Circa 2008 – Mr. Manmohan Singh is Prime Minister of India and having best person to be finance minister in his cabinet is unable to rein in the killer inflation. It was last year of his term in the office and in forthcoming elections Congress the ruling party was made to sit in opposition.
Circa 1995, Mr. Manmohan Singh is finance minister of largest democracy in world – India. Inspite of all the efforts and best economics background he fails to tame the rising prices and thus inflation in resilient Indian Economy. This is last year of his term in the office. Will history repeat?
It’s a question that the Congress must also be asking itself anxiously. But the fate of the country’s economy too rests on the answer. After having lived through the trauma of having to mortgage gold to fulfil debt obligations, the country had built up ample forex reserves of over $ 20 billion. The gross domestic product (GDP) growth rate, which was 1.4% in 1991-92, the year in which the Rao government was formed, had increased to 6.4% in 1994-95. This had resulted in a spurt in demand for steel, cement and other consumer items. Companies had gone for huge investment outlays to expand their production capacity.
But the euphoria didn’t last. The government was suddenly confronted with double-digit inflation – a nightmarish prospect with elections less than a year away. To contain inflation, the RBI jacked up interest rates. By 1995, financial institutions like IDBI, ICICI and IFCI were raising funds at 16% from the market and lending to corporates at 18%.
The stockmarket, which had touched an all-time high of 4,500 in June 1994, fell back to 3,300 by June 1995. Facing a bearish stockmarket and soaring interest rates, companies struggled to fund their ambitious
plans even as the money supply tap went dry. By 1997-98, economic growth fell to the much-derided ‘Hindu rate of growth’ of 4.3%. The Congress had already been defeated in general elections earlier — despite the fact that there was no oil shock. Now, 13 years on, Manmohan Singh is the prime minister. The economy is doing well, growing at 9% per annum. Forex reserves have risen to over $300 billion. But, there are troubling signs again. Inflation is once again back into double digits — the first time a new generation of investors and consumers is witnessing such a phenomenon. And the sensex, which was on a triumphant charge till January, is now beating an equally dramatic retreat. There are initial public offers worth almost Rs 1 lakh crore in the pipeline. But companies are understandably apprehensive of tapping the capital markets at this stage.
So, are we headed for a repeat of 1995? Well, in some regards, the situation is actually worse today than it was then. There’s a global slowdown, and the oil price crisis may get worse, with doomsayers darkly muttering about crude hitting $200 a barrel. Prices of food items and essential commodities like steel and cement are soaring, and show little sign of coming under control. A slowdown in economic growth is imminent, since the RBI is bound to pursue a tight money policy to combat inflation.
The saving grace is, well, savings. The savings rate in India is at a high 35%. And as interest rates rise, so will the temptation for investors to save money. At an investment capital output ratio (capital inputs required to generate 1 percentage point of output growth) of around 4, that should help the economy to sustain a growth rate of 9%. For now, consumption demand too has defied dire predictions and remained strong. So, if the global economy is able to stage a comeback, interest rates may be corrected within six months to a year. Hopefully, that will help keep the economy on track. The big question that must be worrying the government, though, is: will it be too little, too late?