December 12, 2008 10:49:51 pm
These are times when John Maynard Keynes has become topical again. First, we are back to discussing the Bretton Woods system, the IMF, flexible exchange rates, a World Financial Organisation (WFO), a global central bank, Bancor (proposed international currency) and a global clearing union. Second, we are back to depression, recession and fiscal policy, away from supply-side economics. In the aftermath of the East Asian financial crisis in 1997, countries like Indonesia and South Korea were cajoled by the IMF to close banks and financial institutions and raise interest rates to exorbitant levels. In contrast, now that it has happened in the West, bailouts and quasi-nationalisation of banks and financial institutions are the norm. “Much of what Keynes wrote still makes sense. You will see us switching our spending priorities to areas that make a difference — housing and energy are classic examples where people are feeling squeezed. What I want to avoid is getting ourselves in a position governments have done in the past, where you face an immediate problem and cut back on the things the country will need in the future… we can allow borrowing to rise.” No, this isn’t a quote from Manmohan Singh, P. Chidambaram or Montek Singh Ahluwalia, though it could well have been.
This is a quote from British Chancellor of Exchequer Alistair Darling, when he unveiled an expansionary fiscal package in October, a quote that would have been unthinkable two years ago. The non-economist may well wonder about economists possessing divergent points of view, unaware that the origin of this joke is also Keynes. Winston Churchill had said, “If you put two economists in a room, you get two opinions, unless one of them is Lord Keynes, in which case you get three opinions.”
That’s the background against which one should consider recent Indian monetary policy (repo and reverse repo rate cuts) and fiscal policy (additional Plan expenditure of 0.4 per cent of GDP, Cenvat cut of 0.17 per cent of GDP and export incentives of 0.2 per cent of GDP) announcements. Monetary policy was loosened earlier and there could be more fiscal measures (home loan packages). How has
India fared in 2008-09 on growth? Not as badly as one had feared, before Q2 figures came in. The first half produced growth of 7.8 per cent, significantly lower than 9.3 per cent in first half of 2007-08. But 7.6 per cent in Q2 was better than expected. To restate what seems to be obvious to every economist, but perhaps not to every non-economist: the slowdown in 2008-09 pre-dated the global financial crisis and can be attributed to tight monetary policy and hardening interest rates.
The global shock is in addition. The “decoupling” argument in the real sector has been done to death, without people necessarily explaining what they mean by the word. First, there is a cyclical element to decoupling. Ups and downs in growth patterns in the developed world are mirrored by growth cycles in emerging economies, including India. There is no dispute there is no decoupling in this sense. However, if by decoupling one means de-linking of trend growth rates in fast-growing developing economies in Asia from growth trends in the developed world, that decoupling has occurred. When talking about counter-cyclical monetary or fiscal policy, it’s the former kind of decoupling we are after and it is indeed the case India isn’t as insulated as one thinks. (That financial sector is even more globalised and integrated and has spillover effects on real sector is an additional point.) After all, export (goods plus services) GDP ratio is 14 per cent and the import/GDP ratio is 21 per cent. Net invisibles (most service exports figure in invisible flows) are 6 per cent of GDP. Since 2003, Indian growth broke into the 9 per cent league. But that growth happened in a benign global environment. In a short- and medium-term perspective, the global environment is now malign and no domestic initiatives can alter this.
In March 2008, the commerce ministry projected 30 per cent export growth in dollar terms (merchandise trade alone) and an export target of $160 billion ($200 billion with services). In October 2008, export growth was actually negative and life would have been tougher had the rupee not depreciated. Given this, what kind of GDP growth can we expect in 2008-09? The government expects 7 per cent, reinforced by Q2 optimism, and most external forecasters have predictions between 6.5 and 7 per cent. One is effectively taking a call on time-profile of global effects, superimposed on slowdown that preceded it. To what extent will adverse effects show in 2008-09, as opposed to spillovers in 2009-10? Since economists are invariably better at predicting the past, and not the future, the 6.5-7 per cent band seems remarkably like a consensus in 2008-09. 2009-10 is different and is like a Tower of Babel. The former finance minister predicted the economy would recover in six months (without specifying recovery to what), the prime minister said 7-7.5 per cent and the chief economic adviser said 8.5 per cent. External forecasters have spoken of figures as low as 4 per cent (which is an outlier), though 5-6 per cent is more common. That kind of band establishes consensus on complete ignorance.
In fairness, perhaps this disagreement reflects differing views on what monetary and fiscal policy can deliver. Barring some timing issues, monetary policy has been relaxed appropriately. It is a separate matter that monetary policy (despite liquidity infusion) hasn’t yet delivered, either on lower interest rates or on greater bank lending. Everybody agrees on this. The disagreement presumably is on effectiveness of fiscal policy, with a government euphoric over fiscal policy reportedly planning dilution in the Fiscal Responsibility and Budget Management Act. Had fiscal reforms and rectitude characterised years of buoyant growth, life would have been different. But today, properly accounted (not technical definition of fiscal deficit alone) deficits are at pre-1991 levels, with the Centre the culprit. There is little room for fiscal expansion and barring indirect tax cuts, other elements of the new fiscal package sound more promising than they are. As shares of GDP, numbers are insignificant and government spending suffers from time lags, apart from efficiency being doubtful. More importantly, today’s India isn’t in the middle of a great depression, defined as one where resources don’t have opportunity costs. Some questions have been raised about data. Ignoring this, India’s investment rate is now more than 36 per cent. The fiscal stimulus, if significant, implies a switch from private to government expenditure and from investment to consumption expenditure. This knocks the bottom out of what has driven
Indian growth since 2003. Perhaps that reason, rather than global
factors, persuaded non-government forecasters to reduce their forecasts to 5 per cent.
The writer is a noted economist
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