The Hindu Business Line : Economic paradigm shift

The power to drive the global economy now vests with two major players: China and India. It is the size of their domestic economies combined with their savings rate that offers hope for the rest of the world.

V.K. Madhav Mohan

The current global economic scenario is not something we have experienced in our lifetime. Comparisons are being made with the Great Depression (1929-33) and later crises. However, it is dangerous to hark back to the past and try to recycle and refurbish previous policy responses. That is because the Indian economy and the global economy are vastly different from what they were even 5 years ago.

The primary point of departure is the level of integration brought about by information technology. The direct consequence of this integration is that real-time information availability has almost eliminated lead times. Therefore, what happens elsewhere creates immediate repercussions, which need anticipation and speed of decision-making — both of which are inherently absent in our coalition polity.

Furthermore, our leaders are prone to look at the present through lenses of the past. What we are staring at now is simply not an extension of the past. A paradigm shift has occurred right under our noses and strangely, we haven’t even noticed. So, what is this shift that has moved the economic tectonic plates irrevocably?

Global Economics

Firstly, the global financial system is in ruins. When the interbank lending market collapses, the creation of credit grinds to a halt. If banks don’t have confidence in each other’s repayment capabilities, how on earth will they have the confidence to lend to corporates or the retail borrower? How can banks manage their asset liability mismatches in the short run when there is no interbank market?

The loss of credit confidence is reflected in volatility in global stock and currency markets. The rupee-dollar rate is apoplectic because billions are being sucked out of Indian and global financial markets by FIIs and other investors who have to meet their debt repayment obligations in the US. The demand for the dollar has everything to do with staving off bankruptcy of various entities in the US. This is a phenomenon that we have never witnessed before.

Secondly, the failure of regulatory authorities in the US and Europe has, without doubt, proven the effectiveness of the Reserve Bank of India. For all its resources and reputation, the US Fed has been found wanting for its failure to sense the depth of the crisis-in-the-making. Bank regulation has been far tighter in India. The RBI has emerged, arguably, as the best central bank in the world and we can take pride in its competence.

However, some banks are not yet out of the woods in India. Traditionally, the income of the banks comes from three major streams: lending, non-fund business (commissions, charges, etc) and treasury operations. Lending and treasury operations have all but dried up and as a consequence, non-fund business is badly affected. So it will be interesting to watch the financial results of Indian banks for the year when they reveal all on March 31, 2009.

Thirdly, the scope and scale of the crisis has revealed the dangers of export-led strategies. Pursuit of dollar revenues and their attendant concessions is fraught with the risk that importing countries can suffer catastrophic economic meltdowns that can vaporise export markets. A case in point is the example of garment exporters whose businesses have more or less collapsed because large retail chains have stopped ordering.

For the foreseeable future, the US and Europe will not have the horsepower to pull themselves, let alone the rest of the world, on. The power to drive the global economy now vests with two major players: China and India. It is the size of their domestic economies combined with their savings rate that offers hope for the rest of the world. Both these giants are surely learning how to flex their economic muscle and take their rightful place at the high table.

Policies to Mirror the Shift

India has the greatest opportunity in its modern history to regain its economic eminence of yore. If we are to seize the opportunity and resist our tendency to miss the bus we have to make breathtakingly bold policy shifts. That is not to say that we have to eschew our cautious and well considered approach that has protected us thus far. But the policy shift has to mirror the paradigm shift that has by default transferred economic power to us. If we can do that we can perpetuate our dominance.

To consolidate our economic power and continue to grow at over 7 per cent a year we must inject liquidity on a massive scale into our economy, without delay. The way to do that is not to resort to deficit financing or loan write-offs, both of which provide negative incentives for efficiency.

The Underground Beast

According to the World Bank, India’s GDP stood at $1.171 trillion in 2007 (http://devdata.worldbank.org/AAG/ind_aag.pd). That is the official, over-the-ground economy. But everyone knows that India has nurtured a thriving, below-the-ground economy awash with cash. The size of that economy is huge and much bigger than the official economy of many countries. While its not necessary to philosophise here about the reasons for the growth of this beast, let’s assume that it is roughly 30 per cent the size of the official economy. That would make the black economy of about $300 billion, almost entirely in cash, real estate and gold.

When paradigm shifts occur it is necessary to let go of the past and go back to zero-base and look at everything from a new perspective. So let’s look at this $300 billion behemoth below the surface with national interest uppermost in our minds. We badly need to inject a massive dose of liquidity into our system to maintain and perhaps accelerate our economic growth so that we can assert our national economic power on the international economic system. For this we can bring parts of our $300 billion underground economy overground.

Converting “black to white”

Firstly, let’s accept that the underground economy exists and then decide to deploy it in the national interest.

Secondly, let’s introduce a 6-month window for people to invest their “black” cash in the stock markets, no questions asked about the source. This will immediately bring investors back into the bourses and result in an upswing in stock prices. It will also relieve millions of people from the stress of holding undeclared income in cash by helping them convert their “black” holdings into “white” equities.

Thirdly, we can design a targeted sectoral investment plan (government bonds) with the necessary tax waivers and amnesty that will encourage the flow of black money into designated investment avenues. For example, one target avenue for investment of black money with an amnesty would be an infrastructure development bond in which people can invest directly. This would certainly relieve the perennial shortage of resources for infrastructure investment. In a sense that would also prime the pump and give development expenditure a steroid injection.

By combining the three steps listed above with appropriate rules, time frames, conditions and amnesty we can effectively convert a long standing evil into a national asset that strengthens our country and prepares it to regain its economic glory. A pragmatic, paradigm shift in our thinking can immediately pump in anywhere from $30 billion to a $100 billion into our economy. That would perpetuate the India growth story.

TheLonelyCEO@gmail.com

http://TheLonelyCEO.blogspot.com

More Stories on : Financial Markets | Management | IT'S LONELY AT THE TOP

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
DoCoMo-Tata deal

A tax paper of the right standard

Economic paradigm shift

What can be the alternatives to severance?

What is crucial in dealing with loss is not to lose the lesson

Just Do IT

Number Crunch

Why is there less interest in rights issues?

60 Seconds Chief

Stay calm when heckled

Tips for a healthy voice