An Austrian Economist’s Budget Rating: A+ For Intent, C- For Consequences

One of the unintended benefits of following Austrian economics is that I can take my own time to do an analysis of major economic events without having the fear that I will be accused of plagiarising somebody else’s opinion or writings. While this is generally true, I can be nearly certain of this in the context of the analysis of India’s Budget 2021.

I will start with my conclusions. This budget deserves an 'A+' for intentions, an 'A' for effort and an 'F' for future consequence to the Indian economy. Ok, maybe a 'C-'.

Finance Minister Nirmala Sitharaman has virtually exposed India to a massive economic crisis in the months ahead — inflation risk, interest rates hike risk, NPA (non-performing assets) risk, forex risk etc. But the one risk that she really need not be bothered about is 'maverick risk' — the risk of being wrong and being alone.

Given the positive to euphoric commentary to this budget by most market participants, we are indeed going to be caught completely unawares when the crisis above unfolds.

But why such a widespread blind spot? This starts with a basic economic misunderstanding of confusing “malinvestment-induced bubbles” for “lack of demand”. It’s an unequivocally acknowledged thought in India that we suffer from a lack of demand and hence the government needs to “stimulate”.

When the real brains behind the 1991 reforms, Dr Subramanian Swamy, takes such a left-leaning position, it is not in the least bit surprising that almost every economist seems to agree with the basic flawed proposition. The only difference then is on how to splurge the money conjured out of thin air.

What we have in India, and indeed worldwide, are bubbles on rate-sensitive assets such as equities, bonds, real estate and industries such as housing, autos, etc. Plenty of industries, eg, commodities, have been starved of the necessary capital as it has been diverted into these bubble sectors by a combination of artificially low interest rates and government policy.

The solution is to allow for the deflation of these bubbles, by allowing markets to redirect resources through the mechanism of higher interest rates. The fundamental principle to remember that capital allocation is a market function and not a government discretion. Talk of “minimum government, maximum governance” has to be walked!

The irony behind the Indian budgeting exercise is that there is overwhelming consistency in what has been practised over the decades — by the ruling class and the opposition, despite differences in who gets to don these hats. There is very little to distinguish between Congress and Bharatiya Janata Party (BJP) budgets.

All the governments have indulged in reckless fiscal expansion, capital/project allocations to preferred private participants and a modicum of personal tax rebates to keep the circus viewers engaged.

The hypocrisy behind the opposition commentary, for example by Sitharaman on fuel price hikes during earlier Congress rule, is mind-blowing and there is little exception to this practice. The idea that criticisms have to be based on deeply-held economic principles seem to be anathema to our political class. Besides the point perhaps. But the consequences are staggering that we ought not to ignore these any longer.

The Fallacy Of Deficit Spending

Deficit spending is just a euphemism for inflation and it never works though it creates an illusion in the short-run. Inflation masquerades as growth on account of two factors:

• We understate inflation by measuring tweakable end factors (ie, consumer price index and wholesale price index) instead of the objective causative factors, ie, excess money supply.
• By understating the cost of capital through the artificial low interest regimen we maintain.

But the most misunderstood part of the economic axiom is that deficit spending can be just about tolerated during good times, but is the least affordable when times are bad. By definition, capital is scarce and hence has to be prudently allocated by entrepreneurs based on an assessment of risk-reward and not by finance ministers based on political expediency.

Covid-19 just about broke the bubble of decades of central banking-induced malinvestments. As I have written several times earlier, we are virtually at the hot gates of a prolonged period of economic stagflation that will eventually be termed as “the greater depression”. When faced with an economic crisis, should we conserve resources or should we splurge?

The International Monetary Fund’s (IMF’s) advice to governments to “spend as much as you can” is based on the typical Keynesian playbook that has little basis in reality or economic foundational principles.

In general, the last few decades of economic advice that has been doled out in public policy forums sounds more like Quantum Physics than what Adam Smith and company would have envisaged.

Of course, we are living in the payback period for the decades of monetary excesses and continuing to rely on this fact-bereft intellectual framework to fix the breaking world economy is going to be a disaster.

So, What Should The Finance Minister Have Done?

As famed investor Doug Casey would say, the governments the world over are not only following the wrong policy, but the exact opposite of the right policy. Let me rephrase the above question to what I would have done as Finance Minister as it is metaphysically impossible to convey basic Austrian economics, simple enough as it is, to minds trained in gobbledegook.

Downsize: I would move to balancing the budgets and eliminating deficits entirely within a very short span of time of one or two years by allocating resources only to the most vulnerable and needy. Of course, this would imply cutting government expenditure with a chain-saw and eliminating entire departments that just increase the cost of doing business in this country.

The “crowding out” effect of deficit spending gets eliminated and increased capital is available to the private sector for investments in projects that the market determines. This would lead to a growing real gross domestic product (GDP), strengthening currency, lower imports bill and reduced consumer price increases. If I could do only one thing as an finance minister, this unquestionably would be it.

Needless to point out, the exact opposite has been done: loosened the purse strings to an unheard of (and) projected 6.8 per cent of GDP. One can be assured it is going to be well north of 8 per cent by the time we close the books. We will witness substantially higher consumer price inflation, higher market interest rates despite the Reserve Bank of Indian (RBI) continuing to twiddle its thumbs, and NPAs across a broad spectrum of projects.

Deregulate: This is not a budgetary activity, but downsizing departments would automatically lead to deregulation. That said, and to be fair, the BJP has done more deregulation in the last few years than what the Congress has done in the last few decades. Even so, in the context of what needs to be done, it is but a drop-in-the bucket. Sure enough, every drop helps.

From what I have seen in the last few years, and I have no direct contact with anybody remotely in a position of power, the deregulation has largely been an initiative of the Prime Minister. I do hope our Finance Minister can build on the baby steps of deregulation and take it to different trajectory.

What else would I do? While I am day dreaming, I might as well go the distance. Abolishing the RBI and putting the rupee on a hard currency standard would be next on the list. These three steps and time ought to be enough to fix the Indian economy for good without the need for any divine interventions.

The short run of a year or two might be a difficult transition, but the prosperity it unleashes in the markets ought to be enough to take care of whatever the bleeding hearts desire today through government doles.

I don’t in the least expect to be taken seriously but, as I would hasten to point out, the day of reckoning for monetary madness is not far away. When the bubble in US treasuries bursts, every budgetary calculation would go awry. The solace that Sitharaman can draw is that very few saw it coming and that nobody told her about the impending crisis.

Of course, one does not have to foresee the crisis to follow the right principles. But then if one understands the right economics, ie, Austrian economics, the crisis would be the elephant in the room.

When Jonathan Swift wrote his Modest Proposal, he intended it to be a satire. This budget is the modern-day equivalent of that proposal and we will witness the results this year. I have no doubts that our Finance Minister has the most honourable of intentions, but then as ever so often in matters of public policy, the path to hell is paved with good intentions.

About the Author

Shanmuganathan “Shan” Nagasundaram, is the Chief Investment Officer at “Plus43 Capital”. He can be contacted at shan@plus43capital.com