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Updated: May 21, 2012 00:28 IST

India in the European mirror

C. P. Chandrasekhar
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The Hindu

The government needs to increase expenditure to restore growth and employment, but international investors are dictating just the opposite

As Europe descends into an ever-deepening crisis, the much-touted Indian growth story also seems to be nearing its end. Though the two trends are not unrelated, attributing India's predicament solely or principally to what is happening in Europe would be wrong. On the other hand, there are similarities in the two experiences that should be taken into account when framing policy to deal with India's problem.

In India, the evidence that GDP growth is slipping and falling way short of the government's 9-10 per cent target is not the only issue. Even as growth slows, inflation, which had emerged as the country's principal challenge, is showing no signs of going away. Inflation had initially declined a little as compared to the peak levels it had reached last year; but it is now again bound upwards. With the government committed to raising the prices of oil in line with the spurt in international prices, this problem will only worsen. Lower growth and higher inflation seem to be the projection for the immediate future.

Incipient stagflation

To the government's discomfiture, this incipient stagflation is also not serving to reduce the pressures on the balance of payments front. India had been recording trade and current account deficits that were rather easily financed by the large capital flows the country had attracted. But with international oil prices rising sharply, and a combination of speculation and investor flight to safety increasing the demand for imported gold, India's import bill rose sharply in the last financial year. In the event, despite exports having held their own in 2011-12, the current account deficit has burgeoned. The result is weakness of the rupee that now seems to have become the target of speculation, resulting in a sharp downward slide in its value. A collapsing currency is a sure negative signal for international investors, and can accelerate their exit. A downward spiral is a possibility that therefore needs to be pre-empted.

However, there appears to be no convincing response from the government thus far. The RBI is wary about stoking inflation by reducing rates to spur growth. The deficit on the government's budget and India's relatively high public debt to GDP ratio are preventing the government from raising expenditures (as it did in response to the global crisis of 2008). This is partly because of the government's own fiscal conservatism. But the more important reason is the fear that larger fiscal deficits or higher taxation would upset foreign investors and hasten their exit.

In the event, we have the Finance Minister speaking of the need for austerity and harsh decisions amidst a slowdown in growth. That could convert falling growth into a recession. Further, the “harsh decisions” involve measures such as cutting subsidies to reduce expenditure and raising oil prices. Combined with the increase in the prices of imports as a result of the rupee's depreciation, these administered price hikes would only fuel inflation, and further aggravate the tendency towards stagflation.

Bandwagon effect

The potential for a cumulative slide has already triggered a bandwagon effect. Rating agencies have downgraded India and international investors, heeding these agencies, seem to be reducing their exposure. Shaken by this response, the government seems set to implement austerity. That could worsen the downturn without correcting either inflation or the balance of payments. Prices could rise, the rupee could fall and this process could continue till (for reasons no one knows yet) the downturn touches bottom. This scenario is a possibility that policy needs to address. But it is precisely at this juncture that the government appears constrained because of the legacy of financial liberalisation in the form of the accumulated presence of foreign finance in the country. All policy thus tends to be viewed first in terms of the effect it would have on the confidence of those investors, rather than its efficacy in addressing the problems at hand.

Similarity with Europe

It is here that the similarity with the European predicament is apparent. Countries in Europe accumulated large private or public debt as a means to driving growth, encouraged by the easy access to credit that proliferation of finance entailed. That seemed acceptable so long as growth was the norm. Borrowers were seen as being capable of meeting their commitments, based not on additional borrowing but on income expansion. When the global crisis slowed growth or brought it to a halt, this belief was challenged.

In countries where private debt predominated, such as Ireland, the recession resulted in defaults that made lenders wary and froze the credit pipe. That only aggravated the problem, leading to a worsening of the recession, increased unemployment and a larger number of defaults. In many of these countries the response to the crisis was a bank rescue that involved the substitution of public for private debt. Households and firms remained mired in recession, but creditors cut their losses and the debt was passed on to governments. In time, however, these countries as well as those, like Greece, where public debt was the main problem, found that reduced revenues resulting from the recession and larger debt service commitments had left a huge hole in their budgets. On the other hand, their ability to borrow more to finance expenditures and service debt had been significantly curtailed.

Thus sovereign default, which was earlier a developing country problem, became a possibility in the developed world, if additional credit to meet expenditures was not forthcoming. However, additional credit to “help” countries avoid default was provided only on the condition that they opted for austerity. Cutbacks in government expenditure were expected to reduce deficits and release the wherewithal to finance future debt service commitments. This imposed huge burdens on the people in the form of increased unemployment, reduced incomes and a collapse of social security outlays.

