Monday, 19 December 2011

A disaster in the making

I happened to read an article a short while ago, about the Indian Government's decision to go ahead with the National Food Security Bill, which is intended to provide subsidised foodgrains for upto 75% of rural households and 50% of urban households.

On paper it sounds a pretty good idea. I would normally be the first to applaud any initiative aimed at assuring food security to India's starving millions. What got me concerned however, is the fact that the food subsidy is expected to rise by a further Rs. 27,663 crores (about US$ 5.5 billion). The question needs to be asked whether India can afford such a massive subsidy at this critical juncture.

A few billion dollars may not seem such a big deal for a trillion dollar economy, but the current state of some of India's economic indicators are far from encouraging. Economic growth has shown signs of slowing down in recent months. Even more worrying is the fact that industrial output has started shrinking, which means that companies have reduced production- which almost certainly means that jobs have been lost and fresh recruitments have been frozen. Worse still, economic growth is not resulting in higher 'real' earnings because of inflation.

Add to it the fact that Government expenditure has risen dramatically in recent months, due to the weakening of the Indian Rupee against the American Dollar. From 40 odd Rupees to the Dollar just a few months ago, the exchange rate has shot up to over 52  rupees per dollar. Given the fact that India denominates all its international transaction in American Dollars, the weakening exchange rate means that India is having to pay a lot more for its imports than it did a few months ago- which includes billions of dollars on the import of fuel from abroad. The consequent rise in fuel prices has only aggravated the inflationary situation in the economy. Mind you, fuel prices are heavily subsidised.

Given the high fiscal deficit (i.e. the gap between income and expenditure) that the Government of India is currently running, the wisdom of further burdening its finances needs to be questioned. The high debt burden will inevitably result in more borrowing by the Government which in turn results in pushing up the interest rates in the market. And higher rates of interest will result guessed it right, higher inflation. Historically, the lower income earners have always been the ones most severely affected by inflation.

And so an initiative which is intended to provide food security for the weaker sections of society is likely to end up hurting them even more. The economic slowdown caused by higher borrowing costs is likely to result in job losses anyway. And so while on the one hand the Government is proposing to subsidise the cost of foodgrains for the poor, it is, on the other hand,  creating the very circumstances that could adversely impact any opportunities for upward mobility that they have.
I would also hasten to add that I have not even touched upon the impact of a burgeoning fiscal deficit on business and consequently, the economy as a whole. Suffice it to say that a high budgetary deficit is only going to be bad news for all concerned. One can understand the deficit widening due to circumstances outside the control of the Government, but is it advisable for any Government to take a conscious decision that is going to stretch its fiscal deficit even further, at a time when it is already threatening to run out of control?

The old Hindi proverb on cutting the coat according to the cloth (जितनी लम्बी चादर हो उतने ही पैर फैलाना चाहिए) is one that India's policymakers will do well to keep in mind. The Americans, who lived on borrowed money for close to three decades are paying for it now. One only hopes that India managed to avoid going down the same path.

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