October 1929? Not!

October 1929? Not!

by Subroto Roy

First published in

Business Standard, Editorial Page,

18 September 2008

Lehman Brothers filing for bankruptcy protection, Merrill Lynch taken over by Bank of America, Fannie Mae and Freddie Mac and now AIG being nationalised by the US Government, Bear Stearns getting a government bailout, many thousands of low-quality loans going bad … Does it all add up to an American financial crisis in the autumn of 2008 comparable to that in the autumn of 1929? Even Alan Greenspan himself has gone on record on TV saying it might.

 

But there are overriding differences. Most important, the American economy and the world economy are both incomparably larger today in the value of their capital stock, and there has also been enormous technological progress over eight decades. Accordingly, it would take a much vaster event than the present turbulence — say, something like an exchange of multiple nuclear warheads with Russia causing Manhattan and the City of London to be destroyed — before there was a return to something comparable to the 1929 Crash and the Great Depression that followed.

 

Besides, the roots of the crises are different. What happened back then? In 1922, the Genoa Currency Conference wanted to correct the main defect of the pre-1914 gold standard, which was freezing the price of gold while failing to stabilise the purchasing power of money. From 1922 until about 1927, Benjamin Strong of the Federal Reserve Bank of New York adopted price-stabilisation as the new American policy-objective. Britain was off the gold standard and the USA remained on it. The USA, as a major creditor nation, saw massive gold inflows which, by traditional gold standard principles, would have caused a massive inflation. Governor Strong invented the process of “sterilisation” of those gold inflows instead and thwarted the rise in domestic dollar prices of goods and services.

 

Strong’s death in 1928 threw the Federal Reserve System into conflict and intellectual confusion. Dollar stabilisation ended as a policy. Surplus bank money was created on the release of gold that had been previously sterilised.

 

The traditional balance between bulls and bears in the stock-market was upset. Normally, every seller of stock is a bear and every buyer a bull. Now, amateur investors appeared as bulls attracted by the sudden stock price rises, while bears, who sold securities, failed to place their money into deposit and were instead lured into lending it as call money to brokerages who then fuelled these speculative bulls. As of October 22, 1929 about $4 billion was the extent of such speculative lending when Chase National Bank’s customers called in their money.

 

Chase National had to follow their instructions, as did other New York banks. New York’s Stock Exchange could hardly respond to a demand for $4 billion at a short notice and collapsed. Within a year, production had fallen by 26 per cent, prices by 14 per cent, personal income by 14 per cent, and the Greatest Depression of recorded history was in progress — involuntary unemployment levels in America reaching 25 per cent.

 

That is not, by any reading, what we have today. Yes, there has been plenty of bad lending, plenty of duping shareholders and workers and plenty of excessive managerial payoffs. It will all take a large toll, and affect markets across the world.

 

But it will be a toll relative to our plush comfortable modern standards, not those of 1929-1933. In fact, modern decision-makers have the obvious advantage that they can look back at history and know what is not to be done. The US and the world economy are resilient enough to ride over even the extra uncertainty arising from the ongoing presidential campaign, and then some.

Reddy’s reckoning

Against Quackery

Against Quackery

 

 

First published in two parts in The Sunday Statesman, September 23 2007, The Statesman September 24 2007

 

by

Subroto Roy

 

 

Manmohan and Sonia have violated Rajiv Gandhi’s intended reforms; the Communists have been appeased or bought; the BJP is incompetent

 

 

WASTE, fraud and abuse are inevitable in the use and allocation of public property and resources in India as elsewhere, but Government is supposed to fight and resist such tendencies. The Sonia-Manmohan Government have done the opposite, aiding and abetting a wasteful anti-economics ~ i.e., an economic quackery. Vajpayee-Advani and other Governments, including Narasimha-Manmohan in 1991-1996, were just as complicit in the perverse policy-making. So have been State Governments of all regional parties like the CPI-M in West Bengal, DMK/ AIADMK in Tamil Nadu, Congress/NCP/ BJP/Sena in Maharashtra, TDP /Congress in Andhra Pradesh, SP/BJP/BSP in Uttar Pradesh etc. Our dismal politics merely has the pot calling the kettle black while national self-delusion and superstition reign in the absence of reason.

 

 

The general pattern is one of well-informed, moneyed, mostly city-based special interest groups (especially including organised capital and organised labour) dominating government agendas at the cost of ill-informed, diffused anonymous individual citizens ~ peasants, small businessmen, non-unionized workers, old people, housewives, medical students etc. The extremely expensive “nuclear deal” with the USA is merely one example of such interest group politics.

 

 

Nuclear power is and shall always remain of tiny significance as a source of India’s electricity (compared to e.g. coal and hydro); hence the deal has practically nothing to do with the purported (and mendacious) aim of improving the country’s “energy security” in the long run. It has mostly to do with big business lobbies and senior bureaucrats and politicians making a grab, as they always have done, for India’s public purse, especially access to foreign currency assets. Some $300 million of India’s public money had to be paid to GE and Bechtel Corporation before any nuclear talks could begin in 2004-2005 ~ the reason was the Dabhol fiasco of the 1990s, a sheer waste for India’s ordinary people. Who was responsible for that loss? Pawar-Mahajan-Munde-Thackeray certainly but also India’s Finance Minister at the time, Manmohan Singh, and his top Finance Ministry bureaucrat, Montek Ahluwalia ~ who should never have let the fiasco get off the ground but instead actively promoted and approved it.

 

 

Cost-benefit analysis prior to any public project is textbook operating procedure for economists, and any half-competent economist would have accounted for the scenario of possible currency-depreciation which made Dabhol instantly unviable. Dr Singh and Mr Ahluwalia failed that test badly and it cost India dearly. The purchase of foreign nuclear reactors on a turnkey basis upon their recommendation now reflects similar financial dangers for the country on a vastly larger scale over decades.

 

 

Our Government seems to function most expeditiously in purchasing foreign arms, aircraft etc ~ not in improving the courts, prisons, police, public utilities, public debt. When the purchase of 43 Airbus aircraft surfaced, accusations of impropriety were made by Boeing ~ until the local Airbus representative said on TV that Boeing need not complain because they were going to be rewarded too and soon 68 aircraft were ordered from Boeing!

