The Narendra Modi government tabled the White Paper on Indian economy that sheds light on the Congress-led UPA Government’s economic legacy, which can be characterized as a period of missed opportunities for growth, despite inheriting a thriving economy.
The White Paper specifically emphasizes the systematic degradation of the Indian banking system and public finance.
The macroeconomic foundations of a government play a pivotal role in shaping the economic landscape of a country. Fiscal policy, centered on taxation and public spending, strives to strike a balance for economic stability and growth. Monetary policy, under the purview of the central bank, manages money supply and interest rates to influence inflation and overall economic activity.
Government policies on external trade, exchange rates, inflation control, public debt, labor markets, infrastructure, social programs, and financial system regulation collectively contribute to the economic well-being and resilience of the nation. Political stability and effective governance act as cornerstones, fostering confidence among investors and citizens alike. Together, these foundations define a country’s economic environment, determining its capacity for sustainable development and its ability to navigate challenges in the global economy.
Foundations Of Macroeconomic Governance And Consequences Of Neglect
When a government sacrifices all these measures for self-serving purposes and employs appeasement strategies with the sole objective of retaining power, regardless of the well-being of citizens or the nation, what are the consequences?
As per the 2003-04 Economic Survey, the UPA government inherited a thriving economy, providing substantial opportunities to enhance growth momentum while ensuring macroeconomic stability. However, during its ten-year tenure, there was a noticeable downturn in performance. In 2004, when the UPA government initiated its term, the economic landscape exhibited:
1. An overall economic growth of 8%.
2. Expansion of the industry and service sectors by over 7% each.
3. The agriculture sector registering a growth rate of 9%.
Despite the rapid economic growth observed between 2004 and 2008, attributed to NDA reforms and favorable global conditions during the 2002-07 economic boom, the UPA government failed to seize the opportunity to fortify the government’s budget position and invest in future infrastructure. The subsequent global financial crisis (GFC) of 2008, however, did not impact India.
Unrealized Potential Amid Economic Boom And Inflation Woes
An economic signifies robust growth characterized by increased economic activities, job creation, and rising incomes, ultimately enhancing living standards. In the context of a booming economy, when industry, agriculture, and service sectors contribute to an 8% growth, the outcomes encompass heightened innovation, increased government revenues, and a favorable impact on the trade balance. The sector’s strength attracts investments, encourages economic diversification, and facilitates social and infrastructure development. Overall, the robust performance enhances global competitiveness, contributing significantly to the nation’s prosperity and development, notwithstanding its failure to capitalize in the financial year 2004.
Additionally, the UPA government compromised price stability, witnessing a surge in inflation between 2009 and 2014. With high fiscal deficits persisting for six years, the average annual inflation rate reached double digits, imposing hardships on ordinary and poorer households.
For any developing economy price stability is crucial for a country due to several reasons. It fosters consumer confidence by allowing informed purchasing decisions and budget planning. Economic predictability is enhanced, encouraging investment and long-term planning for businesses. Additionally, stable prices aid in maintaining the purchasing power of a currency, reducing uncertainty, contributing to equitable income distribution, and ensuring social and political stability. Overall, price stability forms a foundation for economic health, growth, and prosperity, often targeted by central banks through monetary policy. Inflation is the rate at which the general level of prices for goods and services rises, leading to a decrease in the purchasing power of a currency. Moderate inflation is often considered normal for a growing economy, but high or hyperinflation can have detrimental effects, eroding savings, distorting economic decisions, and impacting overall economic stability. Fiscal deficit is a key indicator that measures the government’s financial health with the difference between the total government revenue and its total expenditure. It represents the amount of money the government needs to borrow to meet its expenses when its expenditures exceed the revenue it generates. A high fiscal deficit relative to GDP indicates that the government is spending beyond its means, potentially leading to increased borrowing and debt accumulation leading to economic disablement.
