Acting in good faith
Almost all discussions about the global economy during the last couple of years have focussed on the Eurozone crisis and, in particular, on the plight of the Greek economy. There were very realistic fears that the Greek government would be forced to renege on the terms of the successive bailout packages offered to them by the European Central Bank and International Monetary Fund. This was not because the Greek government was acting in bad faith, but simply because the degree of austerity being imposed on the people was excessive. The Eurozone crisis intensified because some of the bigger banks in Spain also required huge infusions of funds in order to keep their heads above water. There have been times in the last couple of months when bets in favour of the collapse of the single currency system looked very attractive.
Although European economies are very far away from anything resembling a recovery, they seem to have weathered the storm — at least temporarily. This has been made possible largely because of pressures on Germany from other European countries, as well as from the other side of the Atlantic, to allow the ECB and the European stabilization fund to directly inject funds into troubled banks and also to allow Greece some more flexibility. The German chancellor, Angela Merkel, was initially unwilling to take these steps because of domestic political pressures. “Why should we bail out the rest of Europe?” is a common feeling amongst many Germans. But she eventually succumbed to these pressures, perhaps realizing that the collapse of the single currency system would also have a severe negative impact on the German economy.
Unfortunately, the global economy is very far away from recovering from the meltdown which started in 2009. Storm clouds have been gathering — in fact much closer to India. The Chinese economy, which is now the world’s second largest economy after that of the United States of America, has also been going through a bit of a crisis. Its second-quarter growth rate has now dipped appreciably to the lowest level since the onset of the global crisis in 2009. Of course, to keep things in perspective, the rate of growth is 7.6 per cent — every other country in the world would love to be able to grow at this rate today.
The Chinese economy has been slowing down for over six quarters. Fears that the Chinese economy was overheating after many years of double-digit growth probably resulted in a deliberate government policy to slow down the rate of growth. There has also been an attempt to rebalance the economy away from its excessive reliance on exports and investment towards domestic consumption. However, domestic consumption has yet to grow as much as hoped for. This, together with the slowdown in external demand for China’s exports, has contributed to the much lower rate of growth of the economy as a whole. The Chinese government is aware of the need to stimulate the economy. It has reduced interest rates twice in the last month and has also lowered the cash reserve ratio in order to increase the availability of credit. There are hopes that these measures will help boost the growth of the economy in the next quarter.
Despite this positive expectation, it is clear that world markets will continue to be in the doldrums for some time to come. This has, obviously, serious negative implications for all developing countries, and India is no exception. The latest figures provide a pretty gloomy picture of the Indian economy. The growth rate has fallen to under 5.5 per cent, which is the lowest in many years. Investment has slackened, with foreign direct investment in particular more or less drying up. Not surprisingly, Indian exporters are finding it increasingly difficult to find a market for their products — this is the inevitable outcome of the slowdown in the world economy. The Indian stock exchange has been amongst the worst performers in developing countries, prompting foreign institutional investors to withdraw, at least partially, from the Indian market. This has resulted in a severe depreciation of the rupee. The economy is also crippled by a huge fiscal deficit. The high level of government borrowing may well be crowding out private investment.
Virtually everyone — from the venerable economist to some of the government’s own officials — blame the “policy paralysis” for the slowdown in the Indian economy. It is true that the United Progressive Alliance government in its second incarnation has not implemented any reform, although the Congress itself has often talked about the need to introduce a whole slew of reforms in insurance, banking, and in the organized retail sector. Unfortunately, it is clear that the Congress cannot convince its allies of the necessity of carrying out these reforms. So, we do have to live with the fact that meaningful reforms are highly unlikely to be implemented in the course of this Parliament.
But the inability to enact new legislation does not mean that the government cannot act decisively in order to revive the health of the economy. In fact, in a recent interview, Montek Singh Ahluwalia, deputy chairman of the Planning Commission, has drawn a sharp distinction between “reforms” and “executive action”, the latter referring to steps that the government can undertake without recourse to new legislation, and has pointed out that several executive actions can be taken in order to step up the growth rate.
Perhaps the most important example of executive action would be steps to reduce the fiscal deficit. This cannot be done without a drastic reduction in subsidies. Both the prime minister and Pranab Mukherjee, while he was the finance minister, have talked about the need to bite the bullet. In particular, the government has to ensure that the fuel subsidy is brought under control. This in turn will involve an increase in the price of diesel. Of course, this will be very unpopular in the short run since any increase in the price of diesel will have repercussions throughout the economy. However, it is important to realize that this will be a one-time effect, and will not trigger off an inflationary upsurge. The Congress’s allies will protest vehemently. Mamata Banerjee may threaten to leave the government. But the Congress will simply have to call her bluff and soldier on.
The government must also use its influence with the Reserve Bank of India in order to introduce some much-needed monetary expansion. The RBI has been excessively cautious — or biased — in its policies. It seems to have given undue weight to the need to control prices, and done very little to take steps to ensure availability of credit. The pronounced slowdown in the economy cries out for a fair bit of monetary expansion.
As always, much will depend upon the monsoon. A bountiful harvest will ensure that most food prices remain under control. This will provide the government some flexibility to take some of the hard actions without which the economy cannot grow in the immediate future.