 

 

India imports all passenger and most military aircraft, besides spare parts and high-octane jet fuel. Domestic aviation generates near zero forex revenues and incurs large forex costs ~ a debit in India’s balance of payments. Domestic airline passengers act as importers subsidised by our meagre exporters of textiles, leather, handicrafts, tea, etc. What a managerially-minded PM and Aviation Minister needed to do before yielding to temptations of buying new aircraft was to get tough with the pampered managements and unions of the nationalized airlines and stand up on behalf of ordinary citizens and taxpayers, who, after all, are mostly rail or road-travellers not jet-setters.

 

 

The same pattern of negligent policy-behaviour led Finance Minister P. Chidambaram in an unprecedented step to mention in his 2007 Union Budget Speech the private American companies Blackstone and GE ~ endorsing the Ahluwalia/Deepak Parekh idea that India’s forex reserves may be made available to be lent out to favoured private businesses for purported “infrastructure” development. We may now see chunks of India’s foreign exchange reserves being “borrowed” and never returned ~ a monumental scam in front of the CBI’s noses.

 

 

The Reserve Bank’s highest echelons may have become complicit in all this, permitting and encouraging a large capital flight to take place among the few million Indians who read the English newspapers and have family-members abroad. Resident Indians have been officially permitted to open bank accounts of US $100,000 abroad, as well as transfer gifts of $50,000 per annum to their adult children already exported abroad ~ converting their largely untaxed paper rupees at an artificially favourable exchange-rate.

 

 

In particular, Mr Ratan Tata (under a misapprehension he may do whatever Lakshmi Mittal does) has been allowed to convert Indian rupees into some US$13,000,000,000 to make a cash purchase of a European steel company. The same has been allowed of the Birlas, Wipro, Dr Reddy’s and numerous other Indian corporations in the organised sector ~ three hundred million dollars here, five hundred million dollars there, etc. Western businessmen now know all they have to do is flatter the egos of Indian boxwallahs enough and they might have found a buyer for their otherwise bankrupt or sick local enterprise. Many newcomers to New York City have been sold the Brooklyn Bridge before. “There’s a sucker born every minute” is the classic saying of American capitalism.

 

 

The Sonia-Manmohan Government, instead of hobnobbing with business chambers, needed to get Indian corporations to improve their accounting, audit and governance, and reduce managerial pilfering and embezzlement, which is possible only if Government first set an example.

 

 

Why have Indian foreign currency reserves zoomed up in recent years? Not mainly because we are exporting more textiles, tea, software engineers, call centre services or new products to the world, but because Indian corporations have been allowed to borrow abroad, converting their hoards of paper rupees into foreign debt. Forex reserves are a residual in a country’s international balance of payments and are not like tax-resources available to be spent by Government; India’s reserves largely constitute foreign liabilities of Indian residents. This may bear endless repetition as the PM and his key acolytes seem impervious to normal postgraduate-level economics textbooks.

 

 

Other official fallacies include thinking India’s savings rate is near 32 per cent and that clever bureaucratic use of it can cause high growth. In fact, real growth arises not because of what politicians and bureaucrats do but because of spontaneous technological progress, improved productivity and learning-by-doing of the general population ~ mostly despite not because of an exploitative parasitic State. What has been mismeasured as high savings is actually expansion of bank-deposits in a fractional reserve banking system caused by runaway government deficit-spending.

 

 

Another fallacy has been that agriculture retards growth, leading to nationwide politically-backed attempts at land-grabbing by wily city industrialists and real estate developers. In a hyperinflation-prone economy with wild deficit-spending and runaway money-printing, cheating poor unorganised peasants of their land, when that land is an asset that is due to appreciate in value, has seemed like child’s play.

 

 

What of the Opposition? The BJP/RSS have no economists who are not quacks though opportunists were happy to say what pleased them to hear when they were in power; they also have much implicit support among organised business lobbies and the anti-Muslim senior bureaucracy. The official Communists have been appeased or bought, sometimes so cheaply as with a few airline tickets here and there. The nonsensical “Rural Employment Guarantee” is descending into the wasteland of corruption it was always going to be. The “Domestic Violence Act” as expected has started to destroy India’s families the way Western families have been destroyed. The Arjun-DMK OBC quota corrodes higher education further from its already dismal state. All these were schemes that Congress and Communist cabals created or wholeheartedly backed, and which the BJP were too scared or ignorant to resist.

 

 

And then came Singur and Nandigram ~ where the sheer greed driving the alliance between the Sonia-Manmohan-Pranab Congress and the CPI-M mask that is Buddhadeb, came to be exposed by a handful of brave women like Mamata and Medha.

 

 

A Fiscal U-Turn is Needed For India to Go in The Right Economic Direction

 

Rajiv Gandhi had a sense of noblesse oblige out of remembrance of his father and maternal grandfather. After his assassination, the comprador business press credited Narasimha Rao and Manmohan Singh with having originated the 1991 economic reform. In May 2002, however, the Congress Party itself passed a resolution proposed by Digvijay Singh explicitly stating Rajiv and not either of them was to be so credited. The resolution was intended to flatter Sonia Gandhi but there was truth in it too. Rajiv, a pilot who knew no political economy, was a quick learner with intelligence to know a good idea when he saw one and enough grace to acknowledge it.

 

 

Rule of Law

 

The first time Dr Manmohan Singh’s name arose in contemporary post-Indira politics was on 22 March 1991 when M K Rasgotra challenged the present author to answer how Dr Singh would respond to proposals being drafted for a planned economic liberalisation that had been authorised by Rajiv, as Congress President and Opposition Leader, since September 1990. It was replied that Dr Singh’s response was unknown and he had been heading the “South-South Commission” for Tanzania’s Julius Nyerere, while what needed to be done urgently was make a clear forceful statement to restore India’s credit-worthiness and the confidence of international markets, showing that the Congress at least knew its economics and was planning to take bold new steps in the direction of progress.

