By now we have all read or heard from one source or the other that India is suffering a huge Current Account Deficit (CAD). This post is for those who are wondering what this is and why does it make a difference.
A lesson in Economics
Let us forget the individual companies and corporate houses for a minute and view India as a single entity. When we purchase things from another country we have to pay them in return. Similarly, when other countries buy things from us, they pay us. A simple understanding of budgeting tells us that if we do not sell as much, if not more, than the amount we buy, we are sooner or later going to run out of money. This is what we call a current account deficit. Effectively we, as a nation, are borrowing from other countries to fund our consumption. One way to sustain such a situation is to offset the Current Account Deficit with a Capital Account Surplus.
Capital account is the measure of money that enters and leaves our country in terms of investments. There are three main forms that this can take:
- Foreign Direct Investment (FDI): When foreign investors pick up a large stake in an Indian company or set-up their own operations in India. This is usually a longer term investment as compared to FII (below). For example, when Etihad will buy a stake in Jetairways, they will be paying Indian shareholders with capital from their country.
- Foreign Institutional Investment (FII): When foreign institutional investors trade in the Indian stock exchange they bring capital from their economy into our market.
- External Commercial Borrowing (ECB): When Indian companies borrow from foreign entities which are able to provide capital at a lower rate of interest.
If the cumulative of such investments into the country is greater than such investments out of the country we achieve a capital account surplus. Thus while overall we are running a deficit on our current account (i.e. money is leaving the economy) we are able to sustain it because of the capital account surplus (i.e. money is entering the economy).
Why we are a mess
India has historically managed to run a CAD of around 2% of GDP without stress as the capital inflow was easily able to offset it. However, with the rising uncertainty for investors in India, capital inflow is no longer as reliable as it once was. To add to this, there is threat of capital flocking back to the US where the interest rates might be on the rise soon. The situation is further worsened as our CAD has risen from 2.7% (2011) to 4.8% (2013) of GDP making us ever more reliant on the capital inflow.
So what happens if due to macroeconomic instability, capital inflow decreases and we reach a stage where the capital account surplus cannot offset the current account deficit?
International transactions happen in the US Dollars (USD). Hence, if overall more money were to leave the economy than enter it, the demand for the USD viz a viz Indian Rupee (INR) would be greater, causing the dollar to gain value relative to INR (i.e. INR would depreciate). What does this lead to? Say a year back a good produced in India was priced at $1 in the international market and Rs 50 in the domestic one. At that exchange rate the producer was effectively receiving Rs 50 for his product and he would be indifferent between selling it on the domestic market and the foreign market. However, a year later with the new rates, the foreign consumer is now able to pay Rs 60 to the producer with no extra cost to him. The producer will thus divert his goods to the foreign market till the scarcity in the domestic market raises its price to Rs 60 at which point he will once again be indifferent.
The example above has been simplified considerably to get the basic point across: Devaluation of our currency will cause further inflation. Inflation which is already in its double digits (CPI) and is the worst enemy of the poor which the Government swears to protect.
To make things worse the government has dug us another pit fall due to lack of timely reforms. Of the $502 billion worth of imports in the financial year 2013, $170 billion was spent on oil. Oil which the government provides at a bench-marked price no matter what the price they buy it at. Thus as the currency depreciates faster than the rate at which the government is increasing the price of oil (and related products) the government is in fact forced to provide more subsidy than it previously did. Hence not only is the rise in prices causing inflation but is also increasing the government’s fiscal deficit which reached 4.8 at the end of FY 2013 – another threat to our macroeconomic stability.
And so the cycle continues.
The election is a game for the politicians. It is a competition for them which they have to win. But lets not get mistaken, it is a game for us too: We have to use our one vote to ensure the best possible outcome according to our perspective. This responsibility does not end at choosing who you want the winner to be and voting for him, but requires you to generate a ranking of the candidates in order of preference and calculate who your vote should go to backwards.
Those familiar with economics will recognize my attempt at explaining the basics of Game Theory. But to understand the need for this we must first understand how elections take place in India and what are the implications.
