Who Does Low Inflation “Really” Benefit?

rupee

Every month the ministry of statistics and programme implementation declares the inflation based on the consumer price index. Inflation is essentially the rate of price rise. The inflation for the month of June 2017, came in at 1.5 per cent.

This basically meant that prices in June 2017 overall were higher by 1.5 per cent in comparison to June 2016. This is the lowest inflation that the country has seen over the period of last five years.

Hence, not surprisingly, the government moved very quickly to claim credit. Arvind Subramanian, the chief economic adviser to the ministry of finance, said: “This low, heartening number is consistent with our analysis for some time now.”

This is one of those statements that makes economics the subject that it is, where equally convincing arguments can be made from the two ends of the spectrum.

Allow me to explain.

Low inflation is heartening because the rate of price rise has come down. It needs to be understood here that low inflation does not mean lower prices. It just means that the rate of price rise has come down than in comparison to the past and that is a good thing. Or so the chief economic adviser would like us to believe.

The question is why has the rate of inflation come down? The consumer price index that is used to calculate inflation is made up of a large number of goods and services. The government tracks the prices of these goods and services across the country, in order to arrive at the inflation number.

Food and beverages constitute around 45.9 per cent of the index. Food and beverage prices fell by 1.2 per cent in June 2017 in comparison to June 2016. In fact, prices of some of the constituents like pulses and vegetables have fallen at a much faster rate than the overall rate.

The price of vegetables fell by 16.5 per cent and that of pulses fell by 21.9 per cent. Vegetables and pulses together constitute a little over 8.4 per cent of the index.

So, what does this mean? It means that the overall rate of inflation is down because food prices have actually come down. Lower food prices essentially mean that the farmers growing food, have sold what they grew at a price lower than they had in the past. Also, these lower prices do not always reach the end consumers, with middlemen taking in a bulk of the benefit.

There have been many stories in the media portraying the plight of these farmers who have had to sell their produce at lower than their cost price and face losses and get even more indebted. In fact, it is not surprising that over the last few months, there has been so much demand for loans to farmers to be waived off, all across the country.

The larger point is that if inflation has become very low then someone is not being paid as much as he was in the past. And this can be due to various reasons. In this case that someone happen to be farmers. Farmers form around half the working population. If they face losses then they are less likely to spend as much money as they had in the past. This will impact rural growth and in the process, the overall economic growth.

Hence, when Subramanian finds low inflation heartening, he ignores this line of thought totally. As Evan Davis writes in Post Truth—Why We Have Reached Peak Bullshit and What We Can Do About It: “There are certainly such things as facts, and no one should persuade you otherwise. But aside from quite banal facts (‘the sun is shining’) we always have to use judgement in deciding what is a fact and what to believe: we have to apply a judgement as to the weight of evidence in its support relative to the weight of interpretation put on it.”

The column originally appeared in the Bangalore Mirror on July 19, 2017.

With Farmer Loans Waived Off, UP Govt Has Its Oh Darling Ye Hai India Moment  

Given that I am a big film buff, I have watched my share of trashy cinema over the years and continue to do so. A particularly trashy film that I watched in 1995 (which was also the year that Dilwale Dulhaniya Le Jayenge (DDLJ) released) was called Oh Darling Ye Hai India, and like DDLJ it also happened to star Shah Rukh Khan.

The title song of the movie had the line: “Jo bacha nahi wo baant dia,” which when translated into English essentially means, what has not been saved has already been distributed. Every time a government decides to waive off farmer loans, I am reminded of this song. And as I keep telling anyone who cares to listen, Hindi film lyricists have written songs for almost every situation that one can encounter in life, including farmer loans being waived off.

The question is why am I reminded of the song whenever a government waives off farmer loans or even talks about it. The government waiving off loans needs to compensate banks which had given loans to the farmers in the first place. Of course, the government hasn’t saved money to pay off these banks. And in that sense what has not been saved has already been distributed.

