Six months ago, the government was seen as a hopeless, paralysed ditherer, frightened of annoying anybody (especially Mamata Banerjee). But since Chidambaram became Finance Minister, the government has started looking like an activist reformer that means business.
Risking defeat in Parliament, FDI in multibrand retail has been pushed through. Rail fares have been increased, diesel prices are going to rise every month till the implicit subsidy disappears , a cap has been put on LPG gas connections, and foreign investor fears have been assuaged on general anti-avoidance tax measures. Chidambaram has been touring the world, promising to slash this year’s fiscal deficit to 5.3 per cent of GDP, and next year’s to 4.8 per cent.
Many observers are rubbing their eyes in disbelief . Does the transformation have firm roots? Will it be sustained?
Yes, because the underlying politics of the electoral cycle has changed. For Sonia Gandhi, the big overarching question after the 2009 election was “How do we survive a full five-year term?” That has now been replaced by a new question,” How do we get re-elected in 2014?” The new question has produced a new answer, and that has driven the change in economic approach.
In the 2009 election, the UPA coalition fell marginally short of a majority, and obtained a hairline majority using minor parties. The big message from Sonia was, “Don’t rock the boat with adventurous proposals. Don’t take risks. Surrender to Mamata (or any other strong vote bank) whenever necessary. Ensure a full fiveyear term.”
In pursuance of risk avoidance, Finance Minister Pranab Mukherjee said that major reforms would be possible only where the BJP agreed, ensuring a clear majority in both Houses. If this meant a very limited reform agenda, so be it. The focus was on survival, not activism. Seen in this light, part of the supposed policy paralysis of the UPA was actually conscious policy.
But by mid-2012 , it was clear that continued risk-averse inaction would mean electoral defeat in 2014. The headlines were dominated by scams and tales of paralysis. Economic growth had slowed dramatically to 5 per cent, implying fewer jobs and economic opportunities. Inflation remained stubbornly high, a recipe for defeat.
Prime Minister Manmohan Singh had long argued that oil subsidies should be slashed and rail fares raised to check the fiscal deficit and improve the investment climate. But this would have spurred rebellion by Mamata and possibly other allies, so Singh could not carry the day.
This accentuated the sense of drift. International rating agencies like Moody’s warned that if nothing changed, they would downgrade India’s credit rating to junk status.
Normally, politicians would have shrugged this off as irrelevant. But not this time. Singh emphasised that if India was downgraded to junk, many pensions funds and other foreign investors would pull billions out of Indian stock markets. This would cause the rupee to crash from Rs 55 to the dollar to Rs 60. This would raise all import prices, taking inflation to maybe 15 per cent. That would guarantee crushing defeat in the coming election. Suddenly, avoiding a credit downgrade became politically important, indeed critical.
Rating agencies could not be won over by a couple of one-off measures. Restoring confidence in India required a genuine change in economic approach, a willingness to take politically difficult steps across the economic spectrum. Cosmetic steps would not do. Real sustained action was required.
This carried major political risks. It meant the UPA would lose Mamata’s support and become a minority government. Yet the risk of doing nothing seemed much greater than the risk of going ahead with a wholesale change in economic approach that would revive animal spirits among businessmen, and incentivise foreign investors to pour dollars into India. This would produce a rising rupee that would lower import prices and hence tame inflation, reducing the biggest threat to re-election . It would also revive animal spirits in business, creating more jobs and opportunities in an election years.
Once Sonia was convinced, Chidambaram was brought in to spearhead the new approach. Six months on, this seems to be working. Foreign investors have poured in $7.8 billion in the last two months. The rupee has strengthened. Despite a higher diesel price, wholesale price inflation has finally fallen below 7 per cent, raising hopes that consumer prices will follow suit. Many hurdles remain, but the climate has changed from one of doom and gloom to hopes of a better 2013.
This does not guarantee election victory for the UPA. But it does portend a better outcome than seemed likely in the dark days of mid-2012. For that reason, the new economic activism looks here to stay for the rest of the UPA’s term.