Like the European Union, India too is a Union of states. Then why is there a question-mark over the future of the EU and the euro, but not about India and the rupee, despite the fact that both federations are in deep economic trouble? Why is Greece going down the tubes, but a heavily-indebted West Bengal is not?
Here’s what is common and different about India and the EU.
#1: The creation: The European Union was created from the ground up after World War II, when politically different states wanted to create an economic union to preserve the peace. India was created top-down and bottom-up from the ashes of colonialism – the Brits gave us a centralised system, and Sardar Patel cajoled and coerced states to sign up to the union.
Facing financial challenge. Image courtesy PIB
The EU was a voluntary union where its nation-states maintained total political sovereignty while surrendering a bit of economic sovereignty; in India, political and economic sovereignty was divided between Centre and the constituent states, with the balance of power veering towards the Centre.
#2: The progress: Over the last 50 years, the EU, with France and Germany providing the leadership backbone, steadily increased the harmonisation of social and economic laws and taxation, and freed the movement of labour and capital. It created a free and unified trade zone. Some political sovereignty was surrendered to the EU bureaucracy and the combined leadership of Germany and France, but not fully. Mechanisms were evolved to transfer resources from the richer to poorer EU nations, but this was not foolproof.
At another level, the EU is really a mish-mash of sub-systems. At the core are the countries in the eurozone, where all countries share the same currency (the euro) and have to meet certain fiscal targets; then there are countries in the next periphery (there are 10 of them, including the UK, Sweden, Denmark, Poland, etc), which have their own national currencies and complete monetary freedom; and then there are countries that are outside even the EU (like Switzerland and Norway), which have near-EU trading status through the European Free Trade Area, but are more sovereign than the rest.
India is a single political and economic union – even though states can erect barriers in the areas where they have legislative power (like agriculture, land and irrigation, movement of goods, etc). This is why even though India is one large market, it is often a collection of several regional markets. The movement of agricultural products, for example, is far from free, though capital and labour movement is free, constrained only by regional political winds.
In India, economic power has remained largely with the centre, but political power has shifted to the states gradually (This is why a Mamata Banerjee can hold up reforms or a Jayalalithaa the NCTC). The inequitable distribution of political and economic power between centre and states is one key cause of tension in the Indian Republic. States could do with more economic power, and the Centre with a clearer job profile.
In India, states (correctly) have no monetary role. The rupee is entirely the responsibility of the Centre and the Reserve Bank of India. No state can do anything about the rupee.
#3: The issues: The euro is on the verge of break-up while the rupee is not because the eurozone does not have a central bank – a lender of last resort like the Reserve Bank of India. The European Central Bank (ECB) does set monetary policy, but it does not have the ultimate power to create money like the RBI does, or the US Federal Reserve does. For the same reason, it could not stop Greece and the rest of the PIIGS (Portugal, Ireland, Italy, Greece and Spain) from overborrowing.
The solution to the eurozone’s woes is to either give the ECB that ultimate power, or for the richer countries to write off the debts of the heavily indebted ones, and restrict a state’s future ability to borrow. The dissenters should opt out of the euro and print their own currencies.
In India, the RBI and the centre can refuse to lend to states beyond a point. The states cannot print their own money. In Europe, the PIIGS had the power to issue their own euro bonds, never mind the level of indebtedness of the state.
This is why Greece may sink under its own debt, but in India, even heavily indebted states like West Bengal and Uttar Pradesh can never go under. They simply cannot borrow more than their limits. Greece’s debt is more than 160 percent of GDP; West Bengal’s is less than 40 percent of its state GDP.
In India, the fiscal indiscipline, if any, is at the centre, which has the power to borrow endlessly by printing notes. This may make the Reserve Bank unhappy, but it has no option but to print them for India is a sovereign with the right to print notes.
A solution to Greece’s problems is to opt out of the euro and print drachmas; West Bengal cannot do that. The best it can do is petition the Centre for a debt relief package – which is what Mamata Banerjee is doing. If Mamata could issue her own bonds endlessly, West Bengal would have become the next Greece.
# 4: The options: What happens when you are part of a single currency, but your state becomes uncompetitive or its inflation gets worse, or its productivity does not improve relative to the stronger states?
In this case, you either suffer an “internal” devaluation and/or seek money transfers from the rich to enable you to compete and reduce your poverty. An “internal” devaluation means lowering wages, cutting public spending, and prices by various means to make yourself competitive.
This internal devaluation is also called austerity, where wages and pensions are docked to lower costs for local businessmen to improve their competitiveness. This is what the Greeks are resisting, and this is what may shortly force them out of the eurozone. If they do that, they can opt for an external devaluation, where a lower priced drachma can improve their competitiveness in the short run, giving them space to boost the economy through exports even while imposing austerity to bring down indebtedness.
In India, Mamata Banerjee, Prakash Singh Badal and Oommen Chandy, all CMs of highly indebted states, have to opt for internal devaluations or seek bailouts from the Centre.
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