The economic stimulus package announced by the government on Sunday, along with the RBI’s steps a day earlier to further reduce interest rates, is welcome. Banks should now respond to the positive steps taken by the RBI by increasing lending and at lower rates without further delay. This should be done as soon as possible given the sharp deceleration that is otherwise possible in industrial production and GDP growth. America’s recession, the decline in Indian exports and the difficulties in credit flows have created an environment in which companies are finding it difficult to function. This means a fall in growth, job losses and pay cuts.
It is important to remember that the medium- and long-run prospects of the Indian economy remain excellent. India is going to be the youngest nation in the world in the coming decades. Of every four workers joining the labour force in the next few years, one will be an Indian. A young India will ensure that we have the ability to achieve high growth. Moreover, the high level of flexibility in our economy will make it possible for the economy to adjust much faster than either European economies, where there are huge labour market rigidities, or countries such as China, which are far more dependent on exports to the US and Europe than India is. This essentially suggests that the Indian economy has the flexibility to be resilient. However, what actually happens depends on the nimbleness of Indian industry and the willingness of the government to support it in various ways. At the moment increasing liquidity, reducing the cost of capital and creating an environment in which banks lend rather than putting up tariff walls to protect some industries, are the correct policies. Further, allowing labour flexibility to function, rather than interfering with the micromanagement of firms, will be essential in the coming months.
The next step should be to continue with financial sector reforms so that the lack of finance from abroad can be compensated by better functioning domestic markets. Making sure that existing projects in roads, bridges, etc, proceed at a fast pace, continuing with opening the capital account and avoiding panic reactions and policy mistakes are essential. In the next one year or two, when world GDP contracts or grows less slowly, there will no doubt be huge pressure on policymakers to provide protection to one lobby or another. It will be essential for the government and the RBI to keep the long-term interests of all sections of the Indian economy in mind and not give in to pressures that can hurt them.