It’s Animal Spirits, Silly

Keynes’ big idea was inspired by Indian attitudes towards money. Yet it is dangerous to apply his policies blindly

One image that flashes through my head whenever the subject of Indian attitudes to money comes up, is that of a village belle slipping a currency note down her blouse. Indians, it has long been said, like to keep their money close to their chest. Among the poverty stricken, this is utterly understandable. But this has long been said of Indians in general, even the well-off, and even business houses.

Ultra-thriftiness—ho-hum—has been a feature of Indian life for longer than anyone cares to research. It’s hardly the kind of stuff that should make anyone’s jaws drop open. Or is it?

Idle money, after all, does the economy no good whatsoever. For things out there to crackle and vroom, as much money needs to get around as possible. This being so self-evident, Indian cash-clutchiness did puzzle at least one observer at one point. Whether he was left agape is hard to tell, it was a long time ago, but it’s a matter of record that the phenomenon perplexed him enough to provoke the world’s biggest breakthrough in behavioural economics.

The observer in question was John Maynard Keynes, an Englishman, and what set him thinking was gold hidden away in safehouses more than tenners slipped down blouses. It’s not clear whether he had any clue of such endowments as streedhan, or ever had occasion to fear having to flee with nothing but the clothes on his back and gold around his neck, but this much is well documented: he looked around pre-Independence India and found a rationale for hoarding gold and stashing away cash. Money, Keynes observed, was not just a ‘means of exchange’, but also a ‘store of value’, a link between the present and future. And when people are faced with ‘uncertainty’ (which he defined as risks that cannot be measured or easily hedged), the role of money as a store of value tends to take control of their mind.

That may have been a perpetual state of affairs in India back then, but it gave Keynes an idea on how to rescue advanced economies from occasional slumps, caused as they were by collective bouts of fear, as he saw them. While economists of the time had insisted that everyone’s pursuit of their own self-interest would eventually turn everything hunky-dory for everybody, he saw this reliance on the long run as fatalistic folly. If consumer and investor sentiment were to slacken, he argued, it was the State’s job to spend big sums of money and push cash around in a grand effort to revive the economy’s ‘animal spirits’ (by ‘animal’ he meant ‘of the mind’, not anything altogether uncivil). And if that required the State to spend more money than it had, he thundered, so be it (drumroll). Enter, deficit finance (stage left).

That’s what a Keynesian stimulus was originally meant to be. But emerging countries soon found that running big budget deficits—with state expenses far in excess of earnings and tax receipts—was a good way to erect infrastructure and spur economic activity along. And elected governments soon found that extra money for public schemes could also mean extra money for populist handouts.

However, the real danger of deficits is not so obvious, and that is inflation, a danger particularly scary in a country like India that may not be as amenable to Keynes’ big idea as we like to imagine. “The Keynesian model assumes surplus capacity in every sector,” says Abheek Barua, chief economist, HDFC Bank, “That’s not the case here.” Far from being a fully-functional economy held back by gloomy moods and glum faces, India is a semi-anarchic country ridden with production snafus and supply clog-ups. So much so that surges of extra cash often do little but send prices soaring. “Deficit financing does not help beyond a point,” agrees Barua, “You get overheating.”

What’s worse, in an economy as hierarchical as India’s, the ravages of inflation are borne largely by those who can’t afford to. For those with immediate access to the Centre’s stimulus funds, inflation is only a prospective worry. But for those at the farthest ends of the economy, the stimulus cash is worth a lot less by the time it reaches them. Direct cash handouts for have-nots, while somewhat inflationary in their effect, at least help subvert the traditional trickle of cash.

Not just that. If the poor and rich alike get ulcers from inflation, it’s because it slows the economy down. It is hardly a coincidence that India’s worst inflation crisis of recent times came roughly a year after the Centre let expenditure loose in 2008-09. This was a sudden reversal of all the hard work done over four years—2004-05 to 2007-08—of steady deficit reduction, a phase in which the Indian economy expanded at an annual average of about 9 per cent, its fastest ever on modern record.

The theme of that grand reversal was a huge farm-loan waiver granted by the Centre in the run-up to India’s 2009 Lok Sabha election. By the time polls came round, though, the Great Recession had hit the world, and stimulus spending was the stuff of high-table talk everywhere on the globe. Since then, the Government has just not been able to crunch its fiscal deficit, despite repeated vows. And now, as 2011-12 comes to a close and the extent of its fiscal slippage becomes apparent, groans about the economy’s outlook are louder than ever. It has been a year of cost escalation, dwindling investment and a sputtering economy. India would be lucky to clock 7 per cent growth this year. Few expect 2012-13 to be better. Sure, global factors have taken a toll, but it’s crazy to deny a confidence crisis of India’s own making.

