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The economy is in the frying pan and PM Modi left it too late to act

Just four months ago, Prime Minister Narendra Modi gave a long speech in the Lok Sabha. One of the things he said was that when he assumed office the economy was in a very poor shape. India, he said, had been placed in a grouping called the Fragile Five by international agencies. But our government has rescued India and our economy is no longer fragile. 

The treasury benches clapped.

Yet, just 16 weeks later, things are looking less rosy, if not actually grim. Forget the perennial structural problems like employment, agriculture, exports etc, even the day-to-day stuff like uncertain inflation, the falling rupee, high interest rates, poor revenue realisation from GST etc have become a handful. 

As a result, the government is looking like Virat Kohli in that Test match in which after having had England 86/6 he let them score over 300 runs. 

The problem was that Kohli had taken a one-way bet on the off-spinner R Ashwin who, unusually for him, failed to perform. That led to Kohli losing his grip on the match and then the match itself.

In a similar manner, the economic managers of the government seem to have taken a one-way bet on low international oil prices.  But as soon as these started to rise, the government has lost its grip. From being in a strong position in May, the economy has begun a phase of great uncertainty now and Mr Modi is reported to have assumed direct charge. 

But that is like Ravi Shastri, the cricket director -- which is just a fancy term for super coach -- trying to run things on the field. It didn’t help. Nor, beyond a point, will Mr Modi’s decision to supervise the economy. He has left it too late.

False assumption

Of the three main things the government relied on – low oil prices, higher revenues from GST and low inflation – it could control the last two but not the first. 

GST was an implementation issue of its own making, which has led to a revenue shortfall of around Rs 100 billion a month since April. But remedial steps have been taken by taking resort to the accumulated sum of around Rs 900 billion in the compensation cess. So, broadly, things should turn out well.

Inflation uncertainty is also manageable if money supply growth is managed sensibly. The prospect of a supply shock from agriculture which bumps inflation up has now vanished for this year. 

Global oil prices, however, are a different story. They do not respond to domestic policies in India. There is every likelihood that they will continue to rise in the foreseeable future because of production cuts by oil producers in West Asia and US sanctions on Iran. The Indian economy is thus well-and-truly in the frying pan. 

This is what happens when you take a one-way bet which is predicated on the assumption that a process is uni-directional. But when that turns out to be a wrong assumption, you end up very much worse off. This is what has happened to the Modi government on oil prices.

A great deal of mathematical and statistical research has been done on the subject of bets. All of it suggests just one thing: it is bad policy to assume that the opposite of what is happening cannot and will not happen in the future.

The Missed Bus

What should have the Modi government done during 2015-17 when oil prices were low? It should have taken a leaf out of Y V Reddy’s book who, as Governor of the Reserve Bank of India, used the favourable financial climate of 2003-08 to build up the capital reserves of the public sector banks. It is that prudent policy which enabled India to withstand the financial crisis of 2008.

Likewise, the Modi government should have (a) let the rupee depreciate gradually over the last three years, thus making imports more expensive and exports more competitive and (b) it should have expanded the strategic oil reserve which is currently just about six million tonnes. This should have been doubled. The belated policy responses that we are seeing now are just that – belated. The delay is going to cost the BJP politically in the 2019 election because now every section of voters is annoyed at the high prices of petrol, diesel and consumer goods imports.

One can only wonder at the quality of advice given to Mr Modi who by inclination doesn’t focus on macro fundamentals. Now he is going to learn the hard way why they are important.

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