The irritating jingle for India’s tourism advertisements uses the slogan “Incredible India”. I for one tend to agree that the country is incredible, if the literal meaning of the adjective may be employed to mean that various aspects of the country’s policy are simply not credible in today’s global economic context.

Just on Friday, the country announced wholesale price index inflation of 11.42%, an acceleration from the 11.05% of the previous week and worse than the 11.22% expected by economists. The jump from the trend rate of about 5% for 2007 to more than double is all too easily blamed on the rise in food and oil prices, but in the case of India at least there are some pretty dumb policy decisions at the heart of the whole mess.

The first major policy error was by the central bank (Reserve Bank of India, or RBI) that tried to use a combination of moral suasion and reserve ratio hikes at banks to curb economic overheating. In an economy that has banking assets less than 50% of gross domestic product, the idea of using bank reserve ratios to curb overall inflation is akin to using a motorcycle to pull a truck along the highway.

RBI officials as recently as last month talked about “allowing” the rupee to rise against the US dollar to combat inflation. Maybe it is just me, but the idea of some ex-communists talking about “letting” or “guiding” any aspect of financial markets always raises ones heckles. It is another matter that such delusions of grandeur pervade the halls of all Asian central banks, but today’s subject happens to be India so let’s stay on message.

On the other side of this fascination with “allowing” the markets to do something is the question of interest rates. Both the central bank and the government maintained until quite recently that keeping interest rates stable was essential to disallow rapid appreciation of the rupee. In other words, the government and the central bank refrained from using the most potent policy tool available – namely interest rates – with the excuse of the currency.
The real reason is of course a profound misunderstanding of the growth-inflation trade-off in policy. Keeping interest rates low creates an incentive for investors to accumulate assets with leverage, thereby creating inflationary spirals. The combination finally ends with a rapid tightening that always causes economic hard landing.

This is precisely what India is headed for.

Reform malarkey

The second troubling aspect of the Indian policy apparatus is the government’s expense management, or more to the point, the complete lack of any discipline and forethought in allocating expenses. Government expenses have the potential to create the exact opposite effect of what is intended because of a fundamental failure to understand demand-supply dynamics.

Much like the experience of China, keeping prices artificially low encourages the wrong kind of consumption, while also limiting new investments. This is the reason China this month agreed to massive fuel price hikes, as its government realizes the importance of improving efficiency of fuel usage as a strategic rather than tactical goal. The same process is all too politicized and, incredibly, not even widely debated in the case of India.

Martin Wolf writing in the Financial Times last week made the valid point that for India to spend more on fuel subsidies than education is scandalous. I agree with that view, and indeed highlighted the wrong policy priorities in India in articles such as The jihadi ate my homework (Asia Times Online, February 24, 2007). Fuel subsidies are meant to benefit the poor in India, but actually are designed to keep political lobbyists from the transportation and manufacturing industries happy enough to keep funding the current political parties. That no Indian media highlights this unholy nexus is by itself a scandal.

A country with an average population age of 25 is actually quite a scary place because a failure to provide youth with the right access to education and opportunities would create the kind of downward spirals that are becoming all too common in Arab countries. (See Love your children, those little terrors Asia Times Online, November 4, 2006.)

This is what India faces, especially with respect to its urban populations, whose access to schools is poor and even then they are confronted with a quality of education that is questionable even for the middle classes. In turn, this lack of government-mandated education has hit specific groups like Muslims quite hard, effectively forcing their children into religious education that creates people completely unsuited for a modernizing economy.

Another aspect of government spending that Indian financial media haven’t quite cottoned onto is the fertilizer subsidies that are seen as pro-poor (that is, supporting subsistence farmers), but actually benefit only large farms in the north of the country. Once again, the fear of food price inflation encourages the government to maintain such subsidies, quite ignoring the effects on the quality of fertilizers. In other words, neither producers nor consumers in that industry have any incentive to demand quality or price improvements.

Nuclear power

The last bit of political football that needs a mention here is the goings on in nuclear power. You would think that a country that faces acute power shortages already and is over-dependent on polluting coal and gas-fired power plants would get ready some options on the alternative energy side.

As I wrote previously (Who gives a dam? Asia Times Online, January 6, 2007 ) , the plural political culture of India has created extraordinary challenges to development.

Hydroelectric projects take too long to come to fruition while challenges with nuclear power are already well known. The one strong initiative that India had on the nuclear power side was the agreement with the United States that would have opened up the route to accessing modern nuclear power plants with reduced quality and safety concerns.

This deal has been opposed by the country’s communist parties, who object to anything involving the US, even if that comes at massive costs to India itself. Then again, India’s communists actually pledge their allegiance to Mao and Stalin, and therefore aren’t the ones to think of the country’s national interests in any event.

So what do you call a government that is running up massive deficits while spending on all the wrong things, ignoring the most pressing strategic priorities and that spends all its time wrangling on matters of little import for the country’s future? A few words do spring to mind, but seeing as this is a family publication, I am forced to refrain from using any such language.

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