The outcome was contrary to expectations. Rather than reduce deficits and generate surpluses, the output contraction resulting from expenditure cuts reduced revenues, making it impossible for these countries to meet their deficit reduction targets. A cycle of enhanced austerity, lower growth and worsening debt service capacity followed, with no solution in sight. It is clear from this that in bad times countries need to get out of the slowdown-austerity-recession cycle by substantially increasing expenditures to restore growth and employment. This would, over time, also raise the revenues to finance some of their debt commitments.

Though there are important differences between India and Europe, there are two similarities here that need to be recognised. The first is that India's fiscal deficit and debt to GDP ratios have been declared to be unacceptably high by international finance. The government has also been overly sensitive to the perceptions of international investors because of the latter's large presence in the country. This explains the call for austerity. Catering to the interest of global finance and allowing it to influence or determine policy not only increases economic instability, but also induces an element of “policy paralysis” because of a reduction in the state's room for manoeuvre. Central to that paralysis is a self-imposed limit on spending resulting from a fear of raising resources through taxation and financing expenditures with borrowing. Second, a government afflicted by such paralysis when confronted with slowing growth or even stagflation, tends to adopt policies that trap the country in a recession. This has already occurred in Europe. It is a real possibility for India.

Lesson for government

The way out, as clarified by economists with divergent inclinations, is to escape from this vicious cycle by expanding spending, and finding ways other than expenditure contraction to address inflation or balance of payments difficulties. But that requires not only ignoring the demands of finance, but also countering its speculative manoeuvres. In contexts like India, if recession hits, controls on the movement of footloose and speculative capital are a must to give the government the required room for manoeuvre. That is the lesson the government must glean when seeing its own image in the European mirror.

(C.P. Chandrasekhar is Professor, Centre for Economic Studies and Planning, School of Social Sciences, Jawaharlal Nehru University.)

We need to be very careful and not fall back into 60s and 70s type policy responses. It is clear a lot of our inflation is fueled by oil import bill. There is no sustainable way for an economy like ours to get addicted to oil like the americans or the chinese. There are many creative ways to curb our oil demand:
1. Let oil prices (petrol and diesel) be set directly reflecting market prices of oil/USD and USD/INR. 2. Begin converting largest consumers of oil to non-oil sources. For example, Indian railways is probably the single largest diesel consumer. We can start a program to convert the entire rail network to electric locomotion. Set a target of 10 years, do it.
3. Revive trams. About 50 years ago, most of Mumbai transport was via electric trams. Even now, cities like San Francisco have electric public transport buses.
4. Promote electric personal transport: tax breaks for electric two and four wheelers, charging points at public parking.
Quit this oil addiction.

from:  Yogesh P
Posted on: May 23, 2012 at 17:10 IST

Lot of money in India exists as black money as people who pay income tax at source are again taxed on their savings, compelling them to invest in real estate where black money is generated as huge difference exists in market rate and registered rate. In stock market only brokers make money. Indian middle class also does not spend a lot as tehir counterparts do in US/Europe. They will invest a lot in shares of new start ups if they are available at par as used to be in 80s and 90s.

from:  ramesh
Posted on: May 21, 2012 at 13:10 IST

I m surprised how enhance expenditure will be helpful as increased expenditure is causing Fiscal Deficit. I am unable to understand the rationale. Reckless spending and pathetic execution is responsible for no tangible results yet case is promoted for more spending. In fact such high spending welfare schemes are ending up making a few Babu like Pradeep Shukla super rich and making a few Babu end their life. NHRM Scam of UP has proved it.

from:  Abhinav Shukla
Posted on: May 21, 2012 at 11:05 IST

Debt can be paid off by bringing home the black money. Inflation can be controlled by improving the supply lines.... take the wholesalers and agents away. Put an MRP on fresh produce as is done for processed produce. But alas, there are too many interests here who are selling off the country piece by piece. What an irony that the man who is being told as the 1991 reformer is the one who has landed the nations finances in the same boat as 1991... time to mortgage the gold again, create FUD, force reforms such as FDI in retail, make local industries foreign owned (and controlled) and then take credit for "saving the nations finances, its social fabric... employment, self respect wagera wagera" MMS is a failure.

from:  MAdhu
Posted on: May 20, 2012 at 15:16 IST

Are we seeing the government creating conditions where it will become justifiable to allow permitting the bringing back to India the lakhs of crores of black or unaccountable money stashed away by politicians of all hues abroad? Perhaps the government is on purpose working towards that end.

