The Hindu Business Line : Coping with the crisis

New Delhi needs a multi-tiered plan to lift the enveloping economic gloom. But all it has come up with so far are simplistic solutions to a very complex crisis building up in the economy since January. And time may be running out, says ASHOAK UPADHYAY.

Judging from the apathetic response of the markets and economy to the Reserve Bank of India’s latest measures announced last Saturday, two suspicions now stand confirmed. Since September, the Government has erred about the source of the economy’s current ailment; second, its diagnosis and policy prescriptions have targeted the symptoms rather than the cause of whatever ails India.

When the collapse of Lehmann Brothers and other Wall Street icons sent shock-waves across the western economies and some emerging economies such as Iceland and Argentina, both the Finance Minister and the Commerce Minister assured a jittery economy that India was well-insulated against external shocks.

When the Sensex reversed direction as FIIs began pulling out their stakes to fight the fires back home and almost nothing the RBI did seemed to stop the stock market haemorrhaging in late September and early October, New Delhi began pointing to the credit crunch in the West and the onset of recession as the direct cause of the slowdown back home.

Aiming wrong

One consequence of assuming that India had begun suffering the worse effects of the western crisis was a misplaced policy focus that was evident a fortnight ago when the RBI went overboard in its anxiety to solve a “crisis”.

Mistaking the symptom of a liquidity crunch for the ailment itself — the unwillingness of banks to lend to the growth sectors that had begun to wind down — the RBI backtracked; a number of its measures meant to guard banks against an overexposure to such speculation-prone sectors as the equity market and real estate were reversed on Saturday. The stock market responded indifferently; in fact, realty took a further beating.

Similarly, all that the interaction between the Finance Minister and some chief executives at the India Economic Summit resulted in was a futile ping-pong game; but by urging industries most affected by weakening demand — airlines, hotels, real estate — to reduce prices, Mr Chidambaram seemed to offer a dubious policy solution to the problem.

Weak consumer demand? Reduce prices and we shall consider excise duty reductions. Not surprisingly, the market fell further in response to this simplistic panacea for a very complex crisis building up in the economy since January. In a separate move, the Planning Commission deputy chief, Mr Montek Singh Ahluwalia, offered his own take on the crisis; the Planning Commission, he told this paper, is working on ramping up public expenditure on existing projects to revive economic activity and investments.

At this juncture that sounds like an unexpected voice from the wings; the centre-stage of policy is occupied by monetary policy engaged in futile fund injection and North Block bargaining with fiscal incentives.

Come together right now…

In New Delhi, policy players sound like a band of musicians playing different tunes at the same time; each sounds pleasant but the total effect is discordant. What is needed is someone to put together a strategy that will work over a longer time-frame than the immediate one of weakening demand.

Policymakers must realise that sluggish demand is not an outcome of the global crisis that erupted in September. Weakening demand had begun to affect manufacturing and overall industrial activity even in the last quarter of the last fiscal. In January, the start of Q4 2007-08, industrial production and manufacturing had slipped to around 5 per cent and never looked up thereafter as the vicious cycle of weak demand and falling output kicked in.

The cumulative result was evident in the fall of industrial production to around 4 per cent in the first half the current fiscal, from 8 per cent in the corresponding six months last year.

But how did 2007-08 post a GDP of 8.8 per cent despite the last quarter’s fall in manufacturing? The RBI data show Services GDP at a robust 11.4 per cent in the same quarter; in fact its trend was the opposite of manufacturing; with the sector’s GDP rising one percentage point over the same period, manufacturing fell four percentage points.

Within that high-growth sector, the top of the class were hotels and restaurants and trade, construction and real estate that all grew an average 11-12 per cent. But the last quarter of the previous fiscal was also the last gasp of consumer demand that had peaked. By April-June, Services GDP had dropped one percentage point and what we are now witnessing is the decline in precisely those sectors that had kept GDP shored up till last year.

Symptom and disease

In effect, the fall in manufacturing that has so exercised the Finance Minister was precipitated, not initiated, by the decline in consumer spending in those expansionary sectors, real estate, hotels and trade and transport once the world began to spin out of control from September on. Is it any surprise that hotel bookings are falling, or that real estate stocks are plummeting?

The cumulative effects of high interest rates, high input prices and global inflation (till September) — and, of course, the aftermath of the Wall Street crisis and the tectonic slide of the Sensex — simply pushed demand to a point where producers reacted by cutting output, setting into motion a vicious cycle.

The Indian economy suffers from an extended period of high interest rates, high prices consequent to supply constraints that are more domestic in origin than global and declining business confidence that was ignored by policy players fixated on inflation and blinded by GDP numbers.

But the decline in output is itself a result of a more systemic crisis; four years of sustained expansion have taken a toll on the standards and levels of current infrastructure; roads and ports are clogged, the urban space is a mess and power shortages are hurting. If industrial expansion has to revive, simply reducing prices will not work. The economy has to over-reach itself, which means the core sector has to be scaled up to cater for the next round of growth.

What needs to be done…

The world crisis, therefore, did not create the present crisis; it turned a domestic system failure and its reflections in weak demand and falling output more vivid and urgent. So New Delhi needs a multi-tiered strategy that looks beneath the reflections of the crisis. Monetary measures have to be accompanied by fiscal ones, such as excise duty cuts; both should work for a general reduction in input and interest costs; that would give the policymaker a moral basis to convince producers to lower their final prices.

But, most of all, the Government must spend effectively not simply commit funds on paper to prevent investment demand falling further.

…but may not be done

But time may be running out for the present Government. Key State elections loom and media reports suggest ministers will be busier on the campaign trails than at Group of Ministers’ deliberations over what needs to be done.

New Delhi will let the RBI do the needful, mainly pampering a tantrum-throwing Sensex with promises of more liquidity; interest rates may fall but banks will not lend as freely as they did when the economy was singing in the shower. And, before we know it, it will be time for all of us to vote for the next government.

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