Opinion Areas of darkness

Unfortunately,the rich OCED economies are forecast,by most estimates,to contract by up to 6 per cent in calendar year 2009. And hardly anyone is predicting a recovery before 2010,which means India’s export-oriented sectors are set for a prolonged slump — the statistics are bearing out this trend with exports falling sharply for four months in succession. But remember that exports are still less than 30 per cent of India’s GDP and therefore play a less significant role in determining our overall economic prospects,unlike say in China or other parts of East Asia where exports often exceed 50 per cent of GDP.

At the root of the green shoots hypothesis is the role of domestic consumption which accounts for over 60 per cent of GDP. This may sound counter-intuitive at first — if all the reports about job losses and pay cuts (particularly in boom sectors like IT) are true,what is the realistic likelihood of a consumption surge? The answer is that while these reports are true they tend to focus primarily on the scenario in big cities,whereas the resilience in consumption demand is located in semi-urban and rural areas. There are two reasons for the shine in rural Bharat.

First,a steady and good agricultural performance,coupled with high minimum support prices for key agricultural crops,has brought a certain prosperity to rural India,which continues to be relatively untouched by the global meltdown. A good monsoon this year — the early forecasts suggest that this will indeed be the case — will consolidate the gains made in agricultural incomes.

Second,and perhaps more interesting,is the impact of NREGA on rural incomes and rural wages. There are two effects here. One is the rise in income of those people who were unemployed but now find employment for 100 days a year under NREGA at up to Rs 100 per day. But that surely can’t be enough to boost rural demand significantly,which is why the secondary effect of the NREGA on average rural wages is critical.

Counter to many assumptions,despite a woefully inadequate system of institutionalised social security,we do have minimum wage thresholds in India. There is,however,no single national rate — different states have always set their own. What NREGA has done,however,is to relay the floor in most states. States have been forced to revise their minimum wages upwards post-NREGA — note the change between 2005-06 and 2008-09: in UP the minimum daily wage went up from Rs 58 to Rs 100 day,in Rajasthan from Rs 75 to Rs 100,in MP from Rs 60 to Rs 84,in Maharashtra from Rs 55 to Rs 75. These are significant increases,and in practice workers often get more than even the revised minimum wage rates,since the minimum wage rates mostly coincide with the NREGA rate in the state. Private employers have to usually pay more than the government does under the employment guarantee scheme to attract workers.

The story of resilience in domestic consumption can be cross-checked by looking at the performance of certain industries. Interestingly,the three industries which are showing signs of a comeback — steel,cement and auto — all cater mainly to the domestic market. More importantly,their recovery fits in with the story on resilient rural and semi-urban demand. Steel and cement are catering to the growing construction activities in those areas,which are also witnessing an increased demand for consumer products like vehicles. The one other sector which has,in fact,recorded an impressive performance through the slowdown is telecom. Again,the relatively cheap products and services provided by telecom companies are receiving an overwhelming demand response. Firms have seen a record rise in subscriptions in recent months,something which is reflected in their healthy balance sheets.

The challenge for policy now is to carefully nurture the green shoots. Unfortunately,the main policy obstacle to the flowering of the shoots is the high interest rate regime. Prime lending rates at which only the choicest investors and consumers can borrow are still in double digits. When you combine that with a rate of inflation that is near zero,you have an exceedingly high real rate of interest — a rate higher than the real rate in the period of boom. That is bound to have a perverse effect on economic prospects. Even the highly desirable,stimulus inducing infrastructure projects (which can boost investment and consumption at the same time) are only viable when cost of borrowing is between 8 per cent and 9 per cent.

The RBI,however,continues to be overcautious — it cut the repo rate by a marginal 25 basis points in its annual policy review on Tuesday when the time is ripe for more drastic cuts. But it isn’t all the RBI’s fault. Public sector banks have been lazy at cutting lending rates in sync with the repo rate cuts — they are comfortable making handsome profits at the current rates. Unfortunately,private sector banks,which should have been cutting rates to outcompete PSU banks,are yet to recover from the big,but patently false,spook of failure they received at the height of the financial crisis last year.

It will be a great irony for India if the sector which survived the biggest global financial crisis in many decades relatively unscathed (especially