The newly elected Yogi Adityanath government in Uttar Pradesh has decided to waive off loans worth Rs 30,729 crore to small and marginal farmers in the state. By doing this, it has met its major electoral promise. The state has 2.3 crore farmers. Of this number 1.85 crore are marginal farmers and 0.3 crore are small farmers. Farmers with landholdings of less than 2.5 acres are marginal farmers. Those with landholdings of 2.5 to 5 acres are considered as small farmers.

The waive off amounting to Rs 30,729 crore will benefit 86.68 lakh small and marginal farmers in the state. Over and above this, the state government has also decided to settle bad loans of 7 lakh farmers worth Rs 5,630 crore, with banks.

This puts the total cost at Rs 36,359 crore. The first question that comes up is where is the government going to get this money from? As I said earlier, what has not been saved has been distributed. The state government will bear the cost of funding the farmer loan waive offs and the bad loans settlement with the banks, as well.

Can the state government afford this? The answer is no. In 2016-2017, the UP government was projected to run a fiscal deficit of Rs 49,961 crore or around 4.04 per cent of the state’s gross domestic product (GDP). A government is said to run a fiscal deficit if its expenditure is more than its revenue during the course of the year. The state ended up running a fiscal deficit of Rs 55,020 crore or 4.45 per cent of the state GDP.

Hence, an expenditure of Rs 36,359 crore would add majorly to the state’s fiscal deficit. It would also add to the overall fiscal deficit of India (i.e. the fiscal deficit the state governments plus the central government) which is extremely high to begin with. As Neelkanth Mishra of Credit Suisse wrote in a recent column in the Business Standard: “In the past seven years, even as the absolute fiscal deficit of the Union government has been largely unchanged, that of the state governments has increased two-and-a-half times.”

The state government plans to issue farmer relief bonds in order to generate money for waiving off banks loans. Doubts have been raised whether investors would subscribe to these bonds given the bad financial state of the UP government. A guarantee from the government of India on these bonds is going to help.

I guess this forms one part of the argument. The move will not work out well for the UP government. Nevertheless, that was a given. And honestly, the last things many governments are bothered about is their financial position. So, how will this move work out for the farmers is the more important question.

No doubt it will provide them immediate relief to farmers facing two consecutive years of bad monsoons. At the same time, the state government deciding to settle the bad loans of nearly 7 lakh farmers, has made farmers who paid their loans on time, look like fools

Further, overall this move might not be such a great deal for the farmers. It is important to understand that the waive off does not take away the farmer’s need to borrow money from banks in the days to come. As former RBI governor Raghuram Rajan said in a December 2014 speech:In some states on certain occasions we have had debt waivers. How effective these debt waivers have been? In fact the studies that we have typically show that they have been ineffective. In fact they have constrained the credit flow post waiver to the farmers.”

There are several ways in which farmers who have taken on the benefit of defaulting on bank loans, are denied loans in the time to come. As N Srinivasan, a rural finance consultant writes in the College of Agriculture Business magazine: “The experiences of the past show that there are many ways of denying credit to farmers who chose to benefit from default of bank loans. Delay in sanctions, high collateral requirements, reduction of quantum of loans, lengthy and complex documentation requests, etc. are some of the well known methods of denial of credit. These would be employed to good effect in the post- waiver situations by banks to cut their exposure to farm sector.” And this is possibly not good news for the farmers. If banks deny them credit in the future, they will go back to the local moneylender.

The third constituent in the waive off are the banks. Given that they will be reimbursed by the Uttar Pradesh government, they will not face any losses on the loans that they had given to farmers. But as I had pointed out in the Diary entry dated March 23, 2017, the waive off will create the issue of moral hazard in the days to come.

The economist Alan Blinder in his book After the Music Stopped writes that the “central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it.”

This basically means that once the farmer sees a loan being waived off today, he will wait for elections in the future for the newer loans he takes on to be waived off as well. Essentially, he will see little incentive in repaying loans that he takes on in the future.

