The Hindu Business Line : Combating the present crisis

Since August, two perspectives have influenced the way policymakers viewed the world and India’s place in it. The first view held that India was sufficiently decoupled from the world economy’s stresses, that Indian financial services and, most notably, banks were insulated from the worst excesses coming to light.

The second and prevailing one clearly assigns blame for the current problems India is facing to the contagion effects of global turbulence and the increasing difficulty Indian firms are facing in accessing global capital.

Flurry of policies to what end?

Till the first week of October, three weeks after the collapse of Lehman Brothers and the crisis in AIG and Merrill Lynch had sent Wall Street into a downward spin, the first view held sway and created that sense of complacency evident till the last week of September, almost till the announcement of the US bailout plan. And when the FIIs began mauling the Sensex, the second viewpoint spurred the RBI cut in the CRR in the first week of October. The first viewpoint generated some grandstanding, with the finance and commerce ministers assuring investors that India was adequately prepared for the worst; the second led to an overreaction, a misplaced sense of policy priority.

A liquidity crunch, reflected in the widely disseminated view that banks had little to lend because the RBI was busy selling dollars to exiting FIIs, led to a flurry of policy announcements by the Finance Minister and the RBI much ahead of, and subsequent to, the mid-year review scheduled for late October to fill in the shortage. Yet, credit remains a problem not just for small enterprises but for large industry and consumers too. That is the problem that the Finance Minister sensed when he requested bankers last Tuesday to price their credit right. So was supply of funds or its price the problem?

Price of credit predates global crisis

In part, it was supply, but largely it has been the cost of funds. High interest rates and their baneful effects predate the global meltdown, having been the cornerstone of the RBI’s tight monetary policy for three years. The cost of funds was an issue for consumers seeking home loans and small enterprises unable to tap cheap debt abroad.

The meltdown since September has turned the cost of money into a universal problem for the economy as large companies unable to find cheap capital abroad knocked on domestic bank doors, some in vain. Who would have thought that SBI would be more willing to lend to Air India for its sovereign guarantee than to Kingfisher Airlines?

The global meltdown after September, therefore, did not create the pricing crisis; it only universalised it. Just how much interest pricing had begun to hurt became evident long before the global crisis became the world’s talking point.

Industrial production and manufacturing more than halved in the last quarter of 2007-08 to around 5 per cent; but the decline had begun in 2007-08 itself when both slipped from the peak of 10.6 per cent and 12 per cent respectively. So had consumer spending.

Non-food credit growth averaged 20 per cent, a far cry from the 30 per cent it had in 2003-04 on the strength of a massive build-up in retail and housing credit.

It was the fear of overheating that had led the RBI to increase interest rates and from last year, the cost of bank funds through repo rate and CRR hikes. But though retail credit moderated last year itself, the RBI continued to raise interest rates under the assumption that inflation required it. But the source of primary inflation lay in supply constraints, not in an overheated economy.

Predictably, by January this year, the lagged effects of high interest rates and slipping demand began to tell on output. Despite a Sensex galloping into the 20,000 points region, the Prime Minister’s Economic Advisory Council read the tea leaves and shaved growth forecast to around 8.5 per cent from the 9 of the previous year; in June it scaled it down even further to 7.7 per cent.

It further advised that prospects of “reasonable rate of growth” rest on the “presumption of a return to normalcy” in the global environment.

Coping with the real problem

Considering the current crisis of confidence as an evolving problem explains a number of otherwise puzzling issues. It does seem strange that within a matter of two months, from September to October, the Indian economy with its “strong fundamentals” should so easily and rapidly, crumble — enough to cause blue chip companies across the board to cutback output and costs.

Equity market indices fall suddenly and, precipitously. But economic indicators fall gradually, often in fits and starts though sometimes steadily as manufacturing and industrial output, in general, have over the last four quarters. The outcome of that trend shows up in the slippage in Q1 this fiscal of real Gross Fixed Capital Formation to 9 per cent from 13 in the equivalent period last year.

Yet, intriguingly, credit growth in April-June at 24 per cent was higher than in the same period last year when it dipped to 20 per cent. Also, FDI flows have been the highest at $16 billion.

The story numbers do not reveal

So what story are the numbers telling us? The credit growth numbers are almost meaningless in the context of slipping business confidence and may not presage a trend, given the sticky fingers of bankers; companies may have borrowed more to stay in the same place on account of rising energy prices and interest rates before September.

As for the FDI flow, that is just a number indicating intentions. If the current mood is anything to go by and investors push the pause button, the record FDI flows may just remain that — a record.

The Indian economy has been suffering from a protracted illness that the sudden contagious virus from the West has compounded. To heal such an economy heading into a trough is to understand the supply constraints that four years of high growth has run into.

New Delhi has to consider the impact of tight monetary policy on demand and the need for countercyclical spending that can rejuvenate spending all around. It has to consider the impact of a truncated Parliament session on pending legislation that would have rendered land acquisition and new mining policies valuable catalysts to fresh industrial expansion.

And it has to contend with the idea that the emphasis on liquidity alone may prove as futile as stirring speeches to somebody with rising fever.

Finally, it has to realise that the economy it inherited in 2004 robust at 8.5 per cent GDP could end the year and its term whimpering at less than 7 per cent. That would be the unkindest cut.

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Stories in this Section
Tackling the slowdown

Downward spiral

Calibrating the inflation meter

Combating the present crisis

BoE rate-cut: Barking at the moon?

Keep horn craft alive

Shortage of funds

Industrial relations

Role of supervision