June 1, 2004

The Indian Elections.  Aren’t democracies with growing economies fascinating things to watch?  Last month India held elections and it was widely assumed with a fast growing, non-inflationary economy the ruling BJP party with Prime Minister Atal Bihari Vajpayee would win re-election easily. The BJP was so confident that it called for elections earlier than it had to.

Oh what a surprise…the Congress Party lead by Sonia Gandhi, wife of slain former Prime Minister Rajiv Gandhi, came out on top.  Sure Congress had to former a coalition government with (gasp) Communists, but the BJP is out and Congress is in.

What to make of this?  The Mumbai (Bombay) stock market panicked.  The Mumbai Sensex fell by over 10% on the election results.  Op-ed pieces in the West continued the hand wringing fearing India’s pro-market reforms over the last decade would be undone by the new Congress-Commie coalition.  But, as is usually the case, India turns out to be a much more complex (and more interesting) case than it first appears.

Debate still rages about why the BJP lost…but a consensus is forming is that BJP simply did a lousing job of governing.  On the state level the BJP had built a reputation of running corruption free governments.  But when it came to national power it had difficulty in ensuring that the poor in India would see the benefits of dramatic economic growth.

So what happened is in places where the government was relatively efficient, the incumbents won.  Where the government was inefficient, the poor voted them out.  Even though the rate of poverty in India has fallen significantly over the past decade many of the poor in India want to experience the benefits of economic growth much more quickly.

So now it’s Congress’ turn.  What will they do that the BJP couldn’t?  Well…they are promising economic growth “with a human face.”  Okay…but what that means exactly is not clear.  One positive sign is that the new Prime Minister Manmohan Singh was the chief architect of the initial pro-market reforms of the early 1990’s.  He seems to understand what is needed to keep the Indian economy growing.  Now let’s see if he knows how to get the benefits of this economic growth to the poor of India.

This will not be an easy job.  It has been estimated that the Indian spends 20 rupees one each single rupee of assistance to reach the poor.  So, simply spending more money on projects for the poor will not be enough.  India has to a better job of insuring that assistance does, in fact, reach the poor.

So watch the budget Singh puts together.  Simply spending more is not going to get the job done.  If, as it seems the case, the government is going to be spending more, it is important to recognize that all spending is the same.  Good spending on elementary education, primary health, rural infrastructure and corruption fighting will help the poor of India.  Bad spending on projects on higher education, massive state sponsored power plants, subsidized irrigation and fuel will only lead to even bigger government budget deficits.  In addition, Singh needs to do more to unleash Indian entrepreneurs from the remnants of the Indian “Licence Raj.”  If he and Congress can do it, great days lie ahead for the Indian economy.  If not, the economy will probably continue to grow but the poor will vote Congress out in the next round of elections.  Democracy and economic growth…what a combination.

The U.S. economy:  Mixed messages.  The U.S. economy is sending out some mixed signals.  On the positive side we have the GDP figures suggesting the U.S. economy is growing nicely.  During the first quarter the economy grew at an annualized real rate of 4.4%...very nice.  Reports also showed that industrial output and capacity utilization rates all suggest the economy will continue to grow nicely.  Inflation seems to be in check with the CPI up a scant 2.3% over the past 12 months, with the core rate up only 1.8%.  The PPI is a bit higher at 3.7% but the core is up only 1.5% over the last 12 months.  Look for these to increase as the economy continues to expand.

On the down side the Conference Board index of consumer confidence barely moved in May, much to surprise of economists.  Consumers seem worried over raising gasoline prices, fear of higher interest rates, terrorism and a weak stock market.  Durable goods orders also surprised us by falling 2.9% in April according to the Commerce Department. 

So what will the Fed do?  There are calls for the Fed to raise interest rates to keep the growing economy from “overheating” however higher U.S. interest rates would draw even more capital from emerging financial markets.  But if more signs of growing inflation continue the Fed may have no choice but to raise rates before the November election.

All the best,

MB