 

 

There is no evidence Dr Singh or his acolytes were committed to any economic liberalism prior to 1991 as that term is understood worldwide, and scant evidence they have originated liberal economic ideas for India afterwards. Precisely because they represented the decrepit old intellectual order of statist ”Ma-Bap Sarkari” policy-making, they were not asked in the mid-1980s to be part of a “perestroika-for-India” project done at a foreign university ~ the results of which were received, thanks to Siddhartha Shankar Ray, by Rajiv Gandhi in hand at 10 Janpath on 18 September 1990 and specifically sparked the change in the direction of his economic thinking.

 

 

India is a large, populous country with hundreds of millions of materially poor citizens, a weak tax-base, a vast internal and external public debt (i.e. debt owed by the Government to domestic and foreign creditors), massive annual fiscal deficits, an inconvertible currency, and runaway printing of paper-money. It is unsurprising Pakistan’s economy is similar, since it is born of the same land and people. Certainly there have been real political problems between India and Pakistan since the chaotic demobilisation and disintegration of the old British Indian Army caused the subcontinent to plunge into war-like or “cold peace” conditions for six decades beginning with a bloody Partition and civil war in J&K. High military expenditures have been necessitated due to mutual and foreign tensions, but this cannot be a permanent state if India and Pakistan wish for genuine mass economic well-being.

 

 

Even with the continuing mutual antagonism, there is vast scope for a critical review of Indian military expenditures towards greatly improving the “teeth-to-tail” ratio of its fighting forces. The abuse of public property and privilege by senior echelons of the armed forces (some of whom have been keen most of all to export their children preferably to America) is also no great secret.

 

 

On the domestic front, Rajiv was entirely convinced when the suggestion was made to him in September 1990 that an enormous infusion of public resources was needed into the judicial system for promotion and improvement of the Rule of Law in the country, a pre-requisite almost for a new market orientation. Capitalism without the Rule of Law can quickly degenerate into an illiberal hell of cronyism and anarchy which is what has tended to happen since 1991.

 

 

The Madhava Menon Committee on criminal justice policy in July proposed a Hong Kong model of “a single high-tech integrated Criminal Justice complex in every district headquarters which may be a multi-storied structure, devoting the ground floor for the police station including a video-installed interrogation room; the first floor for the police-lockups/sub-jail and the Magistrate’s Court; the second floor for the prosecutor’s office, witness rooms, crime laboratories and legal aid services; the third floor for the Sessions Court and the fourth for the administrative offices etc…. (Government of India) should take steps to evolve such an efficient model… and not only recommend it to the States but subsidize its construction…” The question arises: Why is this being proposed for the first time in 2007 after sixty years of Independence? Why was it not something designed and implemented starting in the 1950s?

 

 

The resources put since Independence to the proper working of our judiciary from the Supreme Court and High Courts downwards have been abysmal, while the state of prisons, borstals, mental asylums and other institutions of involuntary detention is nothing short of pathetic. Only police forces, like the military, paramilitary and bureaucracies, have bloated in size.

 

 

Neither Sonia-Manmohan nor the BJP or Communists have thought promotion of the Rule of Law in India to be worth much serious thought ~ certainly less important than attending bogus international conclaves and summits to sign expensive deals for arms, aircraft, reactors etc. Yet Rajiv Gandhi, at a 10 Janpath meeting on 23 March 1991 when he received the liberalisation proposals he had authorized, explicitly avowed the importance of greater resources towards the Judiciary. Dr Singh and his acolytes were not in that loop, indeed they precisely represented the bureaucratic ancien regime intended to be changed, and hence have seemed quite uncomprehending of the roots of the intended reforms ever since 1991.

 

 

Similarly, Rajiv comprehended when it was said to him that the primary fiscal problem faced by India is the vast and uncontrolled public debt, interest payments on which suck dry all public budgets leaving no room for provision of public goods.

 

 

 

Government accounts


Government has been routinely “rolling over” its domestic debt in the asset-portfolios of the nationalised banks while displaying and highlighting only its new additional borrowing in a year as the “Fiscal Deficit”. More than two dozen States have been doing the same and their liabilities ultimately accrue to the Union too. The stock of public debt in India is Rs 30 trillion (Rs 30 lakh crore) at least, and portends a hyperinflation in the future.

 

 

There has been no serious recognition of this since it is political and bureaucratic actions that have been causing the problem. Proper recognition would entail systematically cleaning up the budgets and accounts of every single governmental entity in the country: the Union, every State, every district and municipality, every publicly funded entity or organisation, and at the same time improving public decision-making capacity so that once budgets and accounts recover from grave sickness over decades, functioning institutions exist for their proper future management. All this would also stop corruption in its tracks, and release resources for valuable public goods and services like the Judiciary, School Education and Basic Health. Institutions for improved political and administrative decision-making are needed throughout the country if public preferences with respect to raising and allocating common resources are to be elicited and then translated into actual delivery of public goods and services. Our dysfunctional legislatures will have to do at least a little of what they are supposed to. When public budgets and accounts are healthy and we have functioning public goods and services, macroeconomic conditions would have been created for the paper-rupee to once more become a money as good as gold ~ a convertible world currency for all of India’s people, not merely the metropolitan special interest groups that have been controlling our governments and their agendas.

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Swindling India

SWINDLING INDIA

by

Subroto Roy

First published in slightly abbreviated form as “A scam in the making” in The Sunday Statesman April 1 2007, Front page comment

A gigantic financial scheme is in the making. Will it come to be seen in future years as having been in fact a scam – indeed India’s scam of the 21st Century for which India’s unknowing masses will be made to pay for many generations? The scheme is mind-boggling in size as well as its sheer audacity. Bofors, Quattrochi etc amount to peanuts in comparison.

No less a personage than the Finance Minister of India, P Chidambaram, has openly praised the potential of this financial scheme. And he has done so in no less an open and transparent place than his latest Budget Speech to Parliament last February.

