Economic crisis in India

There is more bad news for the Indian economy. The deepening banking sector crisis is the latest pointer to economic mismanagement. The global rating agency Moody's has downgraded the outlook for 15 Indian banks from stable to negative. It further states that the asset quality of various lenders could worsen in the next 18 months owing to high inflationary pressure, monetary tightening and interest rates.

This is a clear warning to the managers of the economy to initiate steps for managing it better so that inflationary pressure could be brought down and more money could flow into the legal instruments.

However, a day later, the S&P came out with a rating that says that the banking sector remains "stable". At the same time, it stated that India has a "high risk" in "credit risk in the economy" - a statement that is not different from Moody's. The S&P's statements though diplomatically worded are not very different from Moody's assessment. The 15 commercial banks account for about 66 per cent of the system's total assets as of March 2011.

The basic question the two global rating agencies are raising is that of the Indian banking sector's viability. This apart there is an indirect reflection on its ethics. So far, the banking sector in the country has withstood some of the worst economic crisis, including the Harshad Mehta stock scam and the UTI scam.  However, during those days nobody raised the question of the banks' viability as is being raised now. 

Clearly, a viable banking sector reflects the quality and safety of assets that people entrust with it. Its erosion has grave consequences. The estimated banking penetration in India is about 45 per cent among middle and high income groups and less than 5 per cent among the low income segment.

Expanding the reach of banking services is critical for tapping the country's savings and investments. Microfinance institutions have been partly effective in tapping rural savings, 41 per cent of which are held as cash according to the National Council of Applied Economic Research (NCAER) estimates. All this   indicates that either the people do not have access to banking or they do not trust the system.

Importantly, there are a few aspects that have been affecting the banking sector. Locking of bank's money -- about Rs 300,000 crore -- in infrastructure, particularly power, projects has dwindled its asset strength. Additionally, the small savings is not attracting money. In the first three months of this fiscal alone, it came down by a whopping Rs 22,000 crore. Worse is the linking of bank deposits with the Government's tax system - a measure to check so-called tax evasion or creation of black money. Sadly, this is one of the most ill-advised moves.

Not only has the Government failed to bring in reforms and structural changes in the tax system, it has forgotten that tax had evolved as a voluntary contribution for the development of society. Regrettably, the bureaucracy has made it oppressive and criminalised it too. This, notwithstanding that a default in tax payment does not amount to a criminal offence, leave aside perhaps even an offence!

However, this is how it was conceived and the bank deposits were brought under the ambit of income-tax net. Some considered it a prudent move. But what the Government did not realise was that it was doubly taxing the same income. Undeniably, it is an imprudent move as many of the small depositors and even the business class prefer to keep their money in other instruments or say lockers to prevent erosion of their assets.

This has caused a massive flight of capital from the banking sector. And, the Government has been repeatedly failing to achieve what it desires i.e. bringing out all the money in the legally transacted system. Recall that in the late 90s, following a few voluntary disclosures and some easing of rules, the banks had witnessed an increase in their deposits.

But as bank depositors were being chased by the tax system, many with so-called black money preferred to withdraw their cash. Mores so, as there was a lingering fear that the taxation department would seize their accounts and put their hard-earned money out of reach. Despite several pleas by the people and even bankers, the Government has yet to amend its rules and allow the banking sector a free path for growth.

The nationalised bankers committed yet another blunder. They hiked the cost of their services exorbitantly and introduced imprudent practices. Take the case of a bank draft. It is issued at a charge that has almost trebled in the last ten years. This apart, earlier there was no charge on cancellation, but now say a Rs 100 worth of draft would invoke a cancellation penalty of Rs 80. Who would like to use such usurious system?

The latest rule for reducing the term of validity of cheques to three months instead of six is another blunder. If the Government wants the banks to survive, it must remove all such clauses that impact their functioning. Let the people put money in banks and help the system grow, rather than flee from them A few dimes of tax are preferred as forgone instead of losing thousands of crores of deposits.

The tax deduction at source (TDS) on bank deposits, which is a double penalty on the depositors, must also be done away. This would open up channels for flow of deposits and as a result, the Government would not have to recapitalise the ailing banks to the extent of Rs 450,000 crore. This apart, the large corporates, would be encouraged to leave their deposits in the bank and not seek credit as they now do because of the TDS. Worse, they default on the payments and thus force the Government to bail out the banks, by utilising the tax payers' money. 

   

A question which also arises is: What is the harm if black money resuscitates the system? The so-called bad money, much of it with the farming class and corporate, can be used for a good cause. Why can't the Government rethink its economic strategies?