As the SBI Chairperson Arundhati Bhattacharya said recently: “We feel that in case of a (farm) loan waiver there is always a fall in credit discipline because the people who get the waiver have expectations of future waivers as well. As such future loans given often remain unpaid… Today, the loans will come back as the government will pay for it but when we disburse loans again then the farmers will wait for the next elections expecting another waiver.” And this isn’t possibly a good thing, if the idea is to promote financial inclusion and take banking to more and more people.

Over and above, all these points, the decision of the Uttar Pradesh to waive off loans, is likely to lead to a similar demand and decisions from other states. Such demands have already been made in Maharashtra. They may soon be made in other states where elections are due in the months to come. And this is something which isn’t good for the nation as a whole.

If several state governments raise money in a quick time, it can push up interest rates as well, despite the fact that currently the demand for bank loans is low. It will also push up the combined fiscal deficit of the state governments and the central government, which as I said earlier in the piece, is already high.

To conclude, India, as well all know, is a land of contradictions. If one thing is true, then it’s possible that the opposite maybe true as well.

Hence, this brings us to the last question of the day: “If banks can write-off lakhs of crore of corporate loans, why can’t they be forced to waive off loans worth around Rs 36,000 crore?” Indeed, that is a good question to ask. (I know some people here would like to point out to me that a write off is different from a waive off. In case of a write off the bank can still try and recover the loan that has been defaulted on. I would request these people to look at the recovery rates of banks, before trying to explain the difference to me).

As I said at the beginning of this piece, Oh Darling Ye Hai India. And that perhaps, explains everything.