It is a scheme openly advocated and currently being developed by our Prime Minister Dr Manmohan Singh’s closest acolytes, Planning Commission head Mr Montek Singh Ahluwalia and HDFC head Mr Deepak Parekh, in collaboration with Reserve Bank Governor Dr YV Reddy and the Finance Ministry’s top bureaucrats. The PM himself has come close to endorsing it explicitly. And this PM is not an elected member of the Lok Sabha but holds office and acts as the executive agent of the UPA Chairperson and Lok Sabha Member from Rae Bareilly, Sonia Gandhi.

I hasten to add nobody in the BJP has objected to this financial scheme — in fact had the BJP been in power today instead of Congress, they would have been likely even more agreeable to the scheme given their close proximity to business lobbies and organized capital. As for the Communists, none of their JNU economics professors is technically competent enough to comprehend or recognize what is going on.

The scheme involves private companies “borrowing” India’s foreign exchange reserves from the Reserve Bank of India, allegedly for purpose of “infrastructure” creation — in collaboration with the American bank Citigroup, the American financial business, Blackstone Group, and possibly the American giant, GE Capital too. Mr Chidambaram took the unprecedented step of naming Mr Deepak Parekh as well as Citigroup and Blackstone in the text of his Budget Speech.

To begin to comprehend the nature of this scheme, we need to recall an earlier case.

Foreign exchange reserves of countries typically include foreign currency holdings as well as gold stocks. One of the biggest Wall Street scams of the 1980s-1990s involved private companies borrowing not countries’ foreign currency reserves but their gold reserves.

In that scam, it was not the Reserve Bank of India that was cheated but the Central Banks of Poland, Malaysia, Portugal and Yugoslavia. The New York financial company involved was a subsidiary of the Drexel Burnham Lambert Group. The Drexel parent went bankrupt on February 13 1990 and its subsidiary followed on May 9 1990.

A report on June 4 1990 by Leah J. Nathans (now Leah Nathans Spiro) in New York’s highly respected Business Week magazine said: “Central banks, those pillars of monetary virtue, lost $219 million ($21.9 crore) to an obscure commodities subsidiary called Drexel Burnham Lambert Trading Corporation”. The sum was small by American standards but it was “a big, big number” for the countries involved at the time.

What had these national central banks done? They had been lured into becoming greedy. They had been sitting on stocks of gold as part of their national reserves which they felt “just collect dust”. So they yielded to the temptation offered by the Drexel subsidiary of leasing the gold to private parties.

In Ms. Nathans’ words, “By leasing gold, a central bank earns a modest interest rate, ranging from less than 0.5% to 2.5%. Typically, the central bank consigns the gold to a dealer – say, for 90 days. The dealer can then lend the gold to a customer, at a higher interest rate. It may be a speculator, who hopes to repay the borrowed gold when the price falls, or a gold mine that wants to repay the broker with gold produced later.”

But the Drexel parent and subsidiary went bankrupt through bad financial decisions. Drexel’s Michael Milken went to jail. The Central Banks of Poland, Malaysia, Portugal and Yugoslavia were left empty-handed – and had to sue as creditors in New York’s courts trying desperately to get back the gold they had been lured into parting with. It would be unwise to take bets on how much of their gold they ever got back.

All the present PM’s men — Messrs Chidambaram, Ahluwalia, Parekh, Reddy et al in collaboration with one or two American financial companies – now have a scheme that will use not the RBI’s gold but its foreign currency reserves.

Mr Ahluwalia and Mr Parekh have made the outlandish claim that “India needs US$320 billion” (US 32,000 crore) by way of “investment for physical infrastructure” during the so-called “Eleventh Five-Year Plan”. (How many so-called “Five Year Plans” is India going to have incidentally? We had our “First Plan” when Manmohan Singh was a student at Punjab University. Stalin, who invented the “Five Year Plan”, died during that time, and even his old USSR has ceased to exist, let alone its “Five Year Plans”.)

That vast amount of “investment for physical infrastructure” is what Mr Ahluwalia says he knows India needs for his purported “9% growth rate” to be achieved. Where are the macroeconomic models and time-series data sets from him or his friends to back such assertions? There are none. None of the PM’s men, no one in the Finance Ministry or RBI or Planning Commission, nor any of their JNU economics professor friends or anyone else in Delhi, Mumbai, Kolkata etc have any such models or data with which to back such assertions. Nor do the World Bank etc. It is all sheer humbug – all a lie. It is part of the mendacity and self-delusion that our capital city has been floating upon.

In any event, the RBI reportedly has “opposed the idea of deploying forex reserves for infrastructure development on the grounds that it will create monetary expansion”. But Mr Chidambaram’s Finance Ministry owns the RBI, and the Ministry has said “the RBI’s concerns had been taken care of, as the investments would be deployed only through a structured mechanism”. (Business Standard 23 March 2007, p. 3)

What is a “structured mechanism”? Mr Chidambaram, mentioning Citigroup and Blackstone Group specifically, said in his Budget Speech that Mr Deepak Parekh has “suggested the establishment of two wholly-owned overseas subsidiaries of India Infrastructure Finance Company Ltd with the following objectives: (i) to borrow funds from the RBI and lend to Indian companies implementing infrastructure projects in India, or to co-finance their External Commercial Borrowings for such projects, solely for capital expenditure outside India; and (ii) to borrow funds from the RBI, invest such funds in highly rated collateral securities, and provide ‘credit wrap’ insurance to infrastructure projects in India for raising resources in international markets. The loans by RBI to these two subsidiary companies will be guaranteed by the Government of India and the RBI will be assured of a return higher than the average rate of return on its incremental investment.”

You do not understand? Well, no one is supposed to. The most exquisite thievery occurs after all not in darkness but in broad daylight with everyone watching but no one able to see or comprehend anything. So let us return to elementary first principles.

What are foreign exchange reserves and why do countries hold them? It is quite simply answered. Consider the USA and Canada, each with its own dollar. Canadians want to purchase American goods and services, give gifts and make loans to American residents, and make investments in the USA. Americans want to do the same in Canada. Each has to use the domestic money of the other when it does so. If an American wishes to lend money to a Canadian or to purchase something from him, he receives Canadian dollar notes from the Canadian Government to make his Canadian transactions, handing over his American dollar notes instead. The American dollar notes he hands over become part of Canada’s foreign exchange reserves, held by its Central Bank. Roughly speaking, a country’s foreign exchange reserves are the residual foreign currency assets its central bank holds after all these transactions are carried out on both sides of the border.

