By Rajendra Prabhu
Despite repeated meetings of the Employees Provident Fund trustees and Union Labour Minister Sis Ram Ola'sintermediation to get the Finance Minister P. Chidambaram to raise the bar on the interest rate on EPF contributions of workers, the controversy is not nearer a solution. Trade unions are asking for a 12 per cent interest payment but might agree to retain the present 9.5 per cent.
The Finance Minister is not willing to go beyond 8.25 per cent. The Labour Minister hopes to get everyone to agree to 9 per cent. Chidambaram can give in only at considerable peril to his way of managing the economy.
And that is where economic realities bite into the political rhetoric.
The entire issue is worth having a good study for those who seek to understand what economic reforms are, what globalisation is and about moving away from a high-cost low-return economy to a low-cost high-return situation that continually generates more wealth and more prosperity. It is not so much an issue in party politics.
Of course, the Left and the Congress capitalised on the genuine fears of the public, particularly of senior citizens and workers in the organised sector, on the implications of economic reforms of the NDA government. When interest rates were pushed down, there were several gains for the middle class including workers?home loans, vehicle loans, education loans, etc., became considerably cheaper?from 18 per cent to 8 per cent.
More important was the impact of economic reforms on prices and inflation. In the last decade, up to December 2003, the inflation rates remained steadily low after the economic reforms were introduced by the same person who is the Prime Minister now. The NDA government gave them a further momentum. A low inflation rate below 5 per cent meant that the difference between your wage income and real income had narrowed down considerably. A low interest rate regime helps control inflation by promoting investment, protecting the value of capital and curbing the tendency to exchange cash for goods. As a result, a healthy and virtuous cycle of low interest regime fuelling higher capital returns and creating economic stability with progress was replacing the existing cycle of high cost of capital restricting investment that also promoted inflation, rapid erosion of the values of wages and salaries and driving capital beyond the borders. After 12 years of economic reforms, more specially in the second phase of it from 1998 to 2003, the Indian economy became strong enough to shake off foreign aid, attract foreign direct investment and even invest significant sums abroad, and the outflow of capital and talent was replaced by their inflow.
A low inflation rate below 5 per cent meant that the difference between your wage income and real income had narrowed down considerably, low interest rate regime helps control inflation by promoting investment, protecting the value of capital and curbing the tendency to exchange cash for goods.
But the flip side angered many others. Interest payments on fixed deposits and other funds came down sharply. Those who leaned for their livelihood on savings were the first victims. The government of the day could only mitigate their problems somewhat by a special interest rate for senior citizens. But that was hardly enough. The earlier fixed deposits were earning interest rates of more than 10 per cent. These returns came down almost to half or three-fourth of the existing interest rates.
EPF is where most of the money is appropriated in government securities, that is, the government borrows from this fund and guarantees a return. But that guarantee is worth the paper on which it is written until the use of these funds by the government leads to more efficient use of the capital. When the capital locked up in power and irrigation projects yields no return, when leakages and high costs of administration reduce the returns, the only way government can maintain high interest on the funds it borrows from EPF (or anywhere else) is by virtually subsidising it through drawing down from the revenues of the government.
It is a vicious cycle leading to continued narrowing of surpluses available to the government out of its revenues for investment in capital, social or economic, and increasing its debt and interest burden enormously. This was what was happening behind the 12 per cent interest rate the EPF once got from the government. Even the market borrowings of the government were being serviced from more borrowings from the same market.
The vicious cycle of the command-and-control economy had kept the rate of domestic savings and investment almost static around 21 to 23 per cent of the GDP for decades. It raised government borrowings and fiscal deficits at an unacceptably huge level year-by-year. The change in this situation began to trickle in with the economic reforms but it needed more time to work itself into a thrust in the rate of domestic savings and investment above 30 per cent. But the fiscal deficit has been under control for the last few years and the Fiscal Responsibility Act was able to prescribe a ceiling mainly because reforms were progressing. Take out these reforms, fiscal deficit would balloon, government borrowings would again grow and crash through the roof and capital would be kept out of coming in. In the last six years the fact that the capital inflow into the country rose rapidly with foreign exchange reserves coursing past the 100-billion-dollar mark itself shows that the fiscal condition of the country moved from one of the continued sickness to one of improving health.
The Congress and the Left might have gained from playing on the fears of the people in the transition period like loss of jobs, reduced interest rates on deposits, etc., and thereby dealing a huge blow to the NDA'spolitical standing. But now the same Congress is telling the same Left that it is NOT possible to pander to sentiments and jettison the good that the reforms have done. Of course, the Congress does not add to it that these reforms were, to a large extent, the contribution of the NDA. To administer the bitter economic medicine?more specifically the restructuring of public sector employment?it required a great deal of self-denying political courage for any political formation. The NDA staked that courage and lost. The Congress, which is the beneficiary of this loss of the NDA, is now facing the disconnect with its political allies of the election and government formation over the reality of the economic logic.
Chidambaram could agree to the demand of the trade unions on the 9.5 per cent interest rate for EPF money only in two situations: one, he agrees to jettison the low interest regime as a whole; two, he succeeds in persuading the EPF trustees to agree to invest the majority of money in the stock market operations, mutual funds, etc. If he agrees to the first alternative, he will face rising interest rates in the next few months as the drought situation begins to bite reducing agricultural production, and rising inflation would be the consequence. If he agrees to the second step, he would help the capital market but invite a large element of risk in the management of the EPF money, to which the trade unions may not agree. Either way he would be rocking the boat of the economy violently. Therefore, it is that Chidambaram is remaining firm as a rock on the 8 per cent interest rate for EPF even though it mocks at the political rhetoric of his own party and its allies in the recent election months.
Look at the political dilemma the Congress is facing over some of the crucial economic reforms it has been continuing with since the NDA days?raising FDI ceilings in telecom, civil aviation and insurance, reducing EPF interest rates, continuing with low interest regime in a potentially inflationary build up situation, to ward off further inflation. And more areas of dilemma are about to follow: for instance, in making the bureaucracy and public sector leaner and raising the returns from public sector investments.
The NDA government had proposed restructuring of the pension scheme for the public sector. The pension payments of the Central Government alone (Rs 15,366 crore in 2003-04) are almost equal to the total grants and aid New Delhi gives to the states and union territories. The proposal was like a bitter medicine. But in the process the government raised anxiety over the future of millions. That was yet another factor that extracted a political price from that government.
To push through a reformist agenda the Congress Finance Minister needs political support in Parliament. His allies of the Left and RJD are not going to provide it to him. In fact, they are making these very necessary steps a point of departure from the Congress. The ruling party could look for support from the Opposition. But in its zeal to please its Left supporters, that backdoor corridor, which is a vital part of parliamen-tary politics (NDA used it on several occasions earlier), stands locked. On FDI issue, for instance, the Congress could look for support from the BJP. But the two stand more estranged from day one of this session than ever.
We are going to witness how the ruling parties become the victims of the conflict between economic sense and political sensibilities.