The column originally appeared on Equitymaster on April 5, 2017

Rahul 2.0 needs some basic lessons in economics

rahul gandhi
Rahul Gandhi recently came back to India from his foreign sojourn of nearly two months. And in his new avatar, Rahul is angry. One of the things he is angry about is the fact that the Narerndra Modi government after coming to power decided to go slow on increasing the minimum support price of wheat and rice. The MSP is the price at which the government buys rice and wheat from the farmers, through the Food Corporation of India(FCI) and other state government agencies.
Rahul told a farmers’ rally in New Delhi on Sunday: “We increased the MSP of wheat from Rs 540 to Rs 1400…The MSP has not changed, no benefit to farmers.”
Between 2005-2006 and 2013-2014, the MSP of wheat was increased at an average rate of 14% per year. The Congress led United Progressive Alliance(UPA) was in power throughout this period. In comparison, between 1999-2000 and 2005-2006, the price had gone up by 4% per year.
The decision to raise MSP did not have any method behind it. It was totally random. A report released by the Comptroller and Auditor General in May 2013 pointed out that “No specific norm was followed for fixing of the Minimum Support Price (MSP) over the cost of production. Resultantly, it was observed the margin of MSP fixed over the cost of production varied between 29 per cent and 66 per cent in case of wheat, and 14 per cent and 50 per cent in case of paddy during the period 2006-2007 to 2011-2012.”
Nevertheless, political decisions do not follow economic logic. But the question is did this decision to constantly keep increasing the MSP benefit the people of India at large. The answer is no. It was the major reason behind the high inflation in general and food inflation in particular, that was seen between 2008 and 2014. As economist Surjit Bhalla put it in 
a November 2013 column in The Indian Express “For each 10 per cent rise in previous years’ procurement prices, there is a predicted 3.3 per cent increase in the current year CPI…When the government raises the MSP, the prices of factors of production involved in the production of MSP products — land and labour — also go up.”
Food inflation hurts the poor the most. Half of the expenditure of an average Indian family is on food. In case of the poor it is 60% (NSSO 2011). What Rahul and the Congress party need to understand is that everyone associated with agriculture does not own land. As per the draft national land reforms policy which was released in July 2013, nearly 31% of all households in India were supposed to be landless. The NSSO defines landlessness as a situation where the area of the land owned is less than 0.002 hectares.
Any price rise, particularly a rise in food prices which is what an increase in MSP leads to, hurts this section of the population the most. Is Rahul not worried about them? They may not be farmers who own land, but they also farm land in this country.
Also, Rahul needs to realize that only a small section of the farmers have a marketable surplus, which they are able to sell to the government. This is primarily because the average holding size of land has come down over the decades. 
The State of the Indian Agricultural Report for 2012-2013 points out that: “As per Agriculture Census 2010-11, small and marginal holdings of less than 2 hectare account for 85 per cent of the total operational holdings and 44 per cent of the total operated area. The average size of holdings for all operational classes (small & marginal, medium and large) have declined over the years and for all classes put together it has come down to 1.16 hectare in 2010-11 from 2.82 hectare in 1970-71.”
This means that only a small section of the farmers make money only from agriculture. Only 17% of farmers survive on income totally from agriculture. The rest do other things as well to make money. And given this they are hurt by the food inflation because of a rapid increase in MSP.
The Congress led UPA government also increased the MSP of rice at a very rapid rate.  In 2005-2006, the MSP for common paddy(rice) was Rs 570 per quintal. By 2013-2014 this had shot up to Rs 1310 per quintal, an increase in price of around 11% per year. In comparison, between 1998-1999 and 2005-2006, the MSP of rice had increased at the rate of 3.8% per year.
This rapid increase in MSP led to a huge amount of food grains landing up with the government. The FCI did not have enough space to store all this grain. “Between 2005 and 2013, close to 1.94 lakh tonnes of food grain were wasted in India, as per FCI’s own admission in the Parliament,” a Crisil Research report points out. Rice formed 84% of the total damage.
While rice and wheat rotting in government godowns, there wasn’t enough of it going around in the open market.  The CAG report referred to earlier points out that in 2006-2007, 63.3 million tonnes of rice landed in the open market. By 2011-2012, this had fallen by a huge 23.6% to 48.3 million tonnes. The same is true about about wheat as well, though the drop is not as pronounced as it is in the case of rice. In 2006-2007, the total amount of wheat in the open market stood at 62.1 million tonnes. By 2011-2012, this had dropped to 61.4 million tonnes.
Also, with MSPs being increased every year at a rapid rate, “the cropping pattern,” the Crisil report points out, was also “biased towards food grains like rice and wheat,” and this led to their “excessive production”.
This is what the Congress led UPA’s policy of constantly increasing MSPs, actually did.
To conclude, as the old English saying goes, “the proof of the pudding is in eating it”. If the policy of the Congress led UPA government of increasing MSPs at a rapid rate was so good, why did the Congress party end up with only 44 seats in the 2014 Lok Sabha elections? Maybe Rahul Gandhi has an answer for that.

