The current struggle of the NDA government to bring the Indian economy out of the mess created by the decade long Manmohan Singh administration reminds me of a childhood memory. The park outside our house in the ALTTC campus in Ghaziabad had two swing sets. The swings were always occupied. Kids used all sorts of ways to organize turns on the swings – first come first serve, age, precinct, threat of mommy watching over from the balcony, time each kid was allowed on a swing etc. A few kids had their own way of getting even – they used to spit on the swing seats after they had enjoyed their time, leaving them unusable for other kids.

Many watched helplessly as a few spoiled the play. There were some, who confronted the perpetrators, made noise and threw a bunch of accusations and curse words. The spitters couldn’t care less; the commotion gave them an additional kick. Then one day a kid caught one of the spitters in the act and beat the hell out of him. The spitting stopped after the incident.

The NDA government has been handed over a swing with spit all over it. There is nothing in the economy for the new government to, for lack of a better word, enjoy. Subramanian Swamy recently warned the government that an unprecedented economic crisis is on the horizon. My articles on SeekingAlpha resonate with his views – Will India Be The First Domino To Fall? and You Can’t Just Invest On Hope.

About two years ago, investors all over the globe had given up on India. All they witnessed during the decade long UPA regime was a banana republic at play; accusations and counter accusations exchanged between the opposition (then BJP) and the government, with no follow up action on the ground. No one was held accountable for the scams that ran into billions of dollars. That was until Subramanian Swamy, the kid who beat the spitters, stepped into the game. Politicians went behind bars and billions dollars’ worth of illegal transactions were cancelled by the Supreme Court.  Investors for the first time saw the rubber meet the road in the judicial system in India, and the airwaves carried that message loud and clear – “If the BJP, which Subramanian Swamy represents, comes to power, the state of affairs is going to change in India.”

In what came as a surprise to the investors, Swamy was not given the finance ministry when the Modi government took oath last year. Today, after about a year and a half, that message is beginning to fade. Jim Rogers, a well-respected investor in the U.S, is more often than not the first one to read the airwaves; and he has decided to quit India. Jim bought into India with a hope that the Modi government will bring free market reforms. He sold all his investments in India last month. “You can’t just invest on hope” were his parting words.

The first three fronts that investors and entrepreneurs evaluate before investing in a country are the reliability of its judicial system in resolving conflicts, fiscal position of the government and monetary policy of the central bank. The government has failed to deliver on all the three fronts. Our bureaucrats (and the politicians they educate), who have been trained under a socialist regime, are shying away from substantial reforms, and are pushing for the same-old “tried and tested” policies, that they believe failed earlier only because of lack of efficient execution. They fail to recognize the fatal conceit.

Subramanian Swamy has proposed two far reaching solutions to deal with the imminent crisis.

    1. Abolition of the income tax

To someone who does not understand how free markets work, abolishing the income tax might look like an out-of-the-world measure. In reality, it is nothing but. No tax on income is something that free market economists in the U.S. have been dreaming about since 1913, before when there was no income tax in the country (only profits were taxed), and before when the country developed at its fastest pace in history.

This single measure can seize a major victory for India on one of the three fronts. When investors and entrepreneurs see that the government has abolished the income tax, they will not need to speculate about whether the government will reduce its size; they will know for a fact that the fiscal policy of the government will be prudent. And the money that is currently being squandered away by the government on its “new and innovative” boondoggles will be freed for productive uses. My article Republic of Ghaziabad explains in layman’s terms how the economy of India will bounce back if the income tax is abolished.

    1. Reducing the prime rate of interest

This solution proposed by Subramanian Swamy is not consistent with free market principles. Interest rates should be determined, without any interference by the RBI, by supply (i.e. savings), demand (i.e. demand for credit) of money and credit risk, which private banks, and not nationalized banks, can assess and determine. Keeping interest rates artificially low benefits a small fraction of the population at the expense of savers, and the poor who suffer from inflation.  The UPA government made exactly the same mistake in late 2008 and we are dealing with the consequences to this day.

Laying down, and announcing, a five year course to abolish the RBI would do better for the Indian economy than any free market reform. India did not have a central bank before 1935. In 1926, Montagu Norman, head of the Bank of England and Benjamin Strong, Governor of the Federal Reserve Bank of New York, used all the resources at their disposal to defeat Basil Blakett’s plan to establish a full gold standard in India. After the push from the U.S. for central banking in India, the RBI was established on April 01, 1935; perhaps the biggest April Fool of the Indian population. Later in 1944 at the Bretton Woods agreement, the U.S. dollar was accepted as the reserve currency. However, in 1947, the British, lacking resources after they were brutally hammered by the Axis powers all over the globe, relinquished their influence over the subcontinent to their war ally, the Soviet Union. Under the Soviet influence, the RBI did not collect the notes printed in the U.S. After the collapse of the Soviet Union in 1991, the RBI started collecting dollars as reserves. The U.S. printed the dollars, without any gold backing, and the RBI collected them from exporters, transferring the wealth of savers and producers in India to consumers in the U.S. and a few exporters in India. The RBI has been draining us dry since 1991. My second article of the series, Republic of Ghaziabad – Part II, explains in detail how the RBI is responsible for the mess our economy is in and how we can put shackles on the institution to prevent it from doing further harm.