In the US-Canada case, neither Government prevents its citizens from exchanging domestic money for foreign money. In India, our rupee has been inconvertible since about 1940. The average Indian cannot freely exchange his/her rupee-denominated assets for foreign exchange denominated ones even if he/she wished to. There has been some import-liberalisation in recent years but only someone with the political access of Mr Tata or Mr Birla can purchase foreign assets and foreign companies using their Indian money – because the rupee is inconvertible, any bad financial decisions they make in using their foreign assets will be implicitly paid for by the Indian public.

Now a country’s central bank, such as our Reserve Bank, is the custodian of its foreign exchange reserves. India’s reserves are supposed to have reached $195.96 Billion ($19,596 Crore) as of March 16 2007. Keep in mind we do not know why they have risen: they can rise merely because foreigners (including NRIs) have lent us more of their money, not because foreigners have bought more of our goods and services. In fact Business Standard yesterday 31 March 2007 said on its front page “external commercial borrowing” was “a major source of accretion” of India’s reserves.

Also keep in mind that the Reserve Bank has the duty to manage these foreign-denominated assets against which it has already issued Indian rupees. It might receive a small conservative income from the cash-management aspect of this but it may not risk them or place them in any jeopardy!

Yet the whole idea behind the Chidambaram-Ahluwalia-Parekh-Reddy scheme under discussion by the Sonia-Manmohan Government is that the RBI will “lend” some of the billions of Americans dollars in its custody to overseas subsidiaries of Indian companies – say, for example, to the Tatas who have now bought foreign “capital assets” of some US$ 12 Billion ($1200 Crore) from Corus without having anything near that kind of foreign income.

Such favoured Indian companies might then use these “borrowed” funds as collateral for other borrowings. In exchange, they will go about undertaking purported “infrastructure” projects in India. So much for the “structured mechanisms” being touted by Messrs Chidambaram, Ahluwalia, Parekh et al.

Before India’s public understands it, the schemers will shout (as they have done with the SEZ Act) that Parliament has passed it. The BJP will applaud with envy. The Communists might uncomprehendingly complain a little, and then be bought off with a sop or two that they do understand, like a little pro-China rhetoric or being let off lightly on Nandigram.

Now international institutions like the International Monetary Fund and the Bank of International Settlements officially exist to advise central banks to stay along the straight and narrow and to avoid all such mischief. Here is what the IMF explicitly warned about such schemes in its Guidelines for Foreign Exchange Reserve Management dated September 20 2001:

Liquidity risk. The pledging of reserves as collateral with foreign financial institutions as support for loans to either domestic entities, or foreign subsidiaries of the reserve management entity, has rendered reserves illiquid until the loans have been repaid. Liquidity risks have also arisen from the direct lending of reserves to such institutions when shocks to the domestic economy led to the borrowers’ inability to repay their liabilities, and impairment of the liquidity of the reserve assets.
Credit risk. Losses have arisen from the investment of reserves in high-yielding assets that were made without due regard to the credit risk associated with the issuer of the asset. Lending of reserves to domestic banks, and overseas subsidiaries of reserve management entities, has also exposed reserve management entities to credit risk.”

Dostoevsky believed man could have evil intent. Socrates was more generous and said man does not do wrong knowingly. It is not impossible our Indian schemers have innocent intent and do not even realize how close they are to becoming scamsters, or are already in the grip of scamsters. But at least we are now forewarned: India faces a clear risk of being swindled of its foreign exchange reserves. Prevention is better than cure.

Fallacious Finance: Congress, BJP, CPI-M et al may be leading India to hyperinflation (2007)

Fallacious Finance: Congress, BJP, CPI-M et al may be leading India to hyperinflation

by

Subroto Roy

first published in The Statesman, March 5 2007

Editorial Page Special Article

It seems the Dream Team of the PM, Finance Minister, Mr. Montek Ahluwalia and their acolytes may take India on a magical mystery tour of economic hallucinations, fantasies and perhaps nightmares. I hasten to add the BJP and CPI-M have nothing better to say, and criticism of the Government or of Mr Chidambaram’s Budget does not at all imply any sympathy for their political adversaries. It may be best to outline a few of the main fallacies permeating the entire Governing Class in Delhi, and their media and businessman friends:

1. “India’s Savings Rate is near 32%”. This is factual nonsense. Savings is indeed normally measured by adding financial and non-financial savings. Financial savings include bank-deposits. But India is not a normal country in this. Nor is China. Both have seen massive exponential growth of bank-deposits in the last few decades. Does this mean Indians and Chinese are saving phenomenally high fractions of their incomes by assiduously putting money away into their shaky nationalized banks? Sadly, it does not. What has happened is government deficit-financing has grown explosively in both countries over decades. In a “fractional reserve” banking system (i.e. a system where your bank does not keep the money you deposited there but lends out almost all of it immediately), government expenditure causes bank-lending, and bank-lending causes bank-deposits to expand. Yes there has been massive expansion of bank-deposits in India but it is a nominal paper phenomenon and does not signify superhuman savings behaviour. Indians keep their assets mostly in metals, land, property, cattle, etc., and as cash, not as bank deposits.

2. “High economic growth in India is being caused by high savings and intelligently planned government investment”. This too is nonsense. Economic growth in India as elsewhere arises not because of what politicians and bureaucrats do in capital cities, but because of spontaneous technological progress, improved productivity and learning-by-doing on part of the general population. Technological progress is a very general notion, and applies to any and every production activity or commercial transaction that now can be accomplished more easily or using fewer inputs than before. New Delhi still believes in antiquated Soviet-era savings-investment models without technological progress, and some non-sycophant must tell our top Soviet-era bureaucrat that such growth models have been long superceded and need to be scrapped from India’s policy-making too. Can politicians and bureaucrats assist India’s progress? Indeed they can: the telecom revolution in recent years was something in which they participated. But the general presumption is against them. Progress, productivity gains and hence economic growth arise from enterprise and effort of ordinary people — mostly despite not because of an exploitative, parasitic State.

