People's Democracy

(Weekly Organ of the Communist Party of India (Marxist)


No. 27

July 08, 2012

India’s Economic Travails


Prabhat Patnaik


THE Indian economy is currently witnessing a mix of illnesses: a slowdown of economic growth, high inflation, a widening of the current account deficit and a depreciation of the rupee.  Neo-liberal economists who have a single-point explanation for all economic ills, viz fiscal profligacy, naturally attribute India’s current economic woes too to this factor.


Their argument runs as follows: since any widening of the current account deficit indicates that the country is absorbing more goods domestically than it produces, this holds true for contemporary India as well. The reason we are absorbing more goods than we produce is that the government, inter alia, is living beyond its means, a fact that expresses itself in a larger fiscal deficit. A larger fiscal deficit, resulting in excess aggregate demand, causes both high inflation and a wider current account deficit; and since this wider current account deficit cannot be covered adequately through the flow of foreign capital, the rupee is depreciating. Hence the root cause of the country’s economic travails is excessive domestic absorption, for which the large fiscal deficit must be held primarily responsible. The cure for our predicament, it follows, lies in cutting back subsidies, making the public distribution system (PDS) more targeted, and so on.




This argument is wrong for a simple reason. If the country was experiencing excess aggregate demand, then there is no reason for growth to slow down. The fact that a wider current deficit, high inflation and a depreciating rupee, are also accompanied by a slow-down in economic growth, indeed a virtual industrial stagnation, and that too at a time when the depreciating rupee should be making domestic goods relatively cheaper compared to imports, suggests that the problem is not of excessive aggregate demand. Indeed there is a deficient aggregate demand for domestic goods which underlies the tendency towards stagnation of the economy.


But why should such a situation of deficient aggregate demand arise? The reason lies in the impact of the world capitalist crisis, which is felt in two ways. First, the overall slowdown in the world economy has affected our exports, and hence aggregate demand, of which exports are a component. And secondly, the inflows of finance capital into the Indian economy which had sustained a domestic credit-sustained bubble, has dried up, because inter alia of the Eurozone crisis (which has resulted in a flight to the safety of the US dollar); and this, apart from its impact on the foreign exchange market (on which more later), has led to a collapse of the bubble, which the Vajpayee and Manmohan Singh governments were so proudly celebrating.


A simple arithmetical example can clarify the argument. Suppose in an economy exports are 100, and domestic absorption (consisting of private consumption, private investment and government expenditure) is 600, of which government expenditure alone is 100; and suppose imports are always a quarter of domestic absorption. Then the country will have imports worth 150 and a current account deficit (assumed for simplicity to be synonymous with the trade deficit) of 50. Its GDP will be 550 = (600 + 100 – 150); and the current deficit of 50 can be seen alternatively as simply the difference between domestic absorption of 600 and domestic output of 550. If tax revenue is 14 per cent of GDP, then it would be 77; the fiscal deficit will be 23 = (100 – 77).


Now suppose because of the world crisis export demand falls by 40 per cent, and exports become only 60. And suppose there is a contraction in domestic absorption in response to this, not to the same extent but by 10 per cent. Then domestic absorption becomes 540 = (600 × [1 – 10 per cent]), imports become 135 (a quarter of domestic absorption), and output becomes 465 = (540 + 60 – 135). Government expenditure which has also contracted by 10 per cent (by assumption) is now 90, while government revenue is 65.1 = (14 per cent of 465). The fiscal deficit now is 25 = (90 – 65); it has widened from 23 to 25. And the current account deficit is now equal to 75 = (135 – 60). It too has widened from 50 to 75. If foreign capital inflows are insufficient to cover this wider current deficit, and indeed if these inflows themselves have undergone a decline because of the world crisis, then the rupee will depreciate, as is happening.


It follows that a wider fiscal deficit, a wider current account deficit, and a declining rupee can arise as a consequence of the world capitalist crisis; they are not necessarily a reflection of domestic excess demand. The fact that a wider current account deficit reflects an excess of domestic absorption over domestic output, which is a truism, does not mean that there is an excess demand pressure in the economy; it may well mean that domestic output is falling faster than domestic absorption because of declining external demand, caused by the world crisis. And this alone can explain a tendency towards stagnation, such as is visible in India today, coexisting with widening current and fiscal deficits.