The column originally appeared on The Daily Reckoning on Apr 23, 2015

Rahul Gandhi’s ‘suit boot ki Modi sarkar’ jibe stinks of hypocrisy

rahul gandhi
Vivek Kaul

Rahul Gandhi, the Gandhi family scion and the vice-president of the Congress party, is back from his two month holiday (57 days to be exact). And if nothing else, he surely has discovered his political machismo during the period. Speaking in the Lok Sabha today (April 20, 2015) Rahul said that the Narendra Modi led National Democratic Alliance(NDA) government was a government of industrialists, or as he put it: ‘suit, boot ki sarkar‘.
In a speech he made at the Ram Lila Maidan in New Delhi on April 19, 2015, he made similar
allegations when he said: “Let me tell you how Modi ji won the election. He took loans of thousands of crores from big industrialists from which his marketing was done. How will he pay back those loans now? He will do it by giving your land to those top industrialists. He wants to weaken the farmers, then snatch their land and give it to his industrialist friends.”
There are multiple points that need to be made here. Is Rahul Gandhi trying to suggest that the Congress party did not get corporate funding to fight the 2014 Lok Sabha elections? Is he trying to suggest that the Congress party has never got corporate funding to fight elections? Is he trying to tell us that the Congress party has never used “black-money” to fight elections?
Or is it more a case of sour-grapes—the fact that when it came to the 2014 Lok Sabha elections the corporates where on Modi’s side, given the sordid performance of the Manmohan Singh government. As Jairam Ramesh told
The Times of India after the Lok Sabha elections: “We were out-campaigned, out-manoeuvred, out-funded and out-spent by Modi.” So, it is clearly a case of sour grapes for Rahul. Also, in all these years that Congress was in power, why did it never try to clean up political funding? Does Rahul have an answer for that?
Rahul, further said in his Lok Sabha speech that: “You know as well as I do, that this government is one that works for industrialists.” So, does this imply that the last Congress led United Progressive Alliance government did not work for industrialists?
If that was the case then why did so many scams involving corporates happen in the second term of the Congress led UPA government? Was the telecom 2G scandal a creation of the Modi government? Did the Commonwealth Games scam happen under the Modi government? Did the coalgate scam, where the governments loss lakhs of crore happen under the Modi government?
Rahul also suggested in his two speeches that the Modi government is hell bent on taking away land from the farmers and giving it to corporates. The question is what were multiple Congress governments doing since the independence?
Until 2013, the land acquisition act 1894, governed land acquisition in India.
A 1985 version of this Act stated: “Whenever it appears to the [appropriate Government] the land in any locality [is needed or] is likely to be needed for any public purpose [or for a company], a notification to that effect shall be published in the Official Gazette [and in two daily newspapers circulating in that locality of which at least one shall be in the regional language], and the Collector shall cause public notice of the substance of such notification to be given at convenient places in the said locality.”
The language of the 1894 Act shows that it gave unlimited power to the government to acquire land. This wasn’t surprising given that the law came into being when the British ruled India. The Act allowed governments all over India to acquire land from the public. Many governments passed on this land to corporates, and in the process both the government and the corporates made money.
The only one who did not make money was the individual whose land was being acquired. Of course, this did not go unnoticed. People saw politicians and corporates making a killing in the process. And the trust that is required for any system to work completely broke down. The various Congress governments which led the country between 1947 and 2013(nearly 66 years) chose to do nothing about it. In 2013, the Congress led United Progressive Alliance (UPA) brought in T
he Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act 2013.
By ensuring that corporates got land on a platter, the Congress party essentially helped build a system of political-corporate corruption. Further, given that governments acquired land for them, Indian corporates have become lazy over the years. Also, many of them started to see themselves as landlords and wanted land just for the heck of it. This can be said from the inefficient use of industrial land in India. Narendra Modi had no role in building this system. He just inherited it.
And there is more. Along with the budget document, the government releases a statement of revenue foregone every year.  “The estimates and projections are intended to indicate the potential revenue gain that would be realised by removing exemptions, deductions, weighted deductions and similar measures,” the statement points out.
For the year 2014-2015, the government is expected to forego revenues of Rs 62,398.6 crore because of exemptions and deductions given to corporates. Interestingly, the bigger the corporate the more deductions and exemptions they take. Corporates which make an operating profit within the range of Rs 0-1 crore have an effective tax rate of 26.89% Those in the Rs 50-100 crore range have an effective tax rate of 24.29%. Whereas those making a profit of greater than Rs 500 crore have an effective tax rate of 20.68%. The overall rate is 23.22%. This is not a recent phenomenon. It has been true for many years.
Who has built this tax system which favours the corporates? The Congress party is the answer. The party has been in the government in every decade after independence. Narendra Modi has not been in power even for a year. Once these factors are taken into account, the only thing one can say is that Rahul’s “
suit boot ki Modi sarkar,” comment, stinks of hypocrisy. Guess, the two month sojourn hasn’t done him much good.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on Apr 20, 2015