from:  bhaskar
Posted on: May 20, 2012 at 13:57 IST

The article is a welcome change compared to the run of the mill cries that our march towards reforms is very slow. International investors will always preach what is good for them to park their funds. Our government should implement measures that are good for the country. India should differentiate between speculative foreign investors and investors in long term projects. There is no point in depending on the foreign stock market funds who cry foul that they are leaving because our reform measures are not going well. India is a big country and no foreign dependence can ensure its sustainable growth. While we are connected with the global economy in a sense we should also learn to survive and prosper when there is a global down turn.

from:  V.S.Chandrasekaran
Posted on: May 20, 2012 at 07:14 IST

The UPA has allowed India to be the "Production Centre" for the
Globalist Oligarchs,who earn by Speculation "without investing
much",by way of plants etc,in their native places and across the
Globe, including India.
India's main import Bill is for Crude Oil.Obviously,at an
appropriate value,based on the break-even price of the Crude,imports
have to cut drastically.For this,India should discourage the use of
Petroleum products,by discouraging the Auto-makers,many of whom are
MNCs,and purchase of vehicles, by reducing Loans,by banks.
M M Singh has converted India into a stock-market-based,
economy.The FIIs are in CONTROL of the Rupee,now.FDIs are taboo,as the
CONTROL will further be,lost to the Foreigners.Once you lose
CONTROL,over your Currency,you are DOOMED!
In the 5 year Plan period,2012-17, a huge LOAN to the tune of $ 1
Trillion,for Infrastructure, is being contemplated by the UPA.This is
NOT the time for such a huge Loan,as the World Recession,may last till

from:  Sadasivan
Posted on: May 20, 2012 at 04:47 IST

Keynesian school of thought on Economics is flawed... High time India listens to Austrian Economist... They been predicting these recessions for decades now.

from:  Anthony
Posted on: May 20, 2012 at 03:34 IST

One of the main reason for the BOP rise is the increase in Oil prices. Why arent there enough measures taken to counteract this. It is true if we spend more right now, it will be beneficial for the future. In this aspect we can do so much. Two very good examples would be Brazil and Sweden. Sweden is on its way to become oil independent country. This would be killing two birds with one stone - First ofcourse the Carbon Emission reduction and second the reduction in oil dependency.
It will take time but is achievable.

from:  Ankur
Posted on: May 19, 2012 at 22:00 IST

PIIGS nation have different story among them. The problem with Greece
is too much spending by its own people; real estate struck with Spain;
though speculation is for sharing common euro is the major cause for
PIIGS. India’s fiscal debacle has something else to depict. I foresee
government spending is obnoxious to deal with financial deficit,
because it s not only saddled the hoi polloi with taxation burden, but
also hassle foreign investor to quit Indian soil. India is versified
most importantly on financially background keeping rest thing aside.
Cloud of Inflation is about to burst on the discriminated section, if
pithy methods won’t follow by the government. Prima facie in this
context is government spending is a must win match for the general
public. Government policy is amiss, and immediate reformation
required. What else can be stand as a vivid example before Telecom
scandal, which is still running on its worst period due to lack of
transparency in policy? Austerity measure is

from:  Prasannajeet Mohanty
Posted on: May 19, 2012 at 17:50 IST

I will give more marks to Keshav than to C. P. CHANDRASEKHAR. The
whole issue of India's present economic predicament got lost in the
clap-trap of macro & micro economic theories with no solution in
sight. Most of the economists build their stories on the flawed
assumption that Indian economy lacks the intrinsic strength to oil the
wheels of the diversified institutions of its society. Even Marx's
AMP was based on that assumption. Historians of Marxist school
explained the lull and subsequent plunging of Indian economy in post
Gupta period to the decline of Roman empire but give little credit was
given to the fact that during the period of isolation Indian economy
worked quite well by devising its own indigenous mechanism commonly
known as Jajmani system which helped economy to tide over the paucity
of currency/specie that was pouring into our economy through Roman
trade. During the time of economic crisis austerity is something that
comes quite naturally to man. In post Gupta period we find numerous
hordes. RS Sharma cited that as many as 75 hordes were discovered in
central India alone belonging to the period circa 6th- 9th AD.

Marx's Asiatic Mode model says India( orient) lacks the organic
strength to support urbanization. Marx too was relying on the fact
that urbanization in India was based on foreign trade & ignored the
fact that orient had its own idiom of Urbanization which is quite
different from the west.