Of course in the example above we have put the entire onus of explanation for the current predicament of the economy on the impact of the world crisis via exports alone. As a matter of fact, the collapse of the financial-inflow-sustained bubble which underlay the high growth of the recent period (“India shining”) has also played its part. The point of the arithmetical example was merely to show that the current travails of the Indian economy arise not from excess demand pressures, but from precisely the opposite source, namely a tendency towards stagnation associated with the crisis of world capitalism, with which the neo-liberal regime has firmly linked our domestic economy.




But then, it may be asked, what about the inflation occurring in the economy? Is that not symptomatic of excess demand pressures? Inflationary pressures at present are not unique to the Indian economy; they are a world-wide phenomenon. They arise, on the one hand, from a decline in per capita global foodgrains availability, because of the ubiquitous assault on petty production by corporate and financial interests, and also of the substantial diversion of grains towards bio-fuels since the days of the Bush administration; they also arise, on the other hand, from rampant speculation in foodgrains and oil markets, where any bullishness in either market manifests itself as a rise in food prices. Both these causes are linked in turn to the hegemony of finance in contemporary capitalism. Indian food prices therefore are not to be explained in terms of excess demand pressures within India; it is global excess demand for foodgrains causing global food price inflation, which is being imported into the Indian economy. The neo-liberal policies of the Indian government, instead of insulating the people from the inflationary squeeze on their living standards, through a universal PDS and an appropriate level of government subsidy, merely import inflation from the world economy, precisely because of their fiscal conservatism.


It is not fiscal profligacy that is causing inflation in India by generating excess demand pressures; on the contrary it is fiscal conservatism that is allowing inflation imported from the world economy to erode into the people’s living standards. And this inflation is further accentuated by the declining rupee which raises import costs, especially of oil; these higher import costs, under the current regime, necessarily get passed on to the people, and, in addition, have cascading effects on other prices. Reducing the fiscal deficit under the present circumstances by cutting back on food and other subsidies, far from reducing inflation, will merely expose the people further to the debilitating effects of this process that will continue with the same pace as before, and that is actually an additional factor, besides the export drop and the collapse of the bubble, contributing to reduced non-food demand in the economy and hence to the tendency towards stagnation.


If the widening current deficit was caused by domestic excess demand then it should normally be the case that export growth should fall and import growth should rise compared to earlier. On the other hand, if the current deficit was caused by the world crisis then there should be a fall in export demand together with some fall, though to a lesser extent, in import demand, exactly as suggested by the above arithmetical example. Figures actually bear this out. In fiscal year 2011-12, India’s exports in US dollars rose by 20.9 per cent over the previous year, compared to 40.5 per cent in 2010-11; the corresponding figures for non-POL import increases were 26.2 per cent and 31.1 per cent respectively. (The oil import figures, influenced strongly by oil prices, follow a trajectory not necessarily linked to domestic demand). With non-POL import growth figures declining compared to the previous year, domestic excess demand can scarcely be adduced as the cause of the widening current account deficit.




The inner circle of economists in the Manmohan Singh government, even though they may, for reasons we discuss later, make public use of this excess demand argument, are unlikely to be naïve enough to believe in it. They must know that the current travails of the Indian economy arise from the reduced world demand for India’s exports, coupled with, in particular, the collapse of the bubble that had underlain the earlier high growth. They must also know that within the neo-liberal paradigm, the only way the economy can overcome its present travails is by once more attracting large amounts of financial inflows. To induce speculators to move funds to India, some gesture, some signal on the part of the government is needed, such as the opening up of multi-brand retail to FDI, or introducing “labour market flexibility,” or curtailing the fiscal deficit and showing the government’s commitment both to “sound finance” and to cuts in welfare payments and subsidies. All these, even if they succeed in reviving high growth and managing the balance of payments, will hurt the people immensely and will be extremely unpopular measures. To justify such measures, all sorts of spurious arguments will be advanced. And one spurious argument that is likely to be advanced in order to cut down on subsidies and to reduce the fiscal deficit is that the current situation is a result of domestic excess demand!


All these blandishments, however, are unlikely to succeed in attracting much financial inflows at the current juncture. But this only means two things: first, any effort to overcome the current economic predicament within the neo-liberal paradigm, can only be at the expense of the people, exactly as is the case in southern Europe; and secondly, even such effort is unlikely to bear much fruit, so that the current predicament will continue despite the adoption of such measures at the expense of the people. This however is merely indicative of the fact that, even in economies like India, which were held up as “triumphs” of neo-liberalism, it has come to the end of its tether. Let us hope, in Marx’s words, that this would “drum dialectics” into the heads of the affluent urban upper middle class that has so far been such a strong votary of neo-liberalism.