Impact Of UPA’s Fiscal Policies, Banking System Deterioration, And External Commercial Borrowing Decline
Banking systems are the backbone of any economy they help sustain an economy but Bad debts and gross non-performing assets (NPAs) weaken a country’s economy by creating a ripple effect across the financial system. When borrowers default on loans, banks and financial institutions incur losses, impacting their profitability and overall stability. Large amounts of bad debts and NPAs erode the capital base of these institutions, limiting their capacity to lend and support economic activities. This credit squeeze can impede business expansion, hinder investment, and lead to a slowdown in economic growth. Additionally, financial institutions may become more risk-averse, further restricting credit flow. The Gross Non-Performing Assets (GNPA) ratio in Public Sector Banks (PSB) rose to 12.3%n including restructured loans, due to political interference by the UPA government in commercial lending decisions of PSBs.Many problematic loans remained undisclosed, as highlighted by a Credit Suisse report in March 2014. The report revealed that the top 200 companies with an interest coverage ratio of less than one owed around ₹8.6 lakh crore to banks and nearly 44% of these loans were yet to be officially recognized as problem assets. In 2018, during a response to a Parliamentary panel, former Reserve Bank of India Governor Raghuram Rajan emphasized that a substantial number of bad loans had originated from 2006 to 2008.
The growth of external commercial borrowings (ECB) experienced a significant decline, with a compounded annual growth rate (CAGR) of 21.1% from FY04 to FY14, compared to a much lower annual rate of 4.5% in the nine years from FY14 to FY23. This decline left the economy vulnerable in 2013, leading to a sharp rise in the US dollar. The relationship between external commercial borrowing (ECB) and the rise of the US dollar is intricate, and shaped by the dynamics of international finance. As countries partake in substantial ECB, borrowing funds from foreign entities, the prevalent choice of currency is often the US dollar, given its status as a global reserve currency. This borrowing contributes to an augmented demand for the US dollar, leading to its appreciation against other currencies interest rates set by the US Federal Reserve, market perceptions of the US dollar as a safe-haven currency, and the broader implications on global liquidity. Reducing the ECB was a nuanced decision due to its potential impact on the financial flexibility of businesses and governments because it serves as a vital avenue for accessing funds from global financial markets. A significant reduction signals constraints in obtaining foreign capital, limiting financing options for crucial projects. This limitation impede infrastructure development, slowing economic progress and hindering a country’s ability to meet its developmental goals. Moreover, a sudden decline in the ECB indicates a loss of confidence in a nation’s economic stability, possibly leading to currency depreciation, increased inflation, and disruptions in international trade and investment relationships.
Depreciation of Rupee And Declining Foreign Exchange Reserves
The UPA government’s compromise on external and macroeconomic stability resulted in a substantial depreciation of the Indian rupee, plummeting by 36% against the US dollar between 2011 and 2013. The depreciation of the Indian rupee refers to a decline in the value of the rupee in the foreign exchange market concerning other currencies. It means that the rupee’s exchange rate has decreased, and it now takes more rupees to purchase a unit of another currency an excessive or rapid depreciation may lead to increased import costs, inflationary pressures, and challenges for businesses and consumers who rely on imported goods and services.
The UPA government faced a significant decline in foreign exchange reserves, dropping from approximately USD 294 billion in July 2011 to around USD 256 billion in August 2013. By the end of September 2013, the reserves were only sufficient to cover a little over 6 months of imports. A decline in foreign exchange reserves is detrimental for a developing country due to potential impacts on currency stability, hindered debt servicing capabilities, and reduced import capacity leading to supply shortages and inflation, including balance of payments issues. Governments and central banks strive to maintain optimal reserves to ensure economic stability, establishing sufficient reserves to withstand external shock but they failed to do so.
UPA’s Response To Global Financial Crisis:
In response to this economic challenge, the Reserve Bank of India (RBI) initiated a special window for Foreign Currency Non-Resident (FCNR(B)) deposits to attract USD deposits at a high premium in August-September 2013. Despite being a costly solution reminiscent of the 1991 Balance of Payments crisis, the amount raised from NRIs through FCNR(B) surpassed the 1991 IMF bailout by 12 times. The UPA government In its pursuit of sustaining high economic growth severely compromised macroeconomic foundations, marked by profound mismanagement and indifference to years of growth and investment, essential economic, social, and administrative reforms were neglected. The 2008 GFC originated in the United States, fueled by a housing bubble and the proliferation of risky subprime mortgages. Complex financial instruments like mortgage-backed securities and global interconnectedness amplified the crisis. The bankruptcy of Lehman Brothers in 2008 triggered a credit freeze, leading to a severe worldwide economic downturn and necessitating unprecedented government interventions to stabilize financial institutions and stimulate recovery but the Indian market or the government did not have a severe impact.