3. “Agriculture is a backward sector that has been retarding India’s recent economic growth”. This is not merely nonsense it is dangerous nonsense, because it has led to land-grabbing by India’s rulers at behest of their businessman friends in so-called “SEZ” schemes. The great farm economist Theodore W. Schultz once quoted Andre and Jean Mayer: “Few scientists think of agriculture as the chief, or the model science. Many, indeed, do not consider it a science at all. Yet it was the first science – Mother of all science; it remains the science which makes human life possible”. Centuries before Europe’s Industrial Revolution, there was an Agricultural Revolution led by monks and abbots who were the scientists of the day. Thanks partly to American help, India has witnessed a Green Revolution since the 1960s, and our agriculture has been generally a calm, mature, stable and productive industry. Our farmers are peaceful hardworking people who should be paying taxes and user-fees normally but should not be otherwise disturbed or needlessly provoked by outsiders. It is the businessmen wishing to attack our farm populations who need to look hard in the mirror – to improve their accounting, audit, corporate governance, to enforce anti-embezzlement and shareholder protection laws etc.

4. “India’s foreign exchange reserves may be used for ‘infrastructure’ financing”. Mr Ahluwalia promoted this idea and now the Budget Speech mentioned how Mr Deepak Parekh and American banks may be planning to get Indian businesses to “borrow” India’s forex reserves from the RBI so they can purchase foreign assets. It is a fallacy arising among those either innocent of all economics or who have quite forgotten the little they might have been mistaught in their youth. Forex reserves are a residual in a country’s balance of payments and are not akin to tax revenues, and thus are not available to be borrowed or spent by politicians, bureaucrats or their businessman friends — no matter how tricky and shady a way comes to be devised for doing so. If anything, the Government and RBI’s priority should have been to free the Rupee so any Indian could hold gold or forex at his/her local bank. India’s vast sterling balances after the Second World War vanished quickly within a few years, and the country plunged into decades of balance of payments crisis – that may now get repeated. The idea of “infrastructure” is in any case vague and inferior to the “public goods” Adam Smith knew to be vital. Serious economists recommend transparent cost-benefit analyses before spending any public resources on any project. E.g., analysis of airport/airline industry expansion would have found the vast bulk of domestic airline costs to be forex-denominated but revenues rupee-denominated – implying an obvious massive currency-risk to the industry and all its “infrastructure”. All the PM’s men tell us nothing of any of this.

5. “HIV-AIDS is a major Indian health problem”. Government doctors privately know the scare of an AIDS epidemic is based on false assumptions and analysis. Few if any of us have met, seen or heard of an actual incontrovertible AIDS victim in India (as opposed to someone infected by hepatitis-contaminated blood supplies). Syringe-exchange by intravenous drug users is not something widely prevalent in Indian society, while the practise that caused HIV to spread in California’s Bay Area in the 1980s is not something depicted even at Khajuraho. Numerous real diseases do afflict Indians – e.g. 11 children died from encephalitis in one UP hospital on a single day in July 2006, while thousands of children suffer from “cleft lip” deformity that can be solved surgically for 20,000 rupees, allowing the child a normal life. Without any objective survey being done of India’s real health needs, Mr Chidamabaram has promised more than Rs 9.6 Billion (Rs 960 crore) to the AIDS cottage industry.

6. “Fiscal consolidation & stabilization has been underway since 1991”. There is extremely little reason to believe this. If you or I borrow Rs. 100,000 for a year, and one year later repay the sum only to borrow the same again along with another Rs 40,000, we would be said to have today a debt of Rs. 140,000 at least. Our Government has been routinely “rolling over” its domestic debt in this manner (in the asset-portfolios of the nationalised banking system) but displaying and highlighting only its new additional borrowing in a year as the “ Fiscal Deficit” (see graph, also “Fiscal Instability”, The Sunday Statesman, 4 February 2007). More than two dozen State Governments have been doing the same though, unlike the Government of India, they have no money-creating powers and their liabilities ultimately accrue to the Union as well. The stock of public debt in India may be Rs 30 trillion (Rs 30 lakh crore) at least, and portends a hyperinflation in the future. Mr Chidambaram’s announcement of a “Debt Management Office” yet to be created is hardly going to suffice to avert macroeconomic turmoil and a possible monetary collapse. The Congress, BJP, CPI-M and all their friends shall be responsible.

Of related interest: Mistaken Macroeconomics,
“The Indian Revolution”, “Against Quackery”, “The Dream Team: A Critique”, “India’s Macroeconomics”, “Indian Inflation”

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Our Policy Process: Self-Styled “Planners” Have Controlled India’s Paper Money For Decades

Our Policy Process:

 

Self-Styled “Planners” Have Controlled India’s Paper Money For Decades

 

by

Subroto Roy

 

First published in The Statesman, Editorial Page Special Article, Feb 20 2007

 

 

Three agencies of the Executive Branch of our Government have controlled the country’s fiscal and monetary processes. The most glamorous is the Planning Commission, a nominated agency of the Government of the day without constitutional status but which has informally charged itself with articulating national and provincial preferences on public spending. It has overshadowed in impact and prestige the Finance Ministry or Treasury, which normally would design the budget, raise taxes, run the fiscal machinery and be accountable to Parliament (the Legislative Branch) via the person of the Finance Minister. In turn, the Finance Ministry owns and controls the Reserve Bank, effectively placing India’s paper money and bank deposits at the discretion of New Delhi’s purported “economic planners”.

 

 

In addition, the Finance Commission is charged with articulating a suitable allocation of public resources between the Union and States, setting some medium-term parameters of federal finance. And the Comptroller & Auditor General is supposed to assess effectiveness of Government behaviour: the “high independent statutory authority..… who sees on behalf of the Legislature that … money expended was legally available for and applied to the purpose or purposes to which it has been applied.” “Audit … is the main instrument to secure accountability of the Executive to the Legislature …. The fundamental object of audit is to secure real value for the taxpayer’s money” (Indian Government Accounts & Audit, 1930).

