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WILL A STRONG RUPEE WIN VOTES?

Swaminathan S Anklesaria Aiyar

The Times of India, August 3, 2008

High inflation means that the Congress-led UPA government is in serious danger of losing the next general election. Voters tend to revolt when inflation exceeds their tolerance level, which today is probably no more than 5%. Wholesale price inflation is currently a whopping 12%. Consumer price data are not available for recent weeks, but are less alarming, suggesting consumer inflation of maybe 8%. Still, that is well above what is electorally tolerable.

In recent years, voters have tended to oust four-fifths of incumbent governments, notwithstanding record economic growth. This reflects widespread dissatisfaction with the quality of governance. Add high inflation to misgovernance, and the chances of an incumbent being re-elected fall close to zero.

What will the Congress do to improve its chances? I offer two predictions. First, the government will seek to strengthen the exchange rate of the rupee, making imports cheaper and thus, creating downward pressure on prices. Second, after having raised interest rates thrice in the last two months, it will raise them further soon, but then lower them shortly before the poll date. This strategy will aim to check inflation right now, while reducing the sting of high EMIs before the election.

A stronger rupee will reduce the profitability and competitiveness of exports. And higher interest rates will hit investment as well as consumer credit, which is crucial for selling property and consumer durables (like cars and two-wheelers). But at election time, politicians naturally favour inflation control over growth.

Politicians have used many financial gambits over the years to try and influence elections. The farm loan waiver is one such. But never before has the exchange rate been used as a vote-winner. That may be about to change. In past decades, India was largely self-sufficient, and had high import barriers. In such circumstances, the exchange rate had only a minimal effect on inflation — other factors mattered much more. But today, imports of goods and services account for over 25% of GDP, and so have a substantial impact on prices. World commodity prices have skyrocketed in the last year, raising the spectre of imported inflation.

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