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Archaic policies put India in a tough economic position

Dr Subroto Roy, economist and policy advisor to former Prime Minister Rajiv Gandhi, tells Ragini Bhuyan about India’s financial troubles, which directly impact national security.

RAGINI BHUYAN  15th Dec 2012

Former President Pratibha Patil with military personnel

ou have said India's biggest national security problem is the Government of India's (GoI) financial incompetence. What is the point in time you would trace the government's fiscal mismanagement to?

A. Yes I do think India's biggest national security problem is the GoI's financial mismanagement. The military budget is the Black Hole of Indian public finance. No one really seems to know what is going on there or why. Other countries like the USA, PRC and even Pakistan, have had massive national debates about the size of standing armies, closure of unnecessary military bases, choice of weapons' systems (e.g. aircraft carriers vs submarines), etc. The amount and direction of military expenditure should be a function of strategy in response to perceived threats. In India it seems more a function of immense background lobbying by foreign powers. A result is that despite massive military expenditure over decades, an outfit like the LeT could attack Mumbai for days on end. So it seems to me serious military men should be candid and thoughtful about the sheer waste of public resources the military indulges in too often and also realize that if the general budget is weak then no country can be considered strong. Regarding precise dates, three relics from wartime British rule starting in 1939 have dominated our macroeconomic policy-making ever since: massive military expenditure, exchange controls, and automatic monetization of budget deficits. These three relics still control Indian policy-thinking decades later as the macroeconomic process we are part of has not been comprehended.

Q. Why do you think the GoI's estimate of the country's savings rate is wrong? You have argued the current GDP figures are unscientific. Can you explain?

A. The PM on June 9, 2009 said to the new Lok Sabha: "I am convinced, since our savings rate is as high as 35%, given the collective will, if all of us work together, we can achieve a growth-rate of 8%-9%, even if the world economy does not do well." The British politician Meghnad Desai claimed in 2006 China "now has 10.4% growth on a 44 % savings rate... " The claim China and India have high economic growth-rates based on purportedly astronomical savings rates has been reiterated endlessly. But it is a mirage. The model relating savings to growth is old-fashioned and rigid, neglecting the critical role of technological progress in generating modern growth. West Germany and Japan had the highest annual per capita real GDP growth-rates starting from devastated post war initial conditions and barely reached 7% or 8%. The idea China or India can achieve 9%-10% per capita growth routinely should seem fishy right away, especially as neither yet meets world standards of measurement described by the UN's System of National Accounts 1993. The actuality may be better or worse than what is being measured, we do not know, and to overly rely on such numbers is absurd. Furthermore, over the last 25 years the average savings rate across all OECD countries has been less than 10%. Claims of discontinuous behaviour are always questionable. If the average OECD citizen has been trying to save 10% of disposable income at best, it is odd India's PM claims a savings rate of 35% or a rate of 44% is claimed for China. Nicholas Kaldor himself, Manmohan Singh's teacher, said rich people saved and poor people did not as the former had something left to save which the latter did not! Savings have been mismeasured. Savings is measured by adding financial and non-financial savings. Financial savings include bank-deposits. But India is not a normal country in this regard, nor is China. Both have seen massive exponential growth of bank-deposits. Does this mean Indians and Chinese are saving phenomenally high fractions of their incomes by assiduously putting money away into their shaky nationalized banks? Unfortunately not. What has happened is government deficit-financing has grown explosively in both countries over decades. In a "fractional reserve" banking system (i.e. a system where your bank does not keep the money you deposit there but lends out almost all of it immediately), government expenditure causes bank-lending, and bank-lending causes bank-deposits to expand. Yes there has been massive expansion of bank-deposits in India but it is a nominal paper phenomenon and does not signify superhuman savings behaviour. Indians keep their assets in metals, land, property, cattle, and cash, not as bank deposits.

Q. You said money is open to being debauched by governments. Why do you think this happens, and what mechanisms need to be instituted to check this in India?

A. Money gets debauched because governments lack the will, ability, or good sense to run public finances properly. In India, formal mechanisms have existed to prevent this but have been long forgotten first by the British during the war and since then by India's pseudo-socialist "planners".

The military budget is the Black Hole of Indian public finance. Despite massive military expenditure over decades, an outfit like the LeT could attack Mumbai for days on end.

Q. In your December 3 lecture, you warned of an impending banking crash because of the GoI's financial mismanagement. Can you elucidate?

A. What I said was that the asset side of the banking system contains vast untold amounts of government debt, and these cannot be valued at world prices because the rupee is not a hard currency, and hence the value of the banks and hence all nominal assets in the economy really becomes an unknown.

Q. You have argued against the standard government spiel that India is safe because we have significant foreign reserves. Please elaborate.

A. The Government has yielded instantly to every Big Business lobby that has demanded access to foreign capital markets; it is that borrowing of foreign capital that has led to high forex reserves, not growth of forex through expansion of manufactured exports. China's growth of forex reserves is fundamentally different, as it has been based on massive merchandise exports to the West over decades.

Q. You said that the current debate about FDI is trivial from an economist's point of view. Please explain.

A. Foreign direct investment is generally a good thing because it helps the balance of payments and it transfers technology. But retail is not where you normally want it! Unless of course you have foreign powers breathing down your neck because you have serious cash flow problems due to military imports and you need to find some quick forex somewhere!

Q. You mentioned that Milton Friedman in 1955 had proposed a convertible currency for India on the lines of the Canadian currency. Why was this suppressed by the GoI?

A. The ideology of India's economists was one of Sovietesque pseudo-socialism and that has remained the ideology of many. Discussing Milton's memorandum at the time would have exploded that, which is what I ended up doing decades later. Rajiv Gandhi agreed with me. Sonia Gandhi and Manmohan Singh apparently do not.

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