When presenting the interim Budget, the Finance Minister also released its White Paper, extolling its 10-year performance compared to the UPA. A war of words and data broke out between the Congress (UPA) and the BJP. Both sides used a wide range of indicators to bolster their respective case.

Certainly, the BJP (NDA) in mid-2014 did inherit a legacy of slow growth, high inflation, and a falling rupee, with India then classified as one of the Fragile Five. They proudly assert that they miraculously transformed it into one of the Top Five in the world. This claim is worth evaluating. However, for various reasons including data issues, a comparison is difficult. It also would require a longer article.

Nevertheless, in one very vital aspect the BJP wins hands down: its inflation record. During Congress’ 10-year reign CPI inflation averaged 8.2 per cent while during the BJP’s ongoing reign it has averaged 5 per cent.

In defense of the UPA, C Rangarajan, former RBI Governor, has recently pointed to a sharp difference in during UPA I (May 2004-April 2009) versus UPA II (May 2009-April 2014). He stated that poor macro economic performance at the fag end of UPA II, was due to non-economic factors, and should not be blamed on their policymakers, whose performance was excellent during UPA I.

In his 2022 book, Rangarajan dwelt on the various factors leading to the UPA’s fag end drop in growth: stalled investment projects due to slow environmental clearances, hesitation of bureaucrats — worried about RTI investigations — to clear files, hurdles to obtaining bank credit since bankers had turned cautious after the surge in NPAs, the retrospective Vodafone tax case etc. All these factors fall under the catchy phrase ‘policy paralysis’ coined in 2012 to characterise the weak economy.

Indeed, in April 2014 itself, Rangarajan pointed to these factors, in a long interview. Although not a policy maker during the UPA regime, he headed the Prime Minister’s Economic Advisory Council during both terms and thereby played an influential role in shaping policy. His 2022 memoirs cite at length from this Council’s widely circulated Reports.

Over decades, both former PM Manmohan Singh and Rangarajan made vast, valuable and enduring contributions to India’s liberalization, and for which its people should be grateful. Nevertheless, whether poor inflation performance under UPA II was due to non- economic factors, warrants examination.

Overheating economy

This article provides evidence that UPA policy was deficient during both terms in one critical respect. Their policy makers missed the overheating of the economy underway in Term One, since they overestimated India’s potential GDP growth — the threshold at which inflation takes off. Their error of judgement stemmed from relying on the Harrod-Domar formula to assess potential GDP growth.

Let us first examine performance under UPA I closely. During May 2004 to April 2009, GDP growth averaged above 8 per cent while inflation was 5 per cent. Growth was almost three percentage points higher while inflation was about a full percentage point lower than during the preceding five-year period. For three fiscal years in a row (2005 through 2007) growth was above 9 per cent accompanied by mild inflation.

This GDP hat-trick, coinciding with India’s winning the inaugural T-20 World Cup in South Africa in 2007, led to wildly optimistic estimates of India’s potential GDP growth! In a section titled Chronicling the 9 per cent Euphoria, my 2017 book provides 10 citations over the 10-year period, from UPA policy makers and others influencing its policies, to this effect, including then PM Manmohan Singh in June 2009.

The Eleventh Five Year Plan for 2007-2012 estimated India’s potential GDP growth as 9 per cent using the Harrod-Domar formula. Dividing the projected 36 per cent savings rate by the projected Incremental Capital Output Ratio (ICOR) of 4 yields 9 per cent growth. Overheating occurs and thus inflation takes off only when actual growth exceeds potential. Steeped in this formula, the UPA economists saw little cause for worry. Their danger mark was 9 per cent, based on the above values for savings rate and ICOR.

This halcyon state of affairs during UPA I did not last. After rebounding well from the global financial crisis, growth suddenly dropped to 5 per cent in 2012-2013, due to the policy paralysis discussed earlier.

Stagflation problem

However a collapse of investment projects implies lower demand, which should reduce inflation. But by then inflation was rising i.e. a situation of stagflation. The policy paralysis view, at best, explains only the ‘stag’, but not the accompanying ‘flation’. By early 2013 it was clear the economy was both overheated and lacking heat. During 2012, China too was slowing but, notably, its inflation also fell, unlike India.

By contrast, the Friedman-Phelps framework of the expectations augmented (or more broadly inflation adjusted) Phillips curve, can explain both the ‘stag’ and the accompanying ‘flation’. This concept is rooted in labour supply. The welfare enhancing measures enacted under NREGA contributed to wage increases.

Between 2007 and 2012, the average daily wage for unskilled labour roughly doubled to ₹152. This rise spilt over into rising agricultural costs, followed by higher minimum support prices, and finally higher retail food inflation. The schemes by themselves may have been welfare enhancing for the poor. But the UPA economists did not factor this labour supply reducing policy into their estimates of India’s potential GDP growth.

The concluding Chapter of Rangarajan’s memoirs reiterates his longstanding approach. The last Review of the Indian Economy under his aegis in April 2013 stated, “The ICOR has shot up from its historical level of around 4.0..to much higher levels.. We have shown..that we can have a growth rate of 8 to 9%...That is the potential growth rate of India..we need to raise the savings and investment rate.”

To summarise, the macroeconomic approach during the UPA’s reign lacked a sound analytical compass to explain high inflation. Various analysts, including the equity manager Ruchir Sharma, attributed the sweeping defeat of the Congress Party in May 2014 to high food inflation. That defeat irrevocably altered the social fabric of India. Whatever the various factors underlying the overall election outcome, UPA era economists should ruminate on their contribution to it.

The writer is Distinguished Professor, St. Joseph’s Institute of Management, Bengaluru