Spillover Effects, Economic Imbalances, Persistent Fiscal Deficits And Populist Measures
The UPA Government’s response to the 2008 Global Financial Crisis through a fiscal stimulus package, intended to mitigate spill-over effects, turned out to be more problematic than the issue it aimed to tackle. The stimulus was beyond the Union Government’s financial capacity and sustainability. While India’s growth slowed to 3.1% in FY09 during the GFC, it swiftly recovered to 7.9% in FY10, with limited impact compared to other economies.
In economics, a spillover effect, also known as a spillover or externalities, refers to the unintended impact that an economic transaction, policy, or event has on parties not directly involved. These effects can be positive or negative and extend beyond the primary participants in the activity. For example, a company investing in cleaner production methods may positively impact the surrounding environment, leading to a beneficial spill-over effect. Conversely, pollution generated by one firm affecting the health of nearby residents represents a negative spill-over effect. Understanding and managing spill-over effects are crucial for comprehensive economic analysis and policy formulation.
Despite this, the misguided stimulus persisted for six consecutive years, leading to a Gross Fiscal Deficit (GFD) to Gross Domestic Product (GDP) ratio of at least 4.5% from FY09 to FY14. The revenue deficit also surged, rising from 1.07% of GDP in FY08 to 4.6% in FY09. The Kelkar Committee for Fiscal Consolidation in FY 2012-13 highlighted risks of runaway fiscal deficits and unsustainable public debt levels. The fiscal deficit, revenue deficit, and their relationship with GDP are pivotal indicators in economic analysis, offering insights into a country’s fiscal health and government financial management. The fiscal deficit represents the government’s borrowing needs, calculated as the difference between total expenditures and revenues (excluding borrowings) reveals the extent to which the government relies on borrowing for day-to-day expenses. To counteract the impact, the UPA government issued special bonds, replacing cash subsidies, leading to increased fiscal and revenue deficits. The government’s securities grew 9.7 times in 2012-13. Capital Expenditure for public investment declined from 31% to 16%, adversely affecting infrastructure development. The economy remained supply-constrained, resulting in higher inflation, a larger current account deficit, and an overvalued currency in 2013.
In the face of supply constraints, higher inflation, a larger current account deficit, and an overvalued currency, a developing economy encounters multifaceted challenges like Limited production capabilities and inefficient supply chains that impede the availability of goods, causing increased prices and negatively impacting overall economic output. Higher production costs contribute to inflation, diminishing the purchasing power of the currency and affecting consumers’ living costs. A larger current account deficit, exacerbated by reliance on imports, strains the trade balance and foreign exchange reserves. An overvalued currency hampers export competitiveness, worsening the deficit. These factors, reflecting economic imbalances, necessitate comprehensive policy solutions to balance inflation control, boost domestic production, and manage external challenges. The consequences, including reduced living standards and potential supply shortages, highlight the urgency for structural reforms, infrastructure enhancement, and diversification to ensure sustained and balanced growth in the long run.
Finally to forget all these they resorted to short-term populist measures, as highlighted in the RBI’s report on Macroeconomic and Monetary developments in April 2009. Large unspent funds for social sector schemes hampered the effectiveness of government initiatives, with 6.4% under spending across 14 major social and rural sector ministries. Health expenditure was burdened by out-of-pocket expenses. The focus on unproductive spending allocated significant funds to consumption rather than productive investment. Initiatives like the Sixth Central Pay Commission and the Agricultural Debt Waiver and Debt Relief Scheme incurred substantial fiscal costs without yielding significant economic benefits. A World Bank Policy research working paper found no evidence of improved investment, consumption, or increased wages resulting from the debt waiver initiative. Overall, the fiscal years 2005 to 2014 witnessed excessive unproductive government borrowings, ineffective spending strategies, and revenue losses due to policy failures.
In conclusion, the UPA government’s compromises, mismanagement, and policy failures have left a lasting impact on India’s economic history, marked by missed opportunities, fiscal challenges, and a degradation of essential foundations for sustained growth and prosperity.
Thankfully, due to the good karma of our ancestors, PM Modi came to power to pull India out of the mess created by Congress.
Satheesh is a freelance writer.
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