Growth and inflation in the time of elections

THE consensus view is that the Reserve Bank of India is likely to persist with its hawkish monetary stance by tightening the rates further, as the Union government would like to keep a lid on inflation ahead of the general elections next year. However, data suggests that other than in 1996, inflation has never fallen in the year preceding a general election in India. 

Analysts question the need of further monetary tightening and its ability to have a meaningful anti-inflationary impact in the run-up to the election. "The most decisive factors in determining election outcomes have been on issues of rather immediate relevance than economic issues of a more enduring nature," says Saurabh Mukherjea, head of Indian equities, Noble. 

He says the reduction in FII inflows (net outflows YTD stand at about $7bn+) has reduced the need for punitive monetary measures. Also, there is not enough time left before the election for further monetary tightening now to have a bearing on the pre-election inflation rate. 

"Contrary to conventional wisdom, economic issues have never been at the heart of any successful general election campaign in India. Even if they were, it was not clear that sacrificing growth at the alter of inflation has ever won votes. In short, consensus 'election economics' and repo rate forecasts are misguided," adds Mr Mukherjea. 

According to a study by UK-based investment bank, Noble, economics was highlighted in the election campaigns only on two occasions — one was the 1971 general election when Indira Gandhi spearheaded the 'Garibi Hatao' (remove poverty) campaign, and the 1980 election which Indira Gandhi won highlighting spiralling prices under the post-Emergency Janata Party regime. 

Sachidanand Shukla, chief economist, Enam Securities, says that the tolerance for high inflation has come down. "But what we have seen so far are only seen knee jerk reaction from the government like banning exports, controlling cement prices, hike in interest rates. At the same time, government spending in the year before the election shoots up, making it difficult to cool inflation. For example, take the case of I-T exemption, farm loan waiver among others," he said. 

A paper by Stuti Khemani of the World Bank in 2001 offers more systematic evidence on this subject. A glance at national elections between 1960 and 1992 shows that price rises are politically damaging. For instance, a 1% increase in inflation in the year before a national election cuts the incumbent's share of the vote by 0.6 percentage points. 

But it turns out growth matters more: A 1% rise in growth just before an election adds 1.66 percentage points to the incumbent's vote. So a determined fight against inflation in a pre-election year may be counter-productive from an electoral perspective. The increase in inflation before the election year is also due to rise in populist spending. 

"There are some instances like onion crisis etc, where it shows that there is not a very good statistical relation between inflation and election but more of perception. However, if we talk about this particular year, purely due to base year effects from early next year, inflation should moderate closer to the elections. So there might not be much need for tightening monetary policy further and risk destabilising Indian growth," says the chief economist of a bank, who does not wish to be quoted. 

Analysts say that focussing on a single economic objective is unlikely to yield the desired electoral gains to the government. The 2004 election, where the ruling party sought to highlight its economic achievements through the 'India Shining' campaign and lost the election to rural India (which could not see anything shining), serves to illustrate the point. To sum up, there is no example of ruling party winning elections in India on the back of a good economic performance.

ET AHD 21st Sept 2008