I am sure all of us are aware of the absolute basics: The country is divided into 543 constituencies which are suppose to be roughly equal in terms of their population. Each of these constituencies elects a representative. This representative need not even achieve a simple majority (i.e. 50%); as long as he has more votes than any other single candidate he will be given the seat in the Parliament. For example, if there are 3 people running from a constituency and the vote share is divided in the ratio 25%, 35% and 40%, the candidate with 40% will be declared the winner. This is called First-past-the-post voting (FPTP).
What does such a mechanism imply? It can result in skewed representation. For example in the 2012 UP state elections SP (Samajwadi Party) received 29.3% of vote share and were allocated 226 seats in the assembly out of 403, where as BSP (Bahujan Samay Party), who received 25.9% of the vote share were allocated only 80 seats. This happened because the SP won several seats against the BSP over a very small margin. Thus while BSP received considerable votes overall, they were thwarted in individual battles and thus annihilated in the war in the world of FPTP.
This may seem like an unfair mechanism, specially when compared to the proportional representation method. But that is a debate for another blog post. What I would like to discuss is what the voter should do.
Let us imagine that the people who voted for BJP would rather have BSP if their only other option was SP. Their strategy should be obvious: Instead of voting for BJP, who anyway did not have a chance of coming to power, they should have voted for their next best choice which was BSP. If we assume that in each constituencies the vote share was identical to the state level data, then with the transfer of BJPs 15% to BSP, the party would be propelled to number one status with almost 41% of the vote share. Thus the BJP supporters might not get their first choice, but at least they would not be stuck with their 3rd or 4th one.
This example is obviously simplified using several assumptions, but the principle remains the same. At the central election level this effect can be observed with Modi being portrayed as the PM candidate for BJP. While Congress’ abysmal performance has lost them support, voters who fear Modi more will fall back to Congress which is the only credible force to stop BJP. The same applies to people who fear another five-year reign of Congress: Recognizing this possibility they will leave their regional parties and flock to Modi (also discussed in Back to the Basics: Polarising Mr Modi).
The FPTP system often has the effect of bringing the war down to two parties. Understanding the system is important or your vote may actually count for nothing.
The India Today group has been running opinion polls before general elections for several years now and their track record is surprisingly not that shabby.
They conducted the first of such polls for the 2014 General Elections with a dummy variable: Modi as PM candidate. The results were significant but far from surprising.
When Modi was not projected as the PM candidate by BJP the seats allocations were: 179 for BJP; 132 for Congress; and 232 for the 3rd front. On the other hand when Modi was projected as the PM candidate both the number of seats to BJP and Congress increased. The benefit, however, was greater for BJP: 41 more seats to BJP; 23 more seats to Congress; and 64 less seats to the 3rd front.
The logic behind this is very straightforward: Modi polarises the electorate. Majority muslims fear his rise to power and vote for Congress instead of their local party. Even though they might hate Congress, they are willing to put up with them as long as Modi does not achieve the PM mantel. The others vote for Modi because of his track record in governance and the image he has been able to cultivate for himself as a man of action and not just of words. After UPA IIs deplorable performance, many people yearn for a strong leader which they see in Modi. For this they are willing to neglect their local/regional loyalties and vote of BJP.
Nitish Kumar’s strategy: Back fired?
Nitish Kumar, the current, popular Chief Minister of Bihar, recently broke his alliance with BJP over their insistence of portraying Modi as the Prime Ministerial candidate. He had hope that he would be able to blackmail BJP, being its chief ally, into not having Modi as the PM candidate. However, according to the survey, this turned out to be good news for BJP. If JDU (Mr Kumar’s party) were to remain in alliance with BJP, the Bihar votes would remain with them. However, the preference for Modi is so great that the voters will ditch their loyalties to JDU and vote of BJP diminishing JDU’s power considerably.
The fact is: People either hate him or love him. The ones that hate him are willing to settle for anyone but him, and the ones that love him simply will not compromise.