The Hindu Business Line : Commodity prices vital for sustained recovery

First, it was believed that no more than a rescue of financial institutions was necessary. So it started with central banks assuring commercial and investment banks of adequate liquidity. Soon, solvency of the banking system became the issue, forcing governments to effectively nationalise failing institutions.

Meanwhile, central banks cut interest rates aggressively, trying to shore up asset prices. One percentage point reductions in one go have become the norm. Such drastic actions have not been seen in recent times and underline the seriousness of the situation.

Dim prospects

All these, it is now clear, are not enough. The G-7 economies have dived into recession. China and India have slowed down significantly. There is little doubt that their prospects look far worse than they did just weeks ago. For India, even 6 per cent growth in current conditions seems optimistic.

The buzzword is Keynes. It is a sign of how quickly things have changed that hardly anyone questions the extraordinary increases in governments’ spending being proposed everywhere, just as Keynes advocated when in dire straits. Nor are alarm bells being sounded over prospective fiscal deficits.

Monetarists and proponents of budget discipline have been stunned into silence at the scale of destruction of economic activity. Implicitly, they agree that there is absolutely no chance of the private sector pulling us out of the abyss.

What is more, they cannot blame Governments, having got all they wanted — lower taxes, deregulation of financial, product and labour markets, independent central banks, et al. The reward – financial buccaneers bringing the global economy to its knees.

President-elect Obama has wasted little time in drafting an ambitious plan of public works to create jobs immediately.

The Indian Government will spend Rs 20,000 crore to revive the economy, apart from the RBI slashing interest rates and reserve requirements to cheapen capital and inject liquidity.

Will all this work? What are the risks?

Silver lining

The silver lining in the crisis is the sharp drop in inflation because of the crash in commodity prices — energy and metals in particular — enabling all the pro-growth actions of governments and central banks.

While policymakers would not be unhappy to see asset prices (house, stock markets) revive from their depths, commodities are a different matter. Any hope of sustainable growth rests very much on continuing soft food and energy prices.

What should governments do? Perhaps build buffer stocks to release into markets if commodity prices get out of hand. Otherwise, the recovery could derail before it gets off the ground.

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