The government says it wants lower interest rates, and then decides to squeeze short-term liquidity to strengthen the rupee. Net result: interest rates have shot up so fast, this is sure to kill whatever growth there is.
The UPA government's credibility on the economy has fallen so low that it ends up achieving the exact opposite of what it intends.
It opened up FDI in many sectors, but nothing is coming in. It shackled gold and told us it was a worthless metal. Gold prices have just shot past Rs 31,000 per 10 gm. This has reassured investors that there is real value in gold and the government is talking nonsense. The Reserve Bank placed new curbs on external remittances to shore up the rupee, but the currency is sinking further. P Chidambaram told us the other day that the 770-point fall in the Sensex last Friday was because our markets were closed for I-Day. Well, on Monday the index fell by a further 290 points to tell him that he is wrong.
The government says it wants lower interest rates, and then decides to squeeze short-term liquidity to strengthen the rupee. Net result: interest rates have shot up so fast, this is sure to kill whatever growth there is. Money market instruments are earning over 11 percent, and five- and 10-year bonds are reporting yields of 9.5 percent to 9.25 percent respectively. These rates are higher than what the State Bank pays its depositors right now. Worse, when interest rates rise, the value of bonds held by banks in their portfolios falls-which means banks are starting at further losses beyond bad loans. They will need even more capital from the government-just when it is short of money.
If the UPA has still not got the message, here it is: the market does not believe you anymore. The more you try to talk up the market, and try to prove you are doing "reforms", the less the market is willing to believe you. This is because the market knows that in an election year, the damaging bits of policy-involving food security and low energy prices-will be in place till the next government comes over.
The market also knows that the real economy is hurting-and hurting badly. In fact, the drop in the Sensex grossly understates the problems faced by corporate India. Since the start of the year, the Sensex fell 5.76 percent, but guess how badly the capital good index fared: down 34 percent. The BSE Bankex fell 27 percent and the Midcap Index 25 percent.
In short, the headline figures for the crash in market indices underestimate the carnage in stocks, and the destruction of investor wealth. The Sensex crash relates only to the best of the best in India. The small and medium companies-the companies that actually create jobs-are simply bleeding profusely. They are probably laying off people and spreading the gloom even more.
Is there anything the government can do to make the markets believe it is up to something good?
Yes, it can do three things-none of which appears politically feasible right now.
First, it can stop trying to prop up the rupee. Once the market knows this will happen, the rupee will find its own level. Even if it falls to 70 to the dollar, it will rebound, since at these levels, there is good value in India. Exports will boom, and imports will be crunched – which is exactly what is required to get the current account deficit down, and stabilise the rupee. If the rupee doesn’t fall now, it will stay weak for prolonged periods of time, and damage the recovery of the economy.
Second, it has to raise diesel prices now-and steeply. Given the rupee's current level and global crude prices, the loss per litre is Rs 10.22-even higher than what it was when slow monthly increases in market pricing were announced. If diesel prices were to be raised in just one or two steps this month and the next, and prices fully deregulated thereafter, the markets would take the government very seriously. Despite the obvious hit growth will take, the markets will see decisive action in this and slow down the rate of decline. The fiscal deficit would crumble, and FIIs will return to the markets. Growth will rebound once the economy adjusts to the new rates. After the fiscal deficit is fixed, interest rates can be easily brought down to levels where growth can resume. If it does not do so, and the US and eurozone economies revive, where do you think crude prices will be? Higher or lower? Time is running out for the UPA on diesel.
Third, the government could announce that it will implement the Food Security Bill only after the fiscal deficit reaches-say-percent of GDP. It can adopt the bill with this proviso, or mandate a coverage that includes only the 22 percent of people below the poverty line (and not 67 percent of the population). This political sacrifice by the UPA can be the most powerful message it can send to the markets of honest intent.
But will the UPA do any of these things? The market does not believe so, and this is why it is rejecting every half-measure of reform with the disdain it deserves.
Granted, no government in an election year would want to take such drastic steps. Then what is the option?
There is one Brahmastra still available to the government: call an early election. If this happens, the market will hold steady as it believes that change is at hand. But this is precisely why the UPA may want to do more damage and cling to power, even if it sends the rupee down further, gold up further, and interest rates higher.
The choice before the UPA is clear: self-preservation or economic mayhem.
The writer is editor-in-chief, digital and publishing, Network18 Group.