 

 

Weakness of Parliament

 

In parliamentary government, the whole Executive Branch is accountable to and the agent of the Legislative Branch. But the utter weakness of our Parliament over decades has led its institutions, including the C&AG, to be run roughshod over by the Government of the day. The Finance Commission, being a temporary and transient body, can hardly take on the entrenched bureaucracy the Planning Commission has become.

 

This unconstitutional subservience of policy-making to the Planning Commission began when the first planners said on December 7 1952: “The raison d’etre of a planned economy is the fullest mobilisation of available resources and their allocation so as to secure optimum results …. There is no doubt that the RBI, which is a nationalised institution, will play its appropriate part in furthering economic development along agreed lines”. When Jawaharlal Nehru as free India’s first prime minister chose to himself lead the “Second Plan”, the fate of India’s paper money was sealed. “Insofar as government expenditure is financed by central bank credit, there is a direct increase in currency in circulation”. That May 14 1956 statement marked the last mention for the next 43 years of India’s money during the process of articulating India’s public expenditure priorities.

 

The Reserve Bank has indeed behaved “along agreed lines”. While superficially presiding over currency, banking and foreign exchange, it has been legally and practically a department (with some 75,000 employees today) of the Finance Ministry. Since the vast bulk of customer deposits are held by nationalized banks owned and managed by the Finance Ministry, India has had practically a “one-tier” banking system on the old USSR model.

 

The “Ninth” and “Tenth” Planning Commissions included not only Prime Minister Atal Behari Vajpayee but also his Finance and Foreign Ministers as members. It was not our Reserve Bank but such persons, including the prominent official (now in post-retirement service) Montek Singh Ahluwalia, who declared on April 5 1999 in the “Ninth Five Year Plan” that a “viable monetary posture” was “to accept an average inflation rate in the region of 7 per cent per annum, which would justify a growth rate of money supply (base money) of 16 per cent per annum”. Recent money supply growth rates under the Sonia-Manmohan Congress have been near 19%-21%, and inflation properly measured may be well above 10%.

 

In Western countries, it would be normal procedure for an acceptable level of inflation to be decided upon, followed by monetary and fiscal targets being set in view of what is statistically expected by way of real economic growth, since growth is mainly a result not of Government behaviour but of spontaneous technological progress and increase in productivity. By contrast, our “planning” process has allowed unconstrained fiscal expenditure to emerge out of chaotic and unconstrained nationwide politics on the sure-fire assumption that budget deficits are going to be “paid for” by money-printing (and hence by invisible taxation of the paper assets of an unknowing public).

 

For a PM and Finance Minister to sign off on fiscal-monetary targets during the “planning” process commits the entire Executive Branch to it. Reversing or even critically discussing such intentions would require nothing less than a Parliamentary Vote of No-Confidence, which itself would require public dissemination of economic models and data exclusively available to the Executive Branch, whether or not the Executive Branch is aware of it. Public exhortations and rhetoric then follow from politicians, bureaucrats and their businessman friends as to how much real growth needs to occur in order for inflation not to be above a given level!

 

The cart is thus squarely placed in front of and not behind the buffalo. If exhortations are not met by reality it is typically said ~ in bureaucrat-speak that avoids accountability ~ “slippages” occurred due to outside factors like rainfall, American business cycles or perhaps, now, global warming and AIDS.

 

Indeed because the upside-down nature of this process has likely not been grasped even by politicians, bureaucrats and establishment economists participating in it, let aside Parliament or the public, it hardly seems a conscious or deliberate “macroeconomic policy” at all, but rather an outcome of habitual, ritualistic routines taking place year after year for decades. And India’s financial press and TV media, instead of soberly seeking facts, have tended merely to flatter top politicians and bureaucrats, as is the wont of businessmen to do.

 

 

War finance, not peace

 

The structure of incentives and information has become such that no one in government, academia, international credit-rating agencies or elsewhere, is able to effectively point out that fiscal intentions expressed in a “Plan” may be infeasible, inflationary or generally unwise. This includes the IMF and World Bank who lead India’s creditors in Western financial markets, and whose staff are generally uninterested in the countries they work on except to make sure loans received are large and repayments timely (as their personal livelihoods depend on such factors). But a brave anonymous squeak can be found hidden in thousands of pages of “Tenth Plan” verbiage dated December 21 2002 ~ that it is all being “financed almost entirely by borrowing …. India’s public finance inherits the consequence of fiscal mismanagement in the past.” Efforts of one recent Governor to carve out a modern independent role for the Reserve Bank have apparently gone in vain, and he too has been co-opted as a Government spokesman in retirement.

 

 

The Bank of England could at one time “theoretically lend the full amount” the British Government was authorized to spend by the UK Parliament (Hirsch). For decades, the RBI has been required by our Government to do almost that in practice (see graph). During the Second World War, the US Government was assured its Central Bank “could and would see that the Treasury was supplied with all the money that it needed for war finance … beyond those secured by taxation and by borrowing from non-bank sources” (Chandler). India’s politicians and bureaucrats have given us macroeconomic processes that pretend our country has since Independence remained at war ~ when in fact we have been mostly at peace.

India’s Macroeconomics

(NB This is one of a set of articles that include “India in World Trade & Payments”, “Fiscal Instability”, “Fallacious Finance”, “Indian Money & Credit”, “Indian Money & Banking”, “Against Quackery”, “Indian Inflation”, “Monetary Integrity and the Rupee”, “The Dream Team: A Critique” etc., as well as “Mistaken Macroeconomics” etc. See My Recent Works, Interviews etc on India’s Money, Public Finance, Banking, Trade, BoP, Land, etc (an incomplete list) )

India’s Macroeconomics

Real growth has steadily occurred because India has shared the world’s technological progress. But bad fiscal, monetary policies over decades have led to monetary weakness and capital flight

by

Subroto Roy

First published in The Sunday Statesman Editorial Page Special Article

January 20 2007

Anyone wishing to understand India’s macroeconomics today must seek to grasp how Government expenditure and taxing behaviour have become related over decades to Government’s rapid creation of paper-money and bank-deposits. Even those policy-makers who have caused this phenomenon (notably our present PM during his long career as the top economic bureaucrat, as well as his many acolytes and foreign and domestic flatterers) seem to have failed to grasp this. Thus they may be unlikely to identify let alone carry out the key political task facing India today, which is to transform the feeble existing state corroded by corruption and waste into a robust modern one with public institutions of a quality meeting or exceeding world standards.

