M R Venkatesh
If the dream team was responsible for the economic growth between 2004 and 2008 they are responsible for the fall between 2008 and now.
Economic policy formulation is certainly a challenging task, but made much more complex by economists. Let me elaborate. Economics is all about production. Production must lead to consumption. Consumption must be below production to ensure sufficient savings. Savings must lead to investment and finally investment must ensure production.
Simply put economic policy formulation is all about ensuring a harmony between, production, consumption, savings and investment.
And should there be an imbalance (where one of the components is in deficit or believe me, even in excess) in one of these four components, economists believe that they can intervene to restore the balance through policy formulations. Put pithily, restoring natural order between these four pillars of modern economics is at the core of economic policy formulation and subsequent management.
But aren't markets supposed to it all by itself where excess or deficit in at once taken care by market forces i.e. without the intervention of such policies in the first place? Well if that be so, why do economists arrogate to formulating economic policies for all of us in the first place while simultaneously talk about the supremacy of markets? It is time someone explains why governments labour so much to fashion market friendly economic policies?
Yet, you have investment rules, exchange rate mechanisms, taxation policies, deficit management, interest rates and a host of other economic policies devised by economists who sincerely believe that even to this day that any modern economy can be managed by such interventions.
More importantly, these economic policies over a period of time get translated in to modern commercial laws. That explains why we have laws to manage exchange rates, competition, secutrities market and several other related issues. What is lost in the melee is that economically illiterate judges often end up interpreting fuzzy economic policies reduced by not so intelligent law makers into dense legal language and explained by loquacious lawyers!
But fundamentals do not change, do they?
Yet there are certain fundamentals in economics that have stood the ravages of policy formulations by economists over a period of time. For instance, economists have come to more or less unanimous in their conclusion that it is impossible to maintain fixed exchange rate, allow free movement of capital and independent monetary policy.
Let me explain. When forex inflows surge, the central bank of the country is compelled to release domestic currency in to the local markets. This leads to inflation which in turn leads to higher interest rates. Similarly, it is impossible to have a surge in forex outflows and a stable exchange rate. Under this scenario, the domestic currency is more often than not, found to depreciate.
The balancing of these three factors all at once remains at the core of economic management. Colourfully, it is explained as an "impossible trinity" or a "trilemma." It is often said governments at best can meet the imperial demands of two of the three factors listed above, but not all of them simultaneously.
Paul Krugman puts it brilliantly: "The point is that you can't have it all: A country must pick two out of three. It can fix its exchange rate without emasculating its central bank, but only by maintaining controls on capital flows (like China today); it can leave capital movement free but retain monetary autonomy, but only by letting the exchange rate fluctuate (like Britain - or Canada); or it can choose to leave capital free and stabilize the currency, but only by abandoning any ability to adjust interest rates to fight inflation or recession (like Argentina today).
Explaining the policy issues that need to be tackled on account of foreign capital flows, the Ministry of Finance, Government of India, stated in 2007, "The management of capital flows is a complex process encompassing a spectrum of policy choices, which inter alia, include: the appropriate level of reserves; monetary policy objectives related to liquidity management and interest rates; and maintenance of healthy financial market conditions with financial stability."
Equally it is impossible to have the opposite - high rates of inflation, depreciating currency and falling forex reserves. Yet, that is what India is witnessing in recent nonths - forex reserves that are continuing to fall, the exchange rate that is continuously depreciating by the hour and of course extraordinarily high rates of inflation. How did we manage the impossible trinity albeit in the reverse?
Nobel for the team !
MS on top of PC - that is how one of the leading pink papers ran its headline when the economic deam team comprising of Dr Manmohan Singh as Prime Minister and P Chidambaram as finance minister took office in 2004. The fact the headlines also punned on Montek Singh (MS) being appointed as the deputy chairman of the Planning Commission (PC) was lost on some.
Much water has flown since then. P Chidambaram is stuck with 2G scam. Pranab Mukherjee's nomination to presidentiship is seen more as reward for non-performance than anything else. Mr. Kaushik Basu (who seems to be more a cheerleader for multinational retail gaints rather then an advisor to the Governmnet of India) and Dr C Rangarajan (who frankly has offered precious little) are all seen as rusted, tired and waiting to be retired. Montek Singh on whom much was expected has been another failure.
Eight years later this dream team of the PM and his team have very little to show. When the growth rate between 2004 and 2008 was up these very people patable themselves on their back. They credited themselves for this growth little realizing that the economic growth rate achieved by them was actually on account of a robust global growth. Now that the Indian growth story is floundering, they blame it on global factors!
Height of intellectual dishonesty, I would say. But there is something deeply flawed in all these arguments. Let me demonstrate.
