The Hindu Business Line : 2008: A forgettable year

While 2008 has, no doubt, been a worrisome year, there is room for rational optimism about 2009, provided appropriate action is taken on the monetary and fiscal fronts.

Allocation of resources for National Rural Employment Programme may help to increase incomes in the rural areas.

S.Venkitaramanan

Dr Suresh Tendulkar, Chairman of the Prime Minister’s Council of Economic Advisers, had, in a statement, called attention to the wave of irrational pessimism that is pervading the country. Whether the pessimism is irrational or not is a matter of opinion. That it exists is a fact justified by what happened in 2008, a truly forgettable year.

Dr Tendulkar has, in his statement, traced the problem of the economy to the draining of domestic liquidity, consequent on the global financial turmoil, and a denouement in various financial institutions that led to the decline in their funding of Indian corporates and stock markets. He is right on dot in his analysis, but the fact remains that the year gone by has witnessed a lot of trouble in the Indian economy.

Too strong a medicine?

The question arises whether some of the actions taken by our proactive Central Bank were too strong a medicine that led to the aggravation of the crisis, instead of its containment. Even as the flow of funds from abroad to India decreased, the RBI started its fight against inflation, tightening the screws and withdrew liquidity through higher cash reserve ratio and imposition of limits of various kinds on borrowings. This was also accompanied by a series of restrictions on lending to real-estate, housing finance companies and NBFCs. The net result of all these measures, albeit well-intentioned, was that the decline in liquidity was magnified by the RBI’s action domestically.

While I continue to be a great admirer of the Reddy regime, which enabled the financial system of India to retain stability in a time of global crisis, it is possible to look back and argue that certain actions were perhaps symptomatic of greater stress, than justified, on inflation control rather than growth.

This raises the question whether the central bank of the country should be so independent in its pursuit of inflation targeting that it tends to under-emphasise the goals of employment generation and economic growth. There seems to be a case for re-examining the Charter of the RBI and introduce specifically a requirement, as in the case of the US Federal Reserve, that the central banker should subserve, simultaneously, the goals of inflation management, employment generation and growth.

It is also important to ensure that the regulatory actions of the RBI do not affect adversely the growth impulses in sectors vital to employment generation.

While it is true that part of the decline in the export sector, such as textiles and auto ancillaries, is the result of the global slowdown, one would have expected a greater extent of contra-cyclical actions from the RBI to meet the impact of the American slowdown.

This could have been accomplished by adjusting the various provisioning requirements for sector lending, apart from actions on the exchange rate front. This is especially true in regard to infrastructure.

The slowdown in the international financial market has already affected Indian infrastructure spending. The requirement that borrowers for infrastructure projects should undergo specific rating, as is prescribed under Basel-II norms, may be inappropriate in the present slowdown. It is to be hoped that in the refashioning of the RBI policy, the Governor, Dr Subbarao, will take this into account, if he has not already done so.

I had referred in an earlier piece (Business Line dated December 29, 2008) to the need for the RBI revising its attitude to the sources of funding for NBFCs. NBFCs are a vital source of financing for various critical units in India, such as consumer durables, transport, automobiles and housing. It is necessary that the RBI should relax its stance on domestic sources of funding for NBFCs.

Spur rural employment

The result of the review of the serious impact of the financial crisis in India has led to the first instalment of fiscal stimulus package.

It is obvious that monetary actions operate with a lag and they have to be accompanied by fiscal stimulus. Mr P. Chidambaram had already initiated a fiscal stimulus package before he moved over to the Home Ministry. A fresh fiscal stimulus package is expected shortly.

It is difficult to visualise the fiscal stimulus package on the lines of the ambitious proposals that the US Administration has in mind. Perhaps, the success of the US’ fiscal stimulus package itself will generate a resumption of consumption and investment activities in the US. This will lead to a beneficial effect on the Indian export sector. But, our second fiscal stimulus package has to bear in mind that employment in rural areas is vital and hence allocation of resources for National Rural Employment Programme may help to increase incomes in the rural areas.

Simultaneously, the textile industry requires special attention in the shape of excise duty relief and interest rate concession. These are parts of the first fiscal stimulus package also. But, it is to be hoped that the second package will give a respectable booster dose to the first package.

BoP situation

An obvious problem remains in that the fiscal deficit of the country may exceed the limits prescribed under the FRBM Act. This cannot be helped in the current circumstances when the situation is one of collapsing economic growth and loss of employment opportunities. The social turmoil that will result when jobs are lost on a wider scale will be costlier than the impact of higher fiscal deficit. The higher fiscal deficit of India need not translate itself into extra borrowings from abroad, given the fact that domestic savings are high. To this extent, there will be no direct impact of the fiscal deficit on the BoP situation.

This takes me to the danger on the BoP front, which arises from our declining export, although it is offset, to some extent, by a sharp decline in crude oil prices. This can be a factor in reducing pessimism in the economy.

While we can do little to correct the decline in US demand, we can definitely help the Indian export industry to become more competitive. The whole structure of taxes and interest rate has to be looked at from the point of view of encouraging exports.

While the situation on the BoP front is robust on the whole because of our forex reserves, there are signs of danger arising from the decline in the merchandise trade. There are some experts who feel that Government of India may have to resort to a fresh instalment of NRI bonds offering higher rates of interest than at present available to our NRI brethren in the international market. We resorted to this method in the 90s.

The NRI bond issue requires elaborate preparation and canvassing. It is essential that we should get the arrangements ready for such an exercise well ahead of the emergency. There are, of course, arguments in favour of not advertising this too early since it might induce loss of confidence in the Indian economy. On the contrary, to be well-prepared is the path of wisdom.

While 2008 has, no doubt, been a worrisome year full of problems, there is room for rational optimism regarding 2009, provided we take appropriate actions on the monetary and fiscal front. Here’s wishing all readers a happier and more beneficial New Year!

( blfeedback@thehindu.co.in)

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