The last straw.

Everybody knows that the economy is on life support, with the S&P threatening a credit downgrade to junk status but India seems to avoid a crisis like that in Iceland, Greece or Ireland whose economies went into severe recession when their banks nearly collapsed under bad loans. The state run banks in India are sagging under Non Performing Assets, as bad loans are called, but they are trusted by the people who know that the government will never allow these banks to fail by recapitalising them with borrowed money. The RBI raises money for government spending by selling bonds. Banks are required to invest 23% of their funds in these bonds which is known as the Statutory Liquidity Ratio. Since the credit rating is suspect, yields on these bonds have risen to 9%. In Europe countries had to be rescued when yields on their bonds rose to 7% but our government borrows money invested in term deposits by citizens in banks controlled by itself. However, this profligacy has consequences. Easy borrowing leads to wasteful expenditure, raises borrowing costs for everyone else, such as businesses, and leads to high fiscal deficit. To adjust for its high borrowing the government allows inflation to rise, which reduces its debt in real terms, but causes enormous suffering for the people which the politicians seek to mitigate through various subsidies in an attempt to get votes, thus making the deficit worse. Any government gets its revenues through taxes but in India only 35 million out of a total of 1,200 million people pay income tax, of which about 89% are in the lowest tax bracket. Agricultural income is completely tax free, which is why a large proportion of politicians list their professions as farmers. To augment its revenues the government has levied a cascade of indirect taxes on every product and service, thereby adding to inflation and reducing consumer demand. When taxes are extortionate people will find ways of avoiding taxes which leads to accumulation of black money. Some of the highest taxes are on properties so it is not surprising that more than half the price of any property is paid in cash, which is the reason why property prices do not fall as in other countries. So far India has averted a crisis like that in Argentina and East Asia but it is a matter of time. Maybe the tapering of QE3 in the US will be the straw that breaks the camels back. We have been lucky so far but will that last?