Economist must understand that theory of probability offers options
but the finite one. If you have exhausted all those options then you
have to try to find out of the box solution and sadly that is not
coming. Nearly all option that were available & which helped America
come out of great depression of 1930 have been attempted in the
present situation and what was achieved is only the postponement of
the crisis but the inevitable could not be averted. The present crisis
is the crisis of capitalist system. From now on capitalism has to come
in a new & fundamentally altered form that entirely depends on the
activism of the people and will be decisive to determine how humane or
how ruthless form of capitalism they can live with.

from:  vikram Kumar
Posted on: May 19, 2012 at 17:13 IST

I agree with Mr. KV Rao. There are several ways to solve a problem - but ONLY if the solution is implemented correctly and efficiently. India can either adopt the European austerity solution or the American stimulus approach. But unless implemented strictly, honestly (without corruption) and efficiently, both these methods will fail.

from:  K. Raghunathan
Posted on: May 19, 2012 at 16:07 IST

CPC has neatly analysed how we are fast emerging a mirror image of Europe in the matter of handling the grim economic reality in India and the call for austerity from the finance-minister reflects that reality.Though CPC is right to hold that in calling for austerity,India had succumbed to international finance ,things began to go wrong when the RBI began tightening the interest rate screw on the economy from March 2010 to November 2011 ,sacrificing growth to controlling inflation,which unfortunately has not happened .That the government was prepared to forego growth rather than take measures to control inflation through supply-side management is the chief cause for our present misery .The finance-minister's misplaced emphasis on raising resources through taxation measures like GAAR(general anti-avoidance rule) was a mis- timed response,which,moreover ,has become a non-starter.

from:  Chidambaram Kudiarasu
Posted on: May 19, 2012 at 16:04 IST

Iam not an economist. I feel the western model of development is not suitable for India with
its huge population. Imagine what will happen if every other Indian owns a car or we start
using toilet paper! We need to concentrate on mass transport (railways), infrastructure
development, safe water, clean air , health and education. Having few crowded big cities with
imported cars, malls will bring restlessness into rest . Investment in Gold to be discouraged
by levying wealth tax and other taxes. We also need to develop class2 cities as growth

from:  Dr.Keshav Rao
Posted on: May 19, 2012 at 16:02 IST

India's growth story is unraveling because the RBI increased interest
rates for 2 years to control inflation. Inflation increased in India
partly because of increase in prices of food (grains, vegetables,
fruits and edible oil) and fuel. By raising interest rates, the cost
of borrowing money increased which in turn got passed on to consumers.

To control inflation and bring the growth story back, the government
needs to reduce interest rates, reduce cost of money and focus like a
laser beam on agricultural productivity. Prices can be managed by
increased supply of food grains, vegetables and fruits. The growth
story will come back with reduced interest rates.

from:  Anand
Posted on: May 19, 2012 at 15:58 IST

In all analysis of financial matters related to India the Experts
still use the same yardstick as others do for Europe.The Indian
scenario is unique in that the investors in Stock Markets form only
a fraction of a billion plus population and majority of the population has become immune to any Economic theory.It is Unique for this country to see millions of tons of Grain get rotted and millions are starving.People suffer due to lack of ANY infrastructure in many states but Govts spends hundreds of Crores on Grandiose Schemes and OVERHEADS(50% of which can be controlled
as non essential)It is only in India that people with capital look for overseas investments where as the Country is the largest Free Mrket in the world.When our own capital is flown out we are crying
for FDI as the PANACEA.

from:  ajith kumar
Posted on: May 19, 2012 at 12:59 IST

Increasing the expenditure, ultimately, results in inflation. Finally, How we are going
to appreciate the rupee?

from:  Prithvi
Posted on: May 19, 2012 at 12:37 IST

I am a little confused here.
Government keeps talking about the rising crude oil price.

Here is a simple fact:
Crude oil price on 11May 2012: $96 per barrel
Crude oil price on 11May 2011: $98 per barrel

Is the crude oil price really rising?
I don't see any rise in last one year

from:  ravi
Posted on: May 19, 2012 at 11:01 IST

An economic slowdown in the country where and when a financial expert with a doctorate from one of the most respectable universities in the world is our Prime Minister!Brining back the Black Money and investing it in Infrastructure development can ease the pressure on the economy.Our politicians and businessmen with overseas unaccounted money are testing the waters of Indian ideology and culture of universal patience and forgiveness.The more we open our news papers, the more frustrated we feel about our country.That is not good for the country as well for the future of its population.A failed state status for such a huge country can create havoc in the whole world demographic, financial and political situation.Congress played their part in winning us our freedom, now they are taking it back. Political killings, corruption and communalism is tearing down the country and the feel-good image it has created in the world.Please dont tear down our thin fabric of oneness and unity.

