this year from 2015. That is big. Global trade contracted in the first half of 2015. It is a tough world. Hence, not a big surprise that India’s exports have not done well. However, we should note the following:

“Manufacturing export values increased sequentially for three straight months through July – bucking the trend in much of Asia.”

(b) is factually wrong. India’s household savings rate was never 34% of GDP. It is the overall savings rate that reached nearly 37% in 2007-08 (Gross Domestic Savings/GDP at market prices) and had declined since then to 30.6% in 2013-14. The base year for calculations has changed in between but the broad trend remains the same.

Now, comes the dizzying part – the prescriptions:

by lowering the cost of capital, by reducing the prime lending interest rates of banks to below 10 per cent; by shifting to a fixed exchange rate of Rs.50 per dollar for the financial year 2016; and lowering the exchange rate further for subsequent years;

the Reserve Bank of India (RBI) Governor, Raghuram Rajan, has single-handedly brought a huge slowdown to the Indian manufacturing sector and exports

How does Dr. Swamy think that strengthening the Indian Rupee would help lift exports? In that case, will he not end up outdoing Dr. Raghuram Rajan who, in his view, has single-handedly brought a huge slowdown to Indian manufacturing and exports. OF course, this blogger does not agree that RBI policy has single-handedly brought about a huge slowdown in India’s manufacturing and exports.

How many countries in the world have been able to bring down interest rates and simultaneously arbitrarily strengthen the currency? By what mechanism would this help address the risk of a crisis/crash that he predicts? If the Rupee were allowed to strengthen and simultaneously China devalues the currency next year, what would it do to India’s exports? If economic fundamentals are strong and sustained over time, currencies can and should strengthen. Otherwise, an arbitrarily strong currency would add to the country’s economic troubles.

Using 100 years of data (1910-2010), two academics have shown that the GBPUSD exchange rate had moved exactly at the average rate of the annual inflation differential. Over a long period of time, inflation rate is the only thing that matters for a currency’s value. Except for the last one year, India has had an inflation problem for the most part. Without addressing that, the currency cannot be fixed at 50 and then at 45 and 40. It won’t sustain. Until 2013, USDINR was at 45. It moved to 68 in few months. Raghuram Rajan is trying, with instruments at his disposal, to usher in and maintain low inflation. Only then, can the currency become stable and then strong. The RBI Governor is playing the long game. Others – in the government and outside – do not seem to have patience for it. Further, they are camouflaging their failure to act in other areas  by throwing blame at him. India’s growth problems cannot be laid at the doors of RBI’ monetary policy.

Dr. Swamy must have read that Indian banks have only passed on a small fraction of the interest rate cuts that the RBI had already announced. In fact, Indian banks are notorious for raising lending rates when interest rates go up and cutting deposit rates when the policy rate goes down. Most of them who do so are public sector banks. They make loans under political pressure and they carry a big load of workers. These are elements of a crash and crisis that he predicts. The ratio of non-performing assets in private banks is far lower. Pity that he has nothing to say on India’s government-owned banks and their inefficiencies.

The issues that this government is yet to address conclusively – the pricing of natural gas, the left-over tax disputes, recovery of loans from deliberately defaulting borrowers, separation of ownership and management in public sector enterprises including banks, the problem of financial viability of pricing of electricity in India and the dire situation in most State Electricity Boards and the glut in the real estate sector – do not seem to have much to do with economists of World Bank/IMF vintage. Indeed, in real estate, low rates will exacerbate the problem. India’s real estate sector needs lower prices for homes and not lower interest rates. No economy with such unjustifiably high asset prices has grown sustainably.

Most of the left-over reforms are in the domain of Indian States. Readers would have definitely loved to hear his thoughts on taking federalism forward and to its logical conclusion – to the village panchayat level.

Dr. Swamy’s piece redeems itself substantially in the last section where he outlines seven solutions. This blogger has few quarrels, if any, with most of them. Some of them are statements of principle. Some of them are specific. I particularly like (a), (b) and (d). In fact, (b) is the best for me. It is specific. Economists who are not of IMF/World Bank vintage might not agree with his pointed suggestion that some political obligations that come as part of the package of seeking technology partnerships with the United States, Israel and Japan are essential.  After (b), I love (a) and (d). Then, come (c) and (e).

Dr. Swamy concludes with a call to rise through innovation and to grow with financial stability. Premature rate cuts can endanger financial stability. No one can quarrel with innovation. The governor of the RBI, incidentally, made the same point in his speech too on Friday. India’s farm and factory structure are ill-suited for innovation. Most of the MSME enterprises – over 90% – are actually micro enterprises. They are not even ‘Small and Medium’. How many of them, Dr. Swamy thinks, are paying for their electricity, water and paying their Sales and Income taxes? How many of them care for product safety or worker safety?

Just as some social activists and economists on the Left romanticise poverty, some economists and commentators of the non-IMF/World Bank vintage romanticise MSME.  They neither create employment, nor output nor value added for the economy. If governments cannot create conditions for them to grow out of their micro and small sizes, then India will never become innovative to the extent that is needed to become a prosperous nation. Dr. Swamy will be doing a big service to the nation if he can advise the government on how it could integrate India’s fragmented and unviable production in its farms and factories.

The world over, evidence is thin that lower interest rates spur investment. Everywhere, the strict central banker is a convenient scapegoat for businessmen who have borrowed thoughtlessly and who fail to work hard and ethically at productivity improvements.

Indian businesses – MSME or large – need to introspect much more than economists of the World Bank/IMF vintage. They are the problem that the Indian economy is unable to grow rapidly for long periods. State patronage extended to India’s micro, small and medium businesses is not sound economic policy. It will merely be the equivalent of what the Left and the Congress Party have done to the poor in India – keep them there.


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