The Pain of Election Economics: Financial Express:11th July 2008

All governments are concerned about their economies especially with an election around the corner. The variable which matters most is inflation, because it affects everyone. Controlling inflation is, however, only a necessary condition for a positive electoral voice and not a sufficient one. One may recollect that in 2004, the government could not retain power despite the India Shining story. The anti-incumbency drive was stronger.
In the current financial year, the government has taken some populist steps which are debatable. The first relates to loan waivers. Loan waivers were announced by the government to the tune of Rs 60,000 crore in the Budget which has now been enhanced to close to Rs 72,000 crore. The justification cannot be questioned as successive governments have been announcing schemes to help industry as well as the infrastructure sector including IT. By this logic, there cannot be anything wrong in giving concessions to a class which has really suffered in the last few decades. But, such waivers create a nationwide moral hazard wherein farmers, both rich and poor, are induced to default on payments, which was what was recently observed in case of tractor loans. In fact, the recent SBI case reflects the flaws in such schemes as it comes in the way of banking prudence, at a time when we are all talking of global best practices that have been advocated by Basel II. In fact there would be expectations of further waivers which will cause more willful defaults in future.
The fight against inflation has been spurred by a modicum of panic which will make the fiscal numbers look worse—doubling of fiscal deficit to around 5% of GDP. There have been five desperate moves, albeit some half hearted, to control inflation.
To begin with, the government has gone slow on raising the prices of oil products even while the oil companies are bearing the losses which are estimated to be Rs 500 crore a day and have cumulated to over Rs 200,000 crore.
Secondly, in a quest to control the growth in prices, the government has reduced the duties on imported edible oils, which again will end up increasing the deficit as its revenues will be affected.
The third manoeuvre on this front has been the excess procurement of wheat, which has crossed 21 mn tonnes this year—well above the 15 mn which the FCI procures every year. In fact, the high .procurement this year is around 45% of the total marketable surplus which has left a smaller quantity for the private players. This panic purchase and stocking of wheat will firstly push the prices up in the private space and also mean additional outlays on the part of the government to support this procurement programme.
The fourth distortion that has been caused is the ban on futures trading in 4 commodities. Prices continue to increase in the market due to shortfalls, and the government is now planning to hedge its price risk in wheat, which was banned last year on an international exchange. This could have been done on an Indian exchange had the ban on futures trading in wheat been revoked.
Lastly, in order to control inflation, the RBI has been continuously increasing the CRR which has already pushed up interest rates by 200 bps over the last 1 year while the repo rate has been increased by 100 bps. Given that inflation has been a supply driven phenomenon and has little to do with excess demand, the current scenario of liquidity being drawn out by the RBI could impact industrial growth when the busy season begins in and around September.
Hence, the cost of populism, which cannot guarantee success at the ballot box, has been a potential threat to the solvency of banks, widened the fiscal deficit, weakened the oil companies, created uncertainty in the commodity futures market and triggered a regime of higher interest rates.