from:  Bibin Babu
Posted on: May 19, 2012 at 10:37 IST

Four years back in 2008 we were able to avoid the blows of recession
because of our internal demand driven growth. Today when we are faced
with another impending threat of inflation the approach is apparently
otherwise & Rightly so. Today to counter and face-off inflation we need an increased internal demand and better export-import sheet. Inflation should be controlled and this calls for not cutting subsidies on oil prices. If oil prices increase the cascading effect will make the common coffer cry for currency. The burden on the fiscal and current account deficit can be annulled by attracting foreign investors. The outlandish clause of GAAR requiring companies to prove their're not guilty has been lifted which persuaded Rs. 873cr return to India ot of Rs. 1100cr. which was withdrawn by international investors in April owing to this. Raise internal demands and make conducive atmosphere for investment are what we must focus on. Politics must not be allowed to annihilate economics.

from:  Ajeet Tiwari
Posted on: May 19, 2012 at 10:18 IST

"The government needs to increase expenditure to restore growth" -
Government spending will only lead to inflation not growth.

from:  Jeevan
Posted on: May 19, 2012 at 10:16 IST

A flawed analysis, I must say. The root cause of our economic woes is that we have become less competitive. Hence the solution lies in economic reforms that would help reducing costs. The first measure in this direction has to be reduction in interest rates. Fiscal discipline is a must and subsidies need to be kept in control. The Government has to find ways to control its expenditure in order to reduce the fiscal deficit. More government spending would spell disaster for the economy.

from:  Pramod Patil
Posted on: May 19, 2012 at 07:49 IST

The article seems Indian version of what Paul Krugman has been
writing. But both seem to lack to suggest that increased expenditure
must be coupled with higher allocation of resources to bottom of
pyramid people which should result in demand for agro, manufacturing
and service produced goods excluding /reducing wasteful demand of
expensive things. Sustainable growth can be achieved only if demand
comes from large no. of people who are provided purchasing power by
way of higher allocation. Do not allow excessive power, charges &
profits to Banking and financial services Industry as happened in west
and root cause of massive problems there.

from:  Atma Gandhi
Posted on: May 19, 2012 at 07:47 IST

India's growth being a consumer driven the article presented may not prove to that extent and also European woes lie in inextricably linked cob-web type of connections between the countries in EU and given that profligacy of finances started after the certain growth had been achieved.India's growth story is a success of some 300-350 million middle class people...still there is a large room to grow....may be there are many moot points which are presented correctly in the article we cannot compare them with Europe!!!!

from:  snakeerth
Posted on: May 19, 2012 at 07:21 IST

Mr. Chandrasekhar works under the illusion that the Indian government retains a policy-independence it does not possess.
National governments including in Europe have been reduced to agencies of world finance capital working out mainly out of New York and London. It is these rapacious world institutions that dictate government policy. For example, as soon as the S&P analyst in Singapore reduced the India's sovereign debt outlook, the Finance Minister and other officials immediately made public comments to satisfy the expectation of world finance. These financial behemoths whose voracious apatite for speculative profits is unquenchable, are along with their political representatives are rushing headlong into a socio-economic disaster of historic proportions.

from:  Murali
Posted on: May 19, 2012 at 05:52 IST

A large country like India with diversified products and services
capabilities should be able to generate its investments largely
internally in a self-sustained way, with the government playing the
role of mere regulator, unlike the smaller European countries which
have the need to integrate strongly with the world trade and finance
and hence are more exposed to volatility of the world markets.
This financial meltdown should jolt our policy makers to turn towards
indigenous options and not run behind easy money from elsewhere and
eventually dance to their tunes.

from:  Hemachander
Posted on: May 19, 2012 at 04:59 IST

If India follow fiscal prudence, belt tightening, governance and internal growth promotion, move away from FDI addiction (need for dollar for India's growth) mania, expand regional relationship and market, strategic prudence (stay away from dollar/media/london clubs dictated what is good for India approach) will take us long way.

from:  ram iyer
Posted on: May 19, 2012 at 02:30 IST

It does not make much difference to India whether it follows the austerity advocated in europe or stimulus advocated in US. The simple reason is India's ineffective administration prevents the country going either direction. What the country needs is to get an handle on the black money, money sheltered in foreign banks and a corrupt free and effective administration. It is important to change the state of mind of the people that India is a land of laws. It is heading that way but needs to quicken the pace.

from:  K V Rao
Posted on: May 19, 2012 at 01:53 IST

Its easier said than done...when u r askin govt to increase the
spending,then can u image the FD/CAD....i think the need of the hour is
tougher reforms/ zero base budgeting,auditing etc by
credible agencies,.....we require an era free of scams/corruption,good
governance etc so as to enhance the credibility of govt/india in general
public and foreign investors.

from:  saurabh sharma
Posted on: May 19, 2012 at 01:29 IST
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