Falling rupee: a kick in the pants for Congress

Will the crash of the rupee to a record low of Rs 54.68 per dollar be a "kick in the pants", to quote economist Arvind Subramanian, that finally forces the government to slash unwarranted subsidies and deepen reforms? Hopefully yes. 

    But Rohini Malkani of Citibank says, after a US visit, that foreign investors view the government as structurally paralyzed. They expect GDP growth to slow to 6-7%, and the exchange rate to fall to Rs 60 per dollar. There is a silver lining. A relentlessly falling rupee and stock market may finally force the anti-reform crowd—including Sonia Gandhi—to swallow bitter medicine needed to cure the current economic malaise. 

    Many alarm bells are ringing. Consumer price inflation is up from 7.4% in January to 10.4% in April. The current account deficit is a record 4% of GDP. Both industrial production and exports shrank in March. The Eurozone crisis has caused billions to be pulled out of all emerging markets. India is especially vulnerable: its credit rating is already at the bottom of the investment-grade range. Any further downgrade will reduce it to junk status, accelerating the exit of foreign investors. 

    Manmohan Singh and Pranab Mukherjee know what's to be done. Commenting on the Budget, Singh said the fiscal deficit must be cut to curb inflation. Open-ended subsidies for petroleum products and urea, threaten to become thrice the entire outlay on NREGA, the government's flagship employment programme. 

    Ideally, the government should decontrol petrol and diesel, limit subsidized cooking gas connections, and replace the kerosene subsidy with free distribution of solar lamps. Urea should be moved to a fixed nutrient-based subsidy, like other fertilizers. And foreign direct investment in multi-brand retail-—cleared by the Cabinet but not yet notified —should officially be notified. 

    Politicians worry about double-digit inflation, which always spells electoral disaster. However, many Congressmen think inflation can be curbed by everrising subsidies. They cannot see how raising diesel or urea prices can curb inflation. 

    Answer: inflation is caused by excess demand in the economy, arising from insufficient production (bad investment climate, paralysis in clearances) and excessive spending (big fiscal deficits). Excess demand also sucks in excessive imports, hitting the balance of payments. 

    This cannot be checked by additional subsidies, for this additional spending itself creates additional excess demand. Note: inflation is low in countries with no oil subsidies, like the US. The solution lies in pruning excess demand at source — by reducing government spending. 

    The axe should fall on the least rational spending. It is surely irrational to spend thrice as much on oil subsidies as on NREGA. The resultant hole in government finances has fuelled a vicious cycle of high inflation, trade deficits and still higher fiscal deficits. 

    Realpolitik pundits rule out any controversial measure during or just before a session of Parliament, since the Opposition will protest violently and paralyze Parliament. Nor are any reforms possible before state elections, which are typically decided on swings of 1-2% of the vote. A reform hitting just 1-2% of voters can be electorally fatal, say these pundits 

    Well, Parliament goes into recess next week, and will not reconvene till July. No state election is due till the year-end. So, the coming weeks constitute a heaven-sent window of time for action. 

    Alas, some politicians oppose any action till the presidential election in July. This is daft. There are no populist vote banks to be wooed in a presidential election. Only elected legislators participate in the presidential election, so what matters is getting enough political parties behind your candidate. 

    Identity politics matters. If, for instance, the Congress party fields a Muslim like Vice President Hamid Ansari, it will be difficult for the Samajwadi Party, Trinamool Congress or Left Front (all of whom woo the Muslim vote) to oppose him. The BJP may propose a rival Muslim like Abdul Kalam. Regional parties have proposed Purno Sangma, a Christian. Whether legislators vote for Ansari, Kalam or Sangma will not depend on whether or diesel and urea prices are decontrolled. 

    Many opposition parties will, of course, castigate these measures. But June is a hot month when politicians go abroad or to hill stations, and political activity is at its lowest ebb. If the government acts forcefully within the next three weeks, opposition protests will be weak, and largely forgotten before the July presidential election. 

    Is this logic strong enough to sway Sonia? Maybe not. But if foreign confidence in India keeps ebbing, and the Greek election on June 17 leads to that country's exit from the Eurozone, the rupee will plummet further, maybe even to Rs 60 per dollar. That should concentrate Sonia's mind wonderfully.