The entire paradigm was succinctly captured by Shankar Acharya in his Working Paper titled India's Macroeconomic Performance and Policies since 2000 wherein he states, "From 2002-03 to 2007-08, India experienced a sustained and unprecedented surge in net foreign capital inflows, which soared ten-fold from $10.8 billion in 2002-03 to$108 billion in 2007-08."
He goes on to add "The surge was particularly strong in the two years between 2005-06 and 2007-08, when net inflows jumped four-fold from $25 billion to $108 billion." Remember these were boom years for the Indian economy and its correlation to the Forex flows near perfect.
The net impact - rupee was relatively stable while forex reserves rose from $76 billion in March 2003 to $310 billion in March 2008, with nearly $160 billion being added in 06-07 and 07-08. And even then inflation remained elevated, government economists explained it as the impact of the "impossible trinity."
All this was simply not because global investors were enmoured about Dr Singh and his wonderful team, but such huge forex flows was obviously because of excess global liquidity. And now that has dried up, forex flow into India too has dried up. No wonder the Time magazine has dubbed the PM as underachiever - in my considered opinion the understatement of the decade.
That is not all. Manufacturing is in doldrums. Business confidence is at all time low. Infrastructure has virtually gone broke. Farmers suicides are an accepted way of life with India slipping everyday in the Human Development Index. The morale of the government officers is completely shattered with the citizenry seem to be scam fatigued. Nothing seems to surprise us or shock us any more.
What is worrying is that the standard response to any scam by the PMO is that the PM was "completely in the dark" as if the PM were some rodent or an insect. How can the PM of the country be always in the dark? Can someone lead him to light please? Crucially can the PM communicate if not lead? Can he express his constraints?
Now when rupee has depreciated substantially, forex exchange has come down by close to $40 billiothen a matter of few months and inflation continues to be elevated, theoretical economists are puzzled in the context of their understanding of our economics. Even in war torn economies we have not witnessed such an economic paradigm as we are currently witnessing in India.
The final question: If exchange rates have depreciated by 20 per cent why is that foreign investors are not finding India attractive even now? The answerexpecting question is obviously Dr. Singh and his team. At least for this reason Dr Singh and his team deserve the Nobel.
PS: So if the dream team was responsible for the economic growth between 2004 and 2008 they are responsible for the fall between 2008 and now. In the alternative if global factors are responsible for the economic downturn since 2008, then it is the very same global factors that is responsible for the sustained growth of the Indian economy between 2004 and 2008. Either way time to bid good bye to Dr. Singh and his team.
The author is a Chennai-based chartered accountant. Comments can be sent to mrv@mrv.net.in
Economic policy formulation is certainly a challenging task, but made much more complex by economists. Let me elaborate. Economics is all about production. Production must lead to consumption. Consumption must be below production to ensure sufficient savings. Savings must lead to investment and finally investment must ensure production.
Simply put economic policy formulation is all about ensuring a harmony between, production, consumption, savings and investment.
And should there be an imbalance (where one of the components is in deficit or believe me, even in excess) in one of these four components, economists believe that they can intervene to restore the balance through policy formulations. Put pithily, restoring natural order between these four pillars of modern economics is at the core of economic policy formulation and subsequent management.
But aren't markets supposed to it all by itself where excess or deficit in at once taken care by market forces i.e. without the intervention of such policies in the first place? Well if that be so, why do economists arrogate to formulating economic policies for all of us in the first place while simultaneously talk about the supremacy of markets? It is time someone explains why governments labour so much to fashion market friendly economic policies?
Yet, you have investment rules, exchange rate mechanisms, taxation policies, deficit management, interest rates and a host of other economic policies devised by economists who sincerely believe that even to this day that any modern economy can be managed by such interventions.
More importantly, these economic policies over a period of time get translated in to modern commercial laws. That explains why we have laws to manage exchange rates, competition, secutrities market and several other related issues. What is lost in the melee is that economically illiterate judges often end up interpreting fuzzy economic policies reduced by not so intelligent law makers into dense legal language and explained by loquacious lawyers!
But fundamentals do not change, do they?
Yet there are certain fundamentals in economics that have stood the ravages of policy formulations by economists over a period of time. For instance, economists have come to more or less unanimous in their conclusion that it is impossible to maintain fixed exchange rate, allow free movement of capital and independent monetary policy.
Let me explain. When forex inflows surge, the central bank of the country is compelled to release domestic currency in to the local markets. This leads to inflation which in turn leads to higher interest rates. Similarly, it is impossible to have a surge in forex outflows and a stable exchange rate. Under this scenario, the domestic currency is more often than not, found to depreciate.
The balancing of these three factors all at once remains at the core of economic management. Colourfully, it is explained as an "impossible trinity" or a "trilemma." It is often said governments at best can meet the imperial demands of two of the three factors listed above, but not all of them simultaneously.
