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Behind the Hype – Understanding the Economic Impact of Political Change

I have always believed that the Indian economy functions despite its political environment. Somehow, the entire economic system has learnt to function despite the endemic political chaos, political inertia and high transaction costs related to the above. And when good politics emerge for short spans, we rejoice because the costs have come down for now. I doubt any business in India assumes stability or continuity in a real sense. It’s like a pipe dream. Basically, the economic system in its entirety functions largely in auto-pilot.
But there are no shortcuts. The economic system is very complex and even a hundred small things take time to have either an upward or downward cascading impact of any kind. One of the most fundamental and most often used phrases in economics is “ceteris paribus’. But in the real world, this is the most ignored aspect because frankly, nothing really stays constant so viewing one aspect of economic growth or development intrinsically impacts the other.

For example, let’s take the example of something that’s affecting us all – inflation. This, in India, is largely driven by the rise in food inflation. This intuitively makes sense. If basic essentials are costly, ingredients of most other commodities get costly as well. But, what will keep this in check? A change in policy decisions, subsidies, monetary controls or all of the above? Or, could it be that the inflationary impact on and of the food sector is driven by systemic issues - the cushion for the existence of middle men, corruption in middle men, the lack of interaction between core producers and end users or even wholesalers? This complicates further when you think of the role of transaction costs.

Think of this scenario: A farmer is empowered with information and knows his produce can be sold for more. However, he has no roads or infrastructure to physically connect him with the buyers. So, despite other things in place, he is still at the mercy of the middle man with the power and resources to connect the village with the end users. The farmer does not get the right level of income and hence he stays at a level where he needs government support and the subsidy bills rise – you can understand how this is a never ending spiral. All this of course is ceteris paribus but then that’s the only way to understand the fundamental issue. My point is this:  there is no simple long term solution. A number of small and not so small things need to fall in place – either sequentially or in a random order for the complete dynamic to change.

The same fundamental principle applies to almost all aspects of economic development. It is all complicated and takes time to create as well as undo. If we saw a decline in the past few years, it was probably not only a political decline – it was probably just the undoing of some quickly taped on solutions. Continuity was never guaranteed and policy decisions reversed easily are a recipe for disaster.

Fundamental economic history will tell you that good markets have existed way before money markets. They survived on a simple principal of barter. Hence, the money market and currencies emerged as tools to aid the good market growth. Logic then tells me, that fundamental economic chaos that we are seeing now can be stemmed at both these levels. The goods and the money market – inflation for instance is not just a function of money markets but of the impact of high transaction costs of doing business. Trading, agriculture, services, and industry – everything has relatively higher costs exacerbated by poor implementation of sound policies, lack of infrastructure and lopsided political will.

Back in 2001, India emerged on economic growth radars after the BRIC report which placed it as one of the key growth economies in future. This was quickly followed by actual growth in India and the great Indian growth story was created. A dream was created and spread like wildfire – fueling actual growth and returns for many. It also raised expectations significantly. Hence, when the realities of global inclusion and interdependence hit the snowball began to melt. And then the political scams and lock jam shattered the dream. But the expectations remained – that India could be that great growth story. We had the potential. We all believed it.

So what happened in the last couple of years to make it all seem so bad? The fundamental system stopped working – and it seemed like everything was going to be sluggish for a while. But with the hope of stability and political change, most people are waiting for this phase to end and for that magic pill to quickly put everything on the fast track again.

We are now at, what most people believe to be, an inflection point of positive change – the stock market definitely thinks so already. I am not saying that things won’t be impacted, all I am saying is that will take time. A lot of time! Basically, the cycle takes time. First, decisions at policy levels need to be agreed to then the system needs to implement them. Also, not all industries are currently directly impacted by policies – so we are largely saying infrastructure and core sectors are likely to get impetus first. But the impact of these sectors is a slow trickle down. In short, the goods market is likely to see a pick up – but eventually and not immediately.

As far as the money market goes, those changes are in place already – again despite the political situation- and these will continue to have an impact at the current pace.

To me, the economic hype around political change this year is not what the hype is all about. The timing for returns is what has been hyped up.  There is no magic wand, no one person and no one day that can change it all. It is system that will work part by part piece by piece once it is re-started. Yes, the hope has emerged that the fundamental blockages will be treated which will get the water, power and other basic essential moving. But these are cogs in the wheels of change. The real value will come beyond the hype of the cogs being in place. 


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