Take a look around, and one could conclude that even big businesses like to keep their money close to their chest. At the end of 2010-11, India’s top 500 companies were found sitting atop a cash pile of about Rs 4.7 lakh crore. Reliance Industries alone had over Rs 30,000 crore lying around; Infosys had above Rs 15,000 crore; and Tata Motors and Tata Steel had almost Rs 11,000 crore each. State-owned companies had most of the other big stacks of undeployed cash; Coal India Ltd had staggering reserves of over Rs 45,000 crore. Given the way 2011-12 has passed, with such little money ploughed in (even as $25 billion was invested overseas in the first nine months alone), those cash piles could well have gotten larger. While India’s domestic investment rate has been on a downtrend ever since its peak in 2007-08, the past 18 months or so have been particularly disastrous. “The macro numbers point to a fall in investment by both the private and public sectors,” observes Barua.

What explains this business behaviour? Broadly speaking, a combination of three factors. One, capital cost escalation, ever since the Reserve Bank started tightening credit—invariably a part of any project’s funding—in early 2010 to quell inflation. Two, sluggish markets, given the economy’s loss of dynamism. And three, uncertainty on the policy front, with the Centre’s economic agenda appearing much too muddled to inspire confidence.

In Barua’s analysis, that last factor is the most critical. “Honestly, interest rates have only played a minor role,” he says, explaining that the Indian economy has not really been awfully interest rate sensitive, and companies have had—at least until the European crisis—easy access to low-cost loans from overseas. So cost-of-capital is not what deprives big investors of sleep. “The real problem is the fundamental uncertainty on policy,” he adds, “The Government says one thing and then goes back on it. This has happened in several cases.” This problem is all the more acute in sectors where investment decisions depend on regulatory clarity and clearances, and it so happens that most of the bulge-bracket projects lined up these past few years have been of this kind.

Evidently, the fallout of the 2G spectrum fiasco has sent shudders down sarkari spines, and now anything to do with the allocation of natural resources gives officials the heebie-jeebies. “Unfortunately,” adds Barua, “there is this adversarial relationship between the Government and Business, an ‘us’ and ‘them’ kind of thing, and it doesn’t give Business a good feeling.”

India Inc relies on the State not just for environmental clearances and so on, but also the demand it whips up for goods and services. And here, things have been in bad shape for the past year-and-a-half. “It’s a bit of a vicious circle,” says Barua, “Public sector projects stopped being implemented around September-October 2010, and that left the private sector without much support from government demand.”

Given the Indian economy’s lack of aggregate demand, this crisis looks like a scenario Keynes would probably have gone hopping high and low to ring alarm bells about. And, true to form, Dr Manmohan Singh’s Government has conjured an ambitious sarkari plan to turn things around in 2012-13. In January, the Prime Minister’s Office came up with an investment programme that calls upon 17 state-run companies, heavy-hitters like ONGC and NTPC among them, to dip into their cash reserves and invest a total of Rs 1.76 lakh crore over the year (a figure that looks suspiciously calculated to signal a difference between notional and usable money). About Rs 1.41 lakh crore of that sum is intended for domestic initiatives. This could reverse the investment trend, and it’s clearly a good idea so long as the 17 use their own money and do not blow another hole in the Government’s budget—a privilege it presumably reserves only for its Food Security plan.

The only hitch is this: for a revival that actually has bang for the buck, private players must pitch in.

So, will India Inc get back into the act? While global worries persist, the great scare of the Great Recession is over. The Indian economy has proven relatively resilient. To rouse its ‘animal spirits’ all over again, with luck, the Government might yet grab the chance to grant the RBI the headroom it needs to start easing credit. This would mean keeping inflation from flaring up, which in turn would mean crunching the fiscal deficit—as a factual rather than fictional enterprise for a change. Actual rates of interest may not matter much, but the signalling effect could work wonders. “A lower fiscal deficit, if underpinned by a credible strategy to achieve it,” says Barua, “might send a signal of better governance ahead.”

Strategy. That’s it. Sometimes, in a world as temperamental as the one we unhabit, with or without ‘animal spirits’, just the suggestion of such a thing’s existence is enough. It’s a fair bet that companies really don’t like keeping their cash close to their chest. They are in business to multiply money, after all, not conserve it.

Maynard Keynesmoneystingy