The author is former director general, National Council for Applied Economic Research [email protected]
The Economist in a special issue titled “Doldrums — The world economy and how to rescue it” argues that the world economy might be entering a period of volatility in the business cycle, following “the bursting of the biggest bubble in American history”. It predicts that “the unwinding of America’s economic and financial imbalances has barely begun”, that the “downturn is not yet over” and we must expect “a protracted period of slow growth — perhaps even a further slump in output”. It says that policies for taming business cycles by governments have moved from Keynesian demand management policies to stabilize economies in the Fifties and Sixties, to an admission in the Seventies that governments were powerless to manage stagflation except to restrain inflation, and in recent years to the belief that recessions were a thing of the past. The growing globalization could result in bigger worldwide booms and busts.
The Central Statistical Organization has announced that between March and June 2002, the economy grew by 6 per cent against 3.5 per cent last year and 5.4 per cent in 2000-01. This “turnaround” as some call it, is said to have been in all sectors, with manufacturing showing a growth of 3.8 per cent (2.7 per cent last year), agriculture 4.4 per cent (1.1 per cent), mining 5.3 per cent (minus 0.3 per cent), construction 6.3 per cent (minus 0.2 per cent). In the past, only the service sector showed large growth. The trade and Central fiscal deficits are reported to have declined. The CSO’s past annual national income estimates have seen dramatic changes, mostly downwards, between the “quick” estimates and the “final” estimates.
We must be more sceptical of an estimate that relates not even to a full year, but only to one quarter. Also, last year’s first quarter was poor and so this year’s first quarter, even with modest improvement, shows a high comparative percentage growth. There are adverse elements still to factor in. This year’s drought over most of the country is already said to have reduced the kharif crop by 15 per cent. The continuing rise in domestic prices of petroleum, oil and lubricants, will affect consumer spending on other items. The rise in international prices of oil and gas will increase the trade deficit.
Prospects of war in Iraq and the possible stoppage of the present flow of Iraqi oil will further raise prices and hurt our balance of trade and consumer expenditures. The present decline in trade deficit perhaps is indicative of poor non-oil imports and some buoyancy in exports of information technology related products and services, as American companies flock to India in their drive to cut costs. The pressures on government expenditures and on its compulsions to borrow more are immense. The bailout of the Unit Trust of India, Industrial Finance Corporation of India and Industrial Development Bank of India, drought relief to states, rising defence and national security expenditures, the securitization of the oil pool deficit and consequent increase in government debt, are some of them.
The decline in interest rates has had little impact on industrial recovery but will reduce interest costs on government borrowings. It will make more borrowings possible without raising the deficit by much. Government borrowings in India are mainly domestic, not foreign. Hence they do not make the economy so vulnerable, as southeast Asia, for example, or Latin America, to fluctuations in overseas sentiment about the country’s economy. Our export dependence is lower and a world recession will not hurt us so badly. And inflation is at record low levels, not so much because of government action as because of the relatively low economic growth, led by low consumption and investment expenditures.
The capital markets are in poor state. Savings are not growing as in past years. Capital formation both in the private and public sectors is poor. Foreign investment does not seem to be adding new capacities, only buying up existing ones. The poor regulatory record of the Securities and Exchange Board of India over the market operators in the past, and of the Reserve Bank of India over non-banking finance companies, cooperative banks and even scheduled banks, has led to a scare among investors. Lenders are also nervous of risk-taking because of the rising levels of their non-performing assets and have huge liquidity.
There is no sign that governments are soon going to improve the financial viability of companies and departmental enterprises run by them. Electricity is a prime reason for state deficits and there is no political consensus on making it viable. The Bharatiya Janata Party in Andhra Pradesh or Karnataka opposes the policy of its own government at the Centre about raising tariffs. Water is another major drain on state revenues with poor metering, billing, collection and very low tariffs. Irrigation does not even pay for its operations and maintenance expenditures.
Most state transport undertakings run at a loss and there is no sign of their being privatized, though governments are unable to improve them. Railways have had such a poor investment and maintenance record that safety and upgradation have been sacrificed. The consumer and industry have certainly not benefited from government ownership and control and suffer poor availability and quality of all government managed services. Is it any wonder that Indian industrialists are seeking investment opportunities overseas'
India has had static if not declining share of manufacturing in gross domestic product, unlike China, where it is higher and rising. We need to build a manufacturing base for a variety of products. Instead, we have services contributing half the GDP, for long showing the fastest growth. The structure of the economy is lopsided for a country at our stage of development and poverty. And the very low levels of inflation signal a decline in demand, not stability.
The significant fall in interest rates in the last few years will probably lead to greater savings and lower consumption. With household savings the largest part of gross savings and substantially probably by people saving for their old age, they will now need to save more to safeguard themselves. But high liquidity in the banking system might keep purchases of durable products buoyant. Manufacturer margins will be eroded.
What should governments be doing in this situation' They must prevent deflation. This may require higher government spending and debt. The boom in construction and hence of related industries, is due primarily to the public roads programme and cheaper housing loans. But the government must strengthen its institutional framework to ensure that public money is spent efficiently, with least leakage. Revenues must be raised by higher user charges and disinvestments. The rupee must be encouraged to decline in relation to other currencies, which will also be declining. This is not the time to even consider capital account convertibility.
Indeed, the RBI needs to keep an even closer watch on outflows of funds, not relax it. Public investment must rise in high multiplier projects like construction-roads, irrigation and so on. The infrastructure must improve. An oil regulator must keep close watch on domestic oil and gas prices. Other independent regulators must have greater responsibility and powers. Instead of spluttering, the disinvestments engine should now be racing. Fiscal measures to stimulate demand might be in order and must be pursued.
Does this mean that we sacrifice the mantra of macroeconomic stability of the Nineties' Despite the mantra having been followed only spasmodically by governments after 1995, the answer is no. But it is time to take a short respite, and meanwhile tighten the supervisory mechanisms. It is good that we are not much attached as yet to the world economy. We can blame our own inefficiencies for most of our problems, not the weaknesses in the rest of the world.