It also needs to reopen discussion on Direct Tax Code (DTC) to bring down the tax rates and ease rules. It should realise that its fiscal deficit has not and cannot be met by high tax rates. Instead, a lower tax rate with bigger contribution from a larger number of people could do wonders.

Clearly, banks should not become victim of odd policies. At the same time, they need to rethink their strategy and reduce the high user charges. Parallel systems develop as charges rise and if they do not act prudently, it would only strengthen the latter. At the end, Moody's may have the last laugh.  

Politics of Economics

Inflation, it is said, is the bane of the common man today. Inflation is basically the incremental amount you need to pay to procure the same set of goods and services that you would have procured cheaper say a year, two years or even a decade earlier. Political parties, especially in the opposition too are experiencing inflation - albeit of a different kind. With the same formula and effort of the last decade, they find that their returns are diminishing; their space is shrinking. The driver of this new inflation is the Congress leadership team, which is silently changing the rules of the game.

Since India's economic liberalisation began in 1991 the social segment that has seen the greatest opportunity for growth is the lower middle class and the middle class. Their dynamic growth has meant that this segment has a continuously growing and changing list of aspirations. This class is the bhadralok that influences the opinion of many vocal sections of the society. V.P. Singh had cast his charm on them in the late 80s and the BJP in the 90s. The combine of Manmohan Singh and Sonia Gandhi has attempted to neutralise this phenomenon with a conscious effort to reconvert this nomadic tribe of voters to the Congress fold.

The 2009 election threw a decisive verdict in favour of the Congress led-UPA. The undercurrent was however to return to one of the old governing principles of Indian democracy - a strong Centre led by a strong centrist party. While our Constitution enshrines the Centre with greater powers, coalition politics in the last one and a half decades ensured that ruling parties at the Centre left many crucial portfolios and policy making roles to regional allies, who often did not rise above parochial interests.

The mandate for the BJP in 1998, 1999 was also essentially for a stronger Centre, but the party could not seize the opportunity. On the contrary the party went for a blind pursuit of allies, creating a government with a weak Centre and often surrendering crucial portfolios to its allies. A Congress party with only 145 seats in '04 ensured that the defence minister was from their party, while the BJP with 182 seats in '98 and '99 could not do so. The pursuit of power thus sometimes dilutes a focus on policy and governance that a strong Centre can give.

The Sonia-Manmohan combine has attempted to solve this dichotomy by uncoupling the process of creating a stable party and government and the process of creating a policy environment. Sonia and Rahul Gandhi focused exclusively on strengthening the party apparatus while the administration has been left to a policy-driven management which used the growing clout of the party to shape decisions. The BJP did the opposite; it used its growing power to attract allies that impacted its base and did not find means to increase its hold over policy-making.

An ability to enforce policy consensus while strengthening the party organisation is a combination that can prove lethal for any opposition. While the Congress does have a focus on Bharat Nirman, the fact is that in an economy where the share of agriculture is shrinking, the party has turned its attention to urban and semi-urban population of India. The two ministries that directly impact the growing urban and semi urban population are the Urban Development Ministry and the Human Resources Development Ministry. Both have made the right noises since the government came to power. Replacing old pipelines, providing new sleek buses, providing assistance for building flyovers, creating new universities and scrapping board examinations are some of those. The new year will see a whole host of measures such as the new tax code, converting the bill for Equal opportunities Commission into legislation and the possible passage of the judicial accountability bill. Several initiatives taken by the government such as the unique identity mission will have long-term impacts and help the ruling party strengthen its hold over the urban and rural poor alike. The Food Security bill is another example.

Politically the Bihar election is expected to help the Congress party consolidate its position as a kingmaker. The party came third in several seats in the recently concluded by polls in Bihar. Importantly, many backward class leaders of smaller parties like the LJP joined the party strengthening it further. This would enable the Congress party to cross into a respectable 20 to 30-seat tally from the current single digit score. With greater numbers on its side the Congress party could look to wean the JD (U) from the NDA and whittle the size of the NDA further. The Congress party is likely to work hard towards strengthening its position in the state of Tamil Nadu - the Youth Congress saw its enrolment drive lead to an all time high number of 13 lakh new enrolments. This is another state where the Congress will drive a tough bargain with an existing ally.

In the '90s, P.V. Narasimha Rao presided over a declining Congress and that offered ready space for a host of opposition parties. Now, they will have to battle hard for that very space. Inflation!