Prepare for double digit inflation next year

Even before secular mediamen had an opportunity to wipe off the froth of excitement from the corner of their mouths after the Railway Budget, our Harvard educated FM announced a stunner of a budget. The Rs. 60,000 crore (about $15B) farmer loan waiver package still remains the talk of the town and likely to remain so, perhaps for years.

RealityCheck and Offstumped addressed some of the immediate problems with this budget, as indeed countless other blogs and editorials.

Yet, no one is talking about what this whopper of a loan waiver can do to our economy. In terms of size, this is about half of the income tax receipt. Naturally the provisions to fund this has been kept off budget. The details will be worked out by June.

The biggest problem of this waiver is perhaps the crude setback this will cause to farmers' insurance programs. To put it most charitably, we do not have adequate farmer insurance infrastructure. Some banks do provide coverage for crop damage due to flood, drought, mice etc. by charging an extra premium. By announcing this ad hoc relief, this waiver will throw insurance schemes totally out of gear. Not only that, it will wipe out historical credit data, thus making it impossible to rationalize premiums.

If the waiver itself is big, the problems are exacerbated by the current world macro-economic context. Some other factors unique to India make it even worse.

With the US financial market in free fall, Ben Bernanke is all set to announce rate cuts on March 18, perhaps by as much as 50 basis points. India's interest rates are already overdue for a cut. At a first glance, it seems to be the right thing to do, but it actually worsens the situation. The interest rate differential attracts FDI and private transfers. These transfers are huge.

We have the pay commission coming in. Coupled with the tax bonanza, our consumers will be flush with extra cash to spend.

Then we have the NREG scheme, which amounts to about Rs. 16,000 crore. So far the scheme has been an almost total failure, adding just froth.

The FM has refused to divulge any details of how the waiver itself will be handled. There is talk of bonds, which will invariably add upward pressure on the real interest rates. The waiver will have a multiplier effect on the liquidity situation. Ordinarily, these loans would be written off as NPAs and show up on the income statements as losses. Now, the banks will get straight capital, which has the potential to add X times one over the cash reserve ratio to the market.

The inflationary pressures on Rupee are already showing up, it ended up weaker against the dollar. Inflation is clocking at 4.89 precent, already up from lows of below 3. This is just the WPI which has a decidely downward bias.

The FM is essentially betting on one of two things. Either he believes that the downward pressure on growth will be so large that extra momentum is necessary even at the cost of inflation. This is essentially a bet on the middle class professional or aspiring to be professional crowd. This could also be an indicator that the export job losses due to a stronger Rupee are significant and not mere propaganda by our industry lobby. If this is the case, the FM perhaps wants to induce inflation, bring the Rupee up to 45 to the dollar, aggressively import food grains and hope for a rebound. Alternately the FM is betting on the fact that inflation is a lagging indicator. By the time the waiver is worked in and all the factors set in, it will be late in the year.

In the latter case we will likely see the general elections happen later this year.