Pranab's Dilemma

It is often said that good politics and good economics cannot go hand in hand.  Pranab Mukherjee, the veteran Bengali politician who is burdened with the post of the Finance Minister of India has found himself in a hard position. Now its time for him to make tough decisions, to choose national interest over his Party's votes.

protesters burning PM Dr. Manmohan Singh's photo

The recent hike in the price of petrol (gasoline) created big turmoil all over the country. It was the biggest hike ever recorded in the history.  For the common man, who is already crippled with high inflation the decision was like adding oil to the fire. If you ask me the hike was inevitable.Forcing the oil companies to sell the petrol under priced  lead to an accumulation of 130,000 crore Rupees debt by the oil companies. After all how long could they go on borrowing to do a loss making business. And when recently the Rupee depreciated drastically against Dollar the government was forced to hike prices. The government is trying hard to reduce the fiscal deficit. So they cannot spend a big sum subsidizing petrol. Soon after the petrol hike the Finance Minister justified: 'Petrol is a deregulated commodity.'

I am not saying that the government is innocent. Under the current situation the government can't do anything but to hike prices. But the reason why we reached at this position is because of the inability of the government. We should not blame blame the government for the rice in petrol prices but for a weak Rupee. India is Importing more than she is exporting. And 70% of our import bill is crude oil. So a weak Rupee means we need to pay more on basic commodities and that means higher inflation.

Depreciating Rupee

So what really made the Rupee to depreciate so drastically. The source of the problem began last year when we had two digit inflation and the government was struggling to contain it. Because of the high inflation the Reserve Bank of India (RBI) was forced raise the key interest rates. But when credit became expensive and there was no liquidity, the nation's industrial growth started to slow down. This coupled with policy paralysis  at the center, rising fiscal deficit and retrospective tax amendments lead to lack of investor confidence in India. And above all, in spite of the GDP growth slipping to 6.9% last quarter,the government failed to arrest the inflation. Under these circumstances we were expecting an innovative budget from the FM in march. But after all he was a politician and he had to please his voters and allies. As the situation deteriorated credit rating agencies started going negative on India. And as a result Foreign Institutional Investments(FIIs) started to pull their money off Indian stocks and bonds in a frenzy. and the Rupee was down almost 10% in 2 weeks.

So What Now?

The immediate options that the government has to bring back Rupee are limited. The RBI has almost 300 billion $ as Forex reserve. They could sell off some of those dollars in the market to bring Rupee up. But RBI already tried this out a couple of times and the effect fizzled out in a matter of hours. So intervening the market is only a temporary option. The core problem which is creating this fall is the current account deficit. For India a country which is having trade deficit the best way to bring down current account deficit is to bring in more Foreign Direct Investment (FDI). unlike FIIs which gets invested in stocks and bonds. Investors can't pull their money out of the country so quickly. It creates real growth and employment.And moreover some big MNCs are impatient to get into the rapidly growing Indian market. Last year when the government pushed for 100% FDI in multi-branded retail the opposition, and even its own allies opposed the move strongly. The government was forced to withdraw the bill. The government can't wait much longer. They should consider this crisis as an opportunity and bite the bullet. The government should immediately clear the 100% FDI in multi branded retail and 49% FDI in aviation  sector. This would result in

1. Appreciation of Rupee because of foreign inflows.
2.  Easing Inflation because of improved supply chain in retail.
3.  Farmers benefiting because of  good price for their products. 
4. Much needed investments in Aviation could save the the imploding companies like Kingfisher and AirIndia.
5. Most importantly the GDP growth would accelerate another 2% to 8-9%.

So its time that our beloved FM Pranab Mukherjee stops pondering over his dilemma and bite the bullet to push for the second wave of reforms for the economy. This may result in a failure of Congress Party in the next elections. But After a decade he will be remembered for the bold decisions he had taken .