Paul Krugman puts it brilliantly: "The point is that you can't have it all: A country must pick two out of three. It can fix its exchange rate without emasculating its central bank, but only by maintaining controls on capital flows (like China today); it can leave capital movement free but retain monetary autonomy, but only by letting the exchange rate fluctuate (like Britain - or Canada); or it can choose to leave capital free and stabilize the currency, but only by abandoning any ability to adjust interest rates to fight inflation or recession (like Argentina today).
Explaining the policy issues that need to be tackled on account of foreign capital flows, the Ministry of Finance, Government of India, stated in 2007, "The management of capital flows is a complex process encompassing a spectrum of policy choices, which inter alia, include: the appropriate level of reserves; monetary policy objectives related to liquidity management and interest rates; and maintenance of healthy financial market conditions with financial stability."
Equally it is impossible to have the opposite - high rates of inflation, depreciating currency and falling forex reserves. Yet, that is what India is witnessing in recent nonths - forex reserves that are continuing to fall, the exchange rate that is continuously depreciating by the hour and of course extraordinarily high rates of inflation. How did we manage the impossible trinity albeit in the reverse?
Nobel for the team !
MS on top of PC - that is how one of the leading pink papers ran its headline when the economic deam team comprising of Dr Manmohan Singh as Prime Minister and P Chidambaram as finance minister took office in 2004. The fact the headlines also punned on Montek Singh (MS) being appointed as the deputy chairman of the Planning Commission (PC) was lost on some.
Much water has flown since then. P Chidambaram is stuck with 2G scam. Pranab Mukherjee's nomination to presidentiship is seen more as reward for non-performance than anything else. Mr. Kaushik Basu (who seems to be more a cheerleader for multinational retail gaints rather then an advisor to the Governmnet of India) and Dr C Rangarajan (who frankly has offered precious little) are all seen as rusted, tired and waiting to be retired. Montek Singh on whom much was expected has been another failure.
Eight years later this dream team of the PM and his team have very little to show. When the growth rate between 2004 and 2008 was up these very people patable themselves on their back. They credited themselves for this growth little realizing that the economic growth rate achieved by them was actually on account of a robust global growth. Now that the Indian growth story is floundering, they blame it on global factors!
Height of intellectual dishonesty, I would say. But there is something deeply flawed in all these arguments. Let me demonstrate.
The entire paradigm was succinctly captured by Shankar Acharya in his Working Paper titled India's Macroeconomic Performance and Policies since 2000 wherein he states, "From 2002-03 to 2007-08, India experienced a sustained and unprecedented surge in net foreign capital inflows, which soared ten-fold from $10.8 billion in 2002-03 to$108 billion in 2007-08."
He goes on to add "The surge was particularly strong in the two years between 2005-06 and 2007-08, when net inflows jumped four-fold from $25 billion to $108 billion." Remember these were boom years for the Indian economy and its correlation to the Forex flows near perfect.
The net impact - rupee was relatively stable while forex reserves rose from $76 billion in March 2003 to $310 billion in March 2008, with nearly $160 billion being added in 06-07 and 07-08. And even then inflation remained elevated, government economists explained it as the impact of the "impossible trinity."
All this was simply not because global investors were enmoured about Dr Singh and his wonderful team, but such huge forex flows was obviously because of excess global liquidity. And now that has dried up, forex flow into India too has dried up. No wonder the Time magazine has dubbed the PM as underachiever - in my considered opinion the understatement of the decade.
That is not all. Manufacturing is in doldrums. Business confidence is at all time low. Infrastructure has virtually gone broke. Farmers suicides are an accepted way of life with India slipping everyday in the Human Development Index. The morale of the government officers is completely shattered with the citizenry seem to be scam fatigued. Nothing seems to surprise us or shock us any more.
What is worrying is that the standard response to any scam by the PMO is that the PM was "completely in the dark" as if the PM were some rodent or an insect. How can the PM of the country be always in the dark? Can someone lead him to light please? Crucially can the PM communicate if not lead? Can he express his constraints?
Now when rupee has depreciated substantially, forex exchange has come down by close to $40 billiothen a matter of few months and inflation continues to be elevated, theoretical economists are puzzled in the context of their understanding of our economics. Even in war torn economies we have not witnessed such an economic paradigm as we are currently witnessing in India.
The final question: If exchange rates have depreciated by 20 per cent why is that foreign investors are not finding India attractive even now? The answerexpecting question is obviously Dr. Singh and his team. At least for this reason Dr Singh and his team deserve the Nobel.
PS: So if the dream team was responsible for the economic growth between 2004 and 2008 they are responsible for the fall between 2008 and now. In the alternative if global factors are responsible for the economic downturn since 2008, then it is the very same global factors that is responsible for the sustained growth of the Indian economy between 2004 and 2008. Either way time to bid good bye to Dr. Singh and his team.
The author is a Chennai-based chartered accountant. Comments can be sent to mrv@mrv.net.in
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