Reality check

Prime Minister Narendra Modi’s warning about the need for “tough economic decisions” in the “larger interest of the nation” couldn’t have been better timed. Just when India’s current account deficit woes seemed to be behind it and inflationary pressures were receding thanks to a strengthening rupee, the economy is being confronted with a fresh external shock. This time, it has to do with an extremist Sunni Islamic group seizing large swathes of northern Iraq, a country that is India’s largest crude oil supplier after Saudi Arabia. While Iraq’s daily production of about 3.3 million barrels constitutes hardly 4 per cent of world consumption, there have been expectations of this increasing to 8 million barrels in the next few years with the rebuilding of its oil infrastructure post-Saddam Hussein. These expectations have now been undermined, while also driving up global prices. The Indian crude basket has touched $111-a-barrel — up $5 in just 10 days — even with the rupee crossing 60-to-the-dollar for the first time since May 9.

But it’s not just Iraq. Of no less concern is the monsoon, which so far has delivered 48 per cent below-normal rainfall. While both Iraq and El Nino can be viewed as ‘shocks’, they also serve as timely reminders of our basic vulnerability to unexpected external developments. True, India’s macro imbalances aren’t as bad as they were in August-September last year when the prospect of a quantitative easing ‘taper’ by the US Federal Reserve triggered huge capital outflows and pulled the rupee to below 68 to the dollar. Yet, we have some way to go in restoring full macro stability, which is fundamental to reining in inflation and bringing back growth.

Modi is right in that “stringent measures” are necessary to restore the economy’s financial health, even if he thinks these may “dent the immense love the country has given me”. Such frankness is unusual, especially ahead of a Budget that will be assessed by investors primarily on fiscal consolidation — both quantitative and qualitative. Central to this will be the steps taken towards phasing out wasteful subsidies on fuel and fertilisers. Although Modi hasn’t specified what the proposed “tough economic decisions” are going to be, preparing people for these is necessary. While Iraq and El Nino may pose fresh challenges to inflation control — thereby making it even harder for the Reserve Bank to cut interest rates — the Centre can do a lot from its end through meaningful fiscal correction. Modi’s talk of the long road ahead before the achchhe din (good days) arrive should be heeded by the markets, which have exhibited more than a touch of irrational exuberance lately. External shocks are a cause of worry; on the flip side, they are useful insofar as they make people rediscover the sober truth.

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