It ain146;t broke. But let146;s fix it

Capitalism8217;s two camps

Yet an utterly pointless argument is being made about the intrinsic lack of worth of the global capitalist system. Another, more substantive, more interesting, but equally pointless argument in fashion now is whether capitalism8217;s purity is being violated by government intervention. Capitalism with impurities is better than any other system and capitalism that8217;s pure but gravely threatened is of no use. We can call these advocacies, respectively, the capitalism-is-broke CIB argument and the capitalism-isn8217;t-about-fixing CIF argument.

However, in the marketplace for popular ideas, just because some advocacies are pointless doesn8217;t mean they are powerless. In mature capitalist democracies, the CIB crowd will most likely not change the rules of the economic game; although some overregulation may happen. The CIF crowd is already being ignored. India8217;s political economy8212;a capitalism in transition, complicated politics, sharper divisions between the left and right, the lack of a permanent, non-party, policy-influencing elite8212;makes it more vulnerable to both sets of arguments. Therefore, how the policy establishment acts in the next few months will determine India8217;s future.

The impact

To see what those managing India8217;s economy should do, it is necessary to understand how these two pointless but potentially powerful arguments can play out in India. Paradoxically, instructively and dangerously both the CIB and the CIF crowd will be happy to see failures. A decline in growth rate8212;RBI8217;s projection is now 7.7 per cent for this financial year8212;in the short term is not the most worrying prospect for economic managers in the short term. Firm and industry-level shocks are what they should be looking out for. The current crisis carries the potential for companies, including post-reforms iconic ones, to get into serious trouble. One likely reason would be the incapacity to service financial obligations and/or raise resources to roll over debt at a time global credit is scarce and expensive. This can apply to financial and real sector firms. The other impact will be via a severe fall in global demand. From brass exporters in Moradabad, diamond polishers in Surat, to IT majors in Bangalore and many more big and small enterprises will face varying possibilities of difficulty or insolvency. Domestic demand crunch will hit the realty sector hard. Already some real estate companies are facing payment problems for land bought from governments. Housing demand is falling and commercial real estate built on the assumption of brisk economic activity can become big liabilities for developers. In fact, a real estate shock isn8217;t out of the question8212;banks with big exposure to real estate see an increase in their bad assets, first time home buyers get into repayment difficulties as incomes shrink and mall developers struggle with excess supply of commercial space.

Some of these changes may lead to big firm-specific or industry-wide failures. How will the CIB and CIF crowd respond? The CIB crowd will say this is proof India8217;s post-1991 embrace of liberal economics was a Ponzi scheme, a capitalist con game that8217;s now been exposed. The CIF crowd will say failures are proof that Indian capitalism is working and that the destruction is creative, new businesses will emerge. The CIF crowd, who are basically good guys who understand and cheer capitalist economic organisation, will be playing right into the hands of the CIB crowd. They will make this mistake because they will ignore India8217;s politics and people.

Politics and liberal economics

India8217;s politics has stopped loathing liberal economics but it hasn8217;t as yet learnt to love its essentials. This is natural at this stage of India8217;s economic evolution. Remember that for 40-plus years, politics was built around the suspicion of business. In a political system where gerontocracy is the most powerful aristocracy, many of our powerful politicians learnt their trade and formed their views in the pre-1990 period. So inside many politicians who have undertaken fine reformist measures over the last two decades lives a person ready to respond to 8216;fears8217; about the market and to bad press about business 8216;fragility8217;. The CIF crowd doesn8217;t understand how powerfully the CIB crowd8217;s arguments may appeal to politicians if and when some big firms/industries collapse.

The CIF crowd is also not factoring in people. The greatest transformation in India over the last two decades is the expansion of the opportunity set for millions of Indians. After 20 years this transformation is not very far from producing a critical mass of people with high stakes in a private opportunity maximising system. These are not the South Delhi/South Mumbai Indians really. South Delhi and South Mumbai8212;haunts of old urban elites8212;were doing quite well in pre-1990 India as well. The transformation has happened in non-elite part of metros, in smaller cities and small towns. It would have reached villages faster had it not been for the dreadful government failure in the provision of even low quality public goods.

These Indians have defined the effects of change till now. In the near future they can be numerous enough and socially/politically vocal enough to become the cause of change. But not if they take big knocks in the next few months. Pure capitalist adjustment as defined by the CIF crowd can mean the new middle class8217;s bet can go horribly wrong. Big job cuts in the new white collar and light blue collar professions, big cuts in planned recruitments by new employment creators, big hurdles to ownership of assets by Indians whose parents grew up in a country where a big, ugly, government-issue telephone was a marker of having arrived8212;technical economics can beautifully argue that these are necessary corrections. Capitalism, however, is not a technical economic system. It8217;s a political economic system. And in India8217;s politics, such a prescription at this point of time will take hope out of its economics.