Government expenditure in a democracy is supposed to be representative of real public needs. But democracy is everywhere imperfect, and spending tends to follow instead the pattern of special interest groups, i.e., who has how much organised lobbying power in the polity. “Whatever can be rescued from useless expenditure is urgently required for useful”, said JS Mill. How can public spending be made more productive (or less unproductive) by cutting waste, fraud and abuse, and instead better alleviate mass ignorance, poverty and destitution? And how can there be reduced chance of a collapse of confidence in public institutions, especially currency and the banks as has happened in other countries at different times? These are central questions for serious macroeconomic policy-making in India today. In fact, it is likely the Indian people are at present both over-taxed and under-taxed: we are over-taxed by the corroded, corrupt wasteful polity that has actually arisen, while we are under-taxed relative to the fiscal and monetary needs of a robust modern democratic polity yet to exist.

India has shared the technological progress the world economy witnessed in the 20th Century. Private ingenuity, enterprise and business acumen at all scales of operation are manifest in countless examples across the country every day. Real economic growth has taken place steadily as a result, and there is no doubt average levels of health, education, and material well-being have improved almost everywhere ~ often despite government action, sometimes thanks to it. Our legendary population has grown mainly due to lowering of mortality rates via better health, nutrition and awareness, causing longer life-spans than ever before. Our village festivals, market-towns and city-streets are filled with bustling shops with busy people and merchandise, while large concrete buildings are being built everywhere by invisible builders. There is no apparent lack of a potential basis for taxation of private resources for public uses in the country.

At the same time, monumental problems of absolute poverty, ignorance, destitution and inequality remain obvious to the naked eye everywhere in India, affecting hundreds of millions of citizens. A rare candid Government study said: “It does not require clever tools of measurement to demonstrate that there are millions of children in India who are totally deprived of any education worth the name. And it is not as if they are invisible, remote, and therefore unreached. They are everywhere in the cities: on the streets, wiping cars at traffic junctions, picking rags in mounds of waste; in the roadside eateries; in small factories, as cheap labour or domestic help; at ‘home’ completing household chores. In the villages again they are everywhere, responding to the contextual demands of family work as well as bonded labour.” (India Education Report, 2002, p. 47). Such and similar children, their parents and kith and kin constitute the hundreds of anonymous millions of India today.

Less than 30 million people are employed in the “organised” sector, about 18 by government and 12 by the “organised private sector”. Even if four dependents are assumed for each, that hardly makes 15% of the whole population of one billion people today. So while there may be some 150 million people in India who in one way or another engage with the “organised sector”, there may be 850 million who do not ~ reminiscent of Disraeli’s “Two Nations” of Dickensian England.

India’s tax-revenues are raised in proportion of about 30% direct to 70% indirect, where the same ratio for an advanced economy like the USA is about 90% direct to 10% indirect. A mere 10 million income-tax returns are received in a given year in all of India. The masses are being taxed, perhaps heavily, though they are mostly unaware of what is being indirectly extracted out of their household budgets through ubiquitous archaic systems of Customs and Excise. From long before the British arrived in India, there was a tax on salt via government monopoly, and long after MK Gandhi’s march to the Arabian Sea to produce salt freely, indirect taxes bear down invisibly upon the masses of democratic India today. Nicholas Kaldor approved the current system in 1956 but by 1959 had retracted and recommended widespread direct taxation instead, which has never happened. Kaldor’s best known Indian student is today PM of the country.

Also, everyone’s holdings of monetary assets in India have been taxed by inflation, without people realising it except for a continual feeling or memory of the dwindling value of the rupee and other paper assets. Government debt, the quantity of money and general price-level of real goods and services (the inverse of the price of money) have been on exponential growth paths, most conspicuously since the compulsory government take-over of banks in the early 1970s, though origins reach back to the start of pseudo-socialist “planning” in the 1950s (see graph).

When transparent visible taxation cannot be proposed and voted for in the “real” economy because it needs too much political effort or insight, governments resort to invisible, undemocratic means of taxing the public’s monetary resources by the subterfuge of inflating currency and bank deposits. Inflation has everywhere raised real resources for governments too weak to administer proper tax systems or resist the onslaught of organised pressure-groups in incurring public expenditure.

Taxation via inflation “does not require detailed legislation, and can be administered very simply. All that it requires is to spend newly created notes. The resulting inflation automatically imposes a tax on cash balances by depreciating the value of money” (Cagan). A routine means of meeting a government’s deficits can become “use of the printing press to manufacture legal tender paper money”, either directly by paying its creditors “with new paper money specially printed for the purpose”, or indirectly by paying its creditors “out of loans to itself from the Central Bank”, issuing money to that amount in exchange for government debt (Dalton). Because public memories are short and economic models and data unavailable to ordinary people, a large scope exists for governments to extract real resources by inflation before “money-illusion” comes to be dispelled. Briefly, such has been how India’s continuous budget-deficits have been financed ever since Independence – made possible with impunity because our rulers have also kept our currency from being internationally convertible (except for themselves).

These quite subtle facts remain practically unknown to the Indian public whose lives and those of future generations are deeply affected by them, though in recent decades elite elements like bureaucrats, academics, military officers, businessmen, politicians etc with better information and access to resources have sensed monetary weakness in the country and exported their adult children and savings abroad expeditiously. The sphere of knowledge and concerns of most people are so close to needs of their own survival that they make easy prey for the machinations of others with better information or access to resources. This may help explain why we, who for more than a century and a half have seen a vast political awakening take place and can take pride in having a free press and the world’s largest electorate, at the same time have had our political life and public institutions wracked by enormous corruption, fraud and venality, enfeebling the political economy by widespread cynicism and loss of confidence, and inducing capital flight abroad on the part of a vapid elite.