Still playing ostrich

By Prem Shankar Jha

There are sins of commission and sins of omission. By soft- pedalling its warning to the government about the country's bleak economic prospects in the near future, the Reserve Bank of India has committed a sin of the latter kind. For five years after the fall of Mr. Narasimha Rao's government, a succession of weak and transient governments in New Delhi has preferred to play ostrich before the growing economic crisis that has enveloped the country.

In its latest annual report, the RBI has tried to inject a dose of realism into the government's thinking but has not done a good job of it. It has pointed out that growth has decelerated for three straight years from 6.6 per cent in 1998-99 to 6.4 per cent in 1999-2000, to 5.2 per cent in 2000-01 but tamely accepted the veracity of these figures. It has further sugar coated its warning by pointing out that the 5.2 per cent growth last year is still above the trend rate of 4.4 per cent.

And it has chosen not to challenge the government's prediction of 6.5 per cent growth this year despite the fact that industry has grown by a paltry 1.4 per cent in the first quarter and the hope of a bumper harvest has faded after a sharp weakening of the monsoon in late July. It is hardly surprising, therefore, that the fears it has expressed about future growth prospects have lost their sting.

The harm that its pussyfooting is likely to do to the country in the coming months is incalculable, because this was the last occasion on which a government organ of unimpeachable integrity could have issued an unambiguous warning of the acute danger that lies ahead. Only weeks ago, Moody's Investors Service and Standard and Poor's lowered their country risk assessment for India from stable to negative. As a columnist in this daily recently predicted, this can easily turn out to be the spark that ignites a full blown foreign exchange crisis.

The only way in which the Government can avert this crisis is to enact all the measures to cut the fiscal deficit that Mr. Yashwant Sinha announced in the budget and do so immediately. But that requires a political consensus among the 19 parties that make up the BJP, which is conspicuous by its absence. The RBI could have helped to generate that consensus. It chose not to do so. The crisis is almost upon us because in the last five years governments have lied systematically to the people about the real state of the economy in order to justify doing nothing to promote its growth. Here are some of the ways in which it has lied to the people:

* GDP estimates have been deliberately overestimated;

* Inflation has been estimated on the basis of the wholesale prices index instead, as is the practice all over the world, of the consumer price index;

* Foreign exchange reserves have been grotesquely falsified to present a rosy picture of the external payments situation.

* Indicators that point in the other direction have been studiously ignored or underplayed. These include the decline in investment, the flatness of consumer demand, the fall in capital raised in the share market, the 17 to 55 per cent fall in the price of equities in the secondary market , the remorseless decline in non-oil imports, and above all the sharp fall in the growth of employment in the organised sector.

Take the GDP figures first. Even now the RBI has preferred to ignore what the Economic Survey of 1999-2000 did not hesitate to point out that 0.7 per cent of the supposed growth was nothing more than the arrears of salaries paid to Central and State governments during 1997-98 to 1999-2000. By a quirk of the UN system of national accounts, an increase in money incomes here is treated as an increase in the real output of the country.

The estimate of GDP for 2000-01 is equally suspect and is almost certain to be revised in the near future. This is because agricultural output fell by 6.5 per cent while value added by industry rose by only 5.3 per cent. Since the two more or less offset each other all the growth in GDP has come from the services sector, whose data are notoriously suspect. According to the Central Statistical Organisation, service sector growth was 7.8 per cent last year. Thus, for an overall 5.2 per cent GDP growth, services would have had to account for fully 70 per cent of the economy. This, of course, is far from being the case. As the actual share of the services sector is nearabout 50 per cent, GDP could not have grown by more than 3.6 per cent in 2000-01. Overall, the true rate of GDP growth has fallen from 7.1 per cent in 1993-97 to 4.8 per cent between 1997 and 2001.

In contrast to the consumer price index, which measures changes in the cost of living, the wholesale price index measures changes in the cost of production. The two are seldom the same. The reasons why India uses the WPI to calculate inflation go back many decades to the time when there was no reliable consumer price index. But persisting with this practice today has had the unintended effect of severely underestimating the real rate of interest being paid by borrowers and masking the true extent of the collapse of consumer demand. For, while inflation according to the WPI has been stable at just under 6 per cent, inflation measured by the CPI has been falling and has hovered around 3 per cent for the past 12 months. Since even after the last round of interest cuts a financially sound, a medium sized exporting company has to pay 15 to 15.5 per cent interest on its loans, the real rate of interest for good borrowers is not 6 to 8 per cent as Mr. Sinha said in his budget speech, but 12 per cent.

The cause of the prohibitive real rates of interest is the Central and State governments' mounting fiscal deficit, now far exceeding 10 per cent of the GDP. The more government borrows to cover its deficit the more it raises the floor rate of interest. But the less there is left for the private sector the more does this push up the ceiling rate of interest. In the end, small and marginal borrowers are crowded out altogether. These rates are 4 to 18 times the real interest rates (of 0.6 to 3.5 per cent) prevalent in the industrialised countries. That is why the share market is dead and gross investment has fallen in real terms to half of what it was in 1995-96. This lack of investment is the true reason for the lack of industrial growth after October 1996.

High real rates of interest have seriously damaged the economy in two other ways. First, they have attracted short-term capital flows that have artificially boosted the real effective exchange rate (the nominal rate less the excess of inflation in India over the average in its main trading partners and competitors). As a result, India is now dangerously vulnerable to consumer goods imports from other Asian countries and is in imminent danger of losing as many as five million jobs in the next two or thee years.

Second, the short term inflows have boosted foreign exchange reserves but also made them highly volatile. Today 93 per cent of the $43 billion worth of foreign currency reserves consist of what the Centre for Monitoring Indian Economy (CMIE) calls "vulnerable liabilities". These are trade credits, NRI deposits, foreign portfolio investment and government short term borrowing, all of which can flow out within months. In addition there are almost $10 billion of NRI deposits of less than one year that are not counted in the reserves, but in which a sudden exodus will cause a crisis just as easily as an outflow in declared foreign currency reserves. India's external payments balance is, therefore, extremely fragile and is becoming more so every month. That is why Moody's and S&P's recent downgrading of India could easily suffice to start an outflow that no conceivable rise in interest rates will stem.The Government has reacted angrily to the downgrading, and one columnist has gone so far as to suggest that it is part of an international conspiracy to force India into a foreign exchange crisis. This may well be the effect but to claim that this is their intention smacks of paranoia. The plain truth is that all, repeat all, of the ills that afflict the economy arise from just one root cause. This is the failure to contain the fiscal deficit.

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