From about 84 per cent of GDP in 2003, India’s public debt-to-GDP ratio has steadily declined to 67 per cent, and projections show a continuing decline. While much of the world is preoccupied with rising debt ratios, India appears to be singularly well-positioned. Or is it?
Here’s the odd thing. Indian general government deficits have been consistently high, averaging about eight per cent of GDP during 2003-2008 and jumping to 9.5 per cent of GDP since 2009. India’s fiscal deficits lead in the elite league of G20 nations. The public deficits of the other BRIC countries have been consistently lower. The only countries that at present match India are the advanced nations fighting recessions. The Indian government has lived well beyond its means for the past decade and yet the debt it owes is a shrinking fraction of the country’s GDP.
The elixir of inflation solves this conundrum. Among the G20 nations, India also had the highest rate of inflation in 2012: over 10 per cent, according to the International Monetary Fund’s (IMF’s) World Economic Outlook. Argentina’s projected inflation at 9.8 per cent is probably understated, but India was ahead of the others by a long shot. Inflation in the other BRICs fell between three and six per cent. And inflation in the North Atlantic advanced nations was in the one to three per cent range.
The large public deficits have two consequences for the government’s debt obligations. They increase the nominal value of the debt. But equally, the deficits keep inflation bubbling, which erodes the real value of debt. The government benefits because it does not pay the price of high inflation — it has privileged access to private savings at near zero real interest rates. With inflation so high, nominal GDP has grown much faster than government debt, leading to the steady fall in the debt-to-GDP ratio.
If this seems like a good deal, it is — but only for the government. The economic consequences are terrible. The system is regressive, erodes competitiveness, and maintains a political equilibrium inimical to reforms.
Make no mistake: by fostering inflation, the government enables the transfer of resources from the poor to the rich. The costs of inflation fall heavily on the most vulnerable. This is especially so since food price inflation has been particularly high. And as the poor struggle, the public deficit is used to dole out large subsidies to those with political clout, including to large farmers.
Families with some cushion to place their modest savings in bank accounts also suffer. Since interest rates have, at best, kept pace with inflation, the savings earn nothing in real terms. Indeed, for many, the savings depreciate in value while the government uses them to finance its growing largesse.
Inflation has hurt growth and increased macro imbalances. Production costs have risen rapidly relative to costs in competing nations. The exchange rate has, however, remained stable (in comparison with the price rise): with weakened international competitiveness, exports and manufacturing growth have, not surprisingly, slowed to a crawl. Headline GDP growth has been held up by buoyant growth in construction and finance. History is not kind to growth led by construction and financial booms.
The more far-reaching concerns relate to the political economy of public spending. Massive public deficits without the corresponding debt obligations have allowed large inefficiencies in spending. Although the deficits pushed up demand pressures, there was no counterbalancing incentive to ease supply bottlenecks (in infrastructure and agriculture). Instead, driven by populist pressures and special interests, regressive subsidies and large “leakages” became integral even to programmes that provide some relief to the poor.
Above all, this system has eroded the incentives for entrepreneurship since access to government subsidies and annuity-like contracts offer handsome returns. Thus, the political forces that have fuelled inflation have also constrained economic growth. And as growth has slowed, supply bottlenecks and inflationary pressures have become more endemic.
In April 2010, the IMF forecast that by 2013, India’s GDP would be growing at eight per cent and the inflation rate would gradually decline. GDP is now forecast to grow at possibly well under six per cent in 2013 while inflation is projected to remain close to 10 per cent. The global environment will offer no easy vent for growth.
The Indian economy has been hurt before by entrenched political lobbies. Liberalisation and a prosperous world unleashed dynamism. But new lobbies and forms of rent-seeking have quickly emerged. The political equilibrium is now maintained by financing a wasteful populism cloaked in the garb of inclusiveness. Too much inertia has been built into the system for a rapid turnaround. Half-hearted policy measures will merely increase the muddles — only a crisis may spur serious reform.
Ashoka Mody teaches at the Woodrow Wilson School, Princeton University. Michael Walton teaches at the Kennedy School, Harvard University, and is a visiting fellow at the Centre for Policy Research