At the G-20 Summit held last month, Prime Minister Manmohan Singh generously pledged $10 billion to the IMF’s ‘financial firewall’ to help the debt-wrecked 17-nation Eurozone, so that the “faltering world economy is protected against the spread of any financial contagion”. One can appreciate the sense of great importance that India would have felt by displaying such spontaneous magnanimity at such a prestigious global forum. After all, western nations lose no opportunity to give us an occasional condescending pat for offering our markets to their MNCs and keep reminding us of our increasing importance in the global financial system.
To appreciate the irony of this, one should understand the genesis of the financial crisis in the Eurozone. At the time of creation of the European Union, those who joined it vowed to limit their respective fiscal deficits to less than 3 per cent of GDP and contain their overall debt liabilities within reasonable limits. Over the years, the governments of several of these countries started violating this norm to accommodate their individual acts of profligacy. The lifestyles in these countries continue to be highly resource intensive and luxurious compared to the developing world.
Meanwhile, walking in the footsteps of their counterparts in the US, European banks developed an irresistible appetite for high-profit, quick-return lending and indulged in giving loans to real estate developers and those in the business of speculation in financial derivatives, knowing well that such businesses could be highly volatile. The universal norm these days in banking seems to be to lend more to those who are imprudent, by restructuring the earlier loans that have turned sour. This is what exactly happened in Europe. While the debt obligations of the governments steadily increased, the debt obligations of the private corporates sky-rocketed. It is such all round financial imprudence that stood at the root of the Eurozone financial crisis. In this globalised world, imprudence is like a contagion that spreads fast and wide, whereas prudence seems to be on the backfoot.
In the US, in a somewhat similar situation, when major banks sank into a serious financial crisis in 2008, the government injected $700 billion in the name of Troubled Assets Relief Programme (TARP) to help them stand on their feet. It has certainly helped improve the balance sheets of the banks, though the banks have shown no inclination to give up their imprudent ways. The outcome of the IMF relief package in the case of the Eurozone may not be far different from this. Against this background, by pledging a large sum to the IMF, India has actually agreed to subsidise Eurozone’s extravagance and imprudence!
The amount now pledged by India for the IMF’s firewall is miniscule compared to the total war chest of $450 billion but it is quite significant compared to the public expenditure it incurs at home on such essential activities as health, school education and food security. One can get a rough picture of this by comparing the figures. The pledged amount of $10 billion, at today’s exchange rate, is twice the expenditure incurred in 2011-12 by the Union government on health, 35 per cent more than the expenditure on school education and 75 per cent of the expenditure grudgingly incurred on food security for the poor. Every third person in India lives below the poverty line and the majority of the population are undernourished. Malnutrition, poor health and inadequate opportunities for education are the direct attributes of poverty in India. To tackle poverty, one of the measures required to be taken is to enlarge the public distribution system (PDS). This will imply the expenditure on PDS being doubled. Arguing that PDS subsidies are economically undesirable and pleading that the funds available in the budget are far too scarce, the UPA government has chosen not to expand the scope of PDS even though universal access to nutritional food is guaranteed in the Constitution.
Since it is the Eurozone’s fiscal problem we are trying to solve, we should also do some introspection on how prudent we have been on the domestic front.
Our own Fiscal Responsibility and Budget Management Act of 2003 required the government to bring down the fiscal deficit (FD) below 3 per cent of GDP over a three-year timespan but, instead of falling in line with it, the UPA government relaxed the norm year after year to increase the FD to around 6 per cent. More than 75 per cent of the annual borrowings of the government go into debt redemption alone; a painful reminder to us that we are caught in a virtual debt trap. With NPAs mounting, as a result of bad loans given to real estate developers, merchant power promoters, franchisees of captive coal blocks, and having indulged in speculative derivative transactions, our banks are trying to window dress their balance sheets by ‘restructuring’ the old debt with new debt, thereby paving the way for a domestic bank crisis soon. No doubt, the government will then be forced to inject further equity capital into the banking system, casting a heavy burden on the tax payer for a sin that is not committed by him or her.
By pledging a substantial amount to the IMF, the government hopes that the IMF will contain the ‘contagion’ effect of the Eurozone crisis affecting the global financial system that encompasses our own financial sector to some extent. Knowing the global appetite for fiscal profligacy, one cannot be sure that IMF will succeed in this. Relief packages usually whet the appetite for further profligacy.
What remains worrisome in our case is that a more virulent crisis is brewing in our own financial system and the government seems to be somewhat nonchalant in dealing with it. Greater fiscal prudence at home would have created more space for the government to allocate adequate funds to be spent on food security, public healthcare and education. Such spending, if properly targeted, will not only amount to good politics but also good economics.
E A S Sarma, a former Union power secretary, is currently based at Visakhapatnam.