The social contract where 8216;ordinary8217; beneficiaries of capitalism grumble but accept extensive economic adjustment because they are able to cope with hard times hasn8217;t been written in India as yet. The West took a long time to get there. Therefore, big economic dislocations in the newly empowered classes in India will find expression in lots of anger and despair towards new economics. The CIF crowd won8217;t be able to do anything about it. But the CIB crowd will be able to dress up the anger and despair as vox populi for status quo ante. Politicians will listen and many of them will agree.

Managing the crisis

Therefore, the primary job of India8217;s policymakers in the next few months should be to prevent failure, anger and despair. The absurd thesis that India is insulated from the global crisis has been proved wrong. The plausible thesis that India can make itself suffer far more than is necessary has to be proved wrong now. That means keeping the levers of growth moving and keeping the spirit of growth up.

Monetary policy has made a start. It must carry on. Heterodox solutions like the government guaranteeing foreign currency debt of financial institutions and temporarily injecting more capital into banks should be used without hesitation. Now, industrial and commercial policy must get ready. The government shouldn8217;t get into complicated arguments about bailouts if a critical sector or company appears close to imploding. Don8217;t let capitalists exploit the situation either8212;help them where help is unavoidable but make them help themselves.

Most important is to sort out the politics of such economic intervention. Don8217;t think of job cuts among young professionals as rationalisation, think of them as lost support for economic policy so painfully put together over 20 years. Don8217;t look at home loan repayment difficulties as the bursting of a bubble. Recognise them as a savage blow to aspirations. Don8217;t look at mutual funds in liquidity trouble as investment vehicles for the rich. Understand that they have democratised capital market participation.

Not everything will be done well enough or quickly enough. There8217;ll be some god almighty controversies. That8217;s the nature of politics. But if policymakers remember their central mission, India should emerge out of this crisis with its economy energised and its politics better equipped to support further economic change. India8217;s capitalism has extraordinary potential. Protect it now from those who deeply hate it and from those who deeply love it.

AFFECTED SECTORS

TOURISM

The 20-billion travel and tourism industry has taken a hit, with inbound tourist flow dipping significantly in the last few months. The US and the UK, the top tourist generators to India, contribute to a major chunk of its revenues. Domestic companies, too, have slashed their travel budgets to cut operating costs.

EXPORTS

Despite the rupee falling to a record low of Rs 50.15 to a dollar on Friday, exporters won8217;t benefit, thanks to the slowdown in demand in US, Europe and Japan markets. Liquidity crunch, expensive credit and lack of confidence among banks about letters of credit issued by overseas counterparts for international trade make trade finance difficult.

EMPLOYMENT

The prices of commodity inputs have gone down, but employee costs stick out like a sore thumb. As industries around the world tighten their belt, labour markets will see demand shrinking. Even as airlines are on a retrenchment drive, the ILO has warned that there would be over 20 million job casualties across the world by the end of 2009.

INFRASTRUCTURE

India8217;s need to finance infrastructure development of over 500 billion has suffered a setback. Prime Minister Manmohan Singh has admitted that it will be a 8216;challenge8217; for India to raise the money in prevailing conditions. 8220;We need new sources of finance,8221; he said in Tokyo. At the ground level, the credit squeeze is hurting road, rail and other infrastructure projects.

REAL ESTATE

Listed companies like Unitech and DLF have been hit hard. The liquidity squeeze has frozen funds for the 8216;high-risk8217; sector and buyers are fast disappearing. To protect SEZs, the UPA Government on Friday decided to re-classify industrial and social infrastructure within SEZs as a 8216;core8217; sector rather than as 8216;real estate8217;.

How the world is absorbing the shock

Iceland

One of the worst hit, Iceland has sought help from IMF. Trading on stock exchange halted. Three largest banks nationalised. Loan sought from Russia.

US

700 billion bailout package. 250 billion to be injected into banks. New bank debt temporarily guaranteed, deposit guarantee increased.

Latin America

Argentina8217;s 10 private pension funds, with 30 billion in investments, nationalised. In Brazil, state-controlled banks allowed to buy shares in private financial institutions, tax on foreign investment scrapped.

France

360 billion Euro package

320 billion Euro in interbank loan guarantees and 40 billion Euro to recapitalise ailing banks.

10.5 billion Euro to be lent to top six banks before year-end to boost their capital reserves.

Japan

45.5 billion injected into the banking system. 18 billion stimulus planproposed.

UK

pound;500 billion banking package8212;pound;200 billion for short-term loans, pound;250 billion to guarantee loans between banks, pound;50 billion for partial nationalisation of banks. Interest rates cut, deposit guarantee raised.

Russia

200 billion allocated for loans and tax cuts. 175 billion rubles 6.64 billion out of the 49-billion National Wealth Fund to be spent on buying domestic shares. Share trading suspended on Moscow stock exchange.

Germany

Blanket guarantee on all savings. curren;500 billion package for bank lending guarantee, underwriting debt of banks, introducing regulations.

Australia

Interest rate cut from 7 to 6 per cent. Bank deposits and their term funding requirements guaranteed. 7.2 billion announced in grants to seniors, families and first-home owners.