All Indians are taught early that there are two ways to catch one’s nose: the direct or the shortest distance method, or the “reverse swing” method of swinging one’s arm behind the head and then grasping for the protrusion. For some reason, Indian politicians and bureaucrats never quite get over their childish fascination with the latter approach. (The fact that it also fits their political economy interests maybe coincidental).

So many uncaught noses, so many wrong policies. Take the policy of food subsidies for the poor - instead of the direct approach of food stamps, or cash transfers, the government goes into reverse swing and procures food from selected farmers at high prices, stores food, sends it to ration shops, and then sells it. Or fertilizer policy - each producing firm has its own negotiated (retention) price of selling! Since the negotiation is done by the government on behalf of innocent taxpayers, the fertilizer firms win, members of government win, and the taxpayer, and farmer, loses. Or take the case of higher education subsidies. The urban middle class benefits by paying only Rs. 10 a month - surely the administration costs of collecting this user charge is more so why not go for universally free education ? Sorry - I believe in the interests of reform the "user charges" for Delhi University have just increased by 100 percent and now cost Rs. 20 a month, or equal to 1.5 kilos of poor man's rice. Another nose not caught.

One nose-bleed left uncommented upon is the removal of the costly managed interest rate structure that prevails in India. A massive distortion that appears to have few, if any, political benefits. A text-book case of a literally senseless policy. Something that has been discussed, ad nauseam it may seem, by me in several articles over the last four years. I will indulge the reader with only two more - this, and one appearing on Monday. But first a discussion of where we are going wrong - again, and again, and...

The nirvana 9 % bull: Pick up any newspaper, any magazine (domestic or international), any TV talking heads discussion, any research seminar, even any Dalal Street broker, anybody-anywhere, and you hear learned people and politicians pontificate on the fiscal deficit. The fisc is in a mess we are told. And then, in hoarse voices, the policy platitudes begin. And now, to the cheers of many, nirvana has seemingly been reached in the form of the Fiscal Responsibility Bill. This bill appeals to the control freaks among us. The deficit is a problem - why not mandate it away since even Indian interventionists have not found a way to wish it away. Policy pronouncements from the temples of control - henceforth, over the next 5 years, the fiscal deficit will reduce by 0.5 percent per annum or some gobbeledy-gook to that effect.  

Myth Policy 1: Raise the savings rate. The CII has just offered this "policy" - and who else has not uttered this learned prescription? And the experts feel glib with this recommendation because Nobel Laureate Arthur Lewis wrote fifty years ago that an economy can be considered developed if it increases its savings rate from 5 to 12 percent. At the time he wrote this, almost all economists thought the same. Since then, the world knows better. In particular, that the savings rate is not a policy lever - it is an outcome. It can no longer be prescribed, just as growth rate wishes do not automatically come true. Only policies that induce higher growth will bring about a higher savings rate.

Myth Policy 2: A slightly more sophisticated version of the above is the recommendation that the growth rate is being held back because of a lack of infrastructure. Never was a tautology better stated. But infrastructure cannot be wished in. Why is there a lack of infrastructure ? Obviously because there is a low rate of return to investment. Somewhat tautological as well, but better. And why is there a low rate of return ? Because the cost of borrowing is too high which makes the returns too low. Better - and now we are getting somewhere. Myth

Inference 1: Interest rates cannot be lowered because we have high inflation with WPI hovering around 7 percent. Core inflation in India has been around 3 to 4 percent for at least five years. Food inflation is zero for two years, and manufacturing inflation has stayed close to 3 percent for the last five years. The WPI is around 7 percent because of increases in administered prices; such necessary price adjustments have a one-time effect on the price level and should not be construed as inflation as some mistaken experts believe. Oil prices have a weight of 10 percent in WPI and such prices are up about 40 percent, year-on-year. So almost two-thirds of WPI inflation is due to an increase in administered prices alone.  

Myth Inference 2: Interest rates cannot be lowered because we have a high fiscal deficit. India's consolidated (center plus state) fiscal deficit is 10 % of GDP, and what might be news to some, it has remained in the 9 to 10 percent range for the last 20 years. During this same time-period, real lending rates have ranged from 4 to 12 percent! It is undoubtedly true that in a closed economy there is a close correspondence between fiscal deficits and real interest rates. In an open economy, foreign savings can neutralize any effect of domestic deficits. India is somewhere in-between. The fact remains, however, that it is a particularly lazy argument to suggest a close relationship between Indian fiscal deficits and Indian interest rates.

Myth Inference 3: China can grow at double-digit rates for two decades, so can India. This is not strictly a myth; it can become reality - but only if some necessary policies are in place. Both India and China have administered interest rates; both India and China have large fiscal deficits; both India and China have bank problems; both India and China have large non-performing loans. Where do they differ - in the nature of administered interest rates. In China, real lending rates (prime minus GDP deflator) have averaged 1.4 percent since 1980, and 0.1 percent since 1991. In the Ministry of Finance Indian interest rate regime, real lending rates have averaged 8 percent since 1980, and 6.3 percent since 1991.

High real interest rates are sufficient to prevent India from ever going past a 6 percent growth rate; and a corollary is that a change in the interest rate regime is absolutely necessary for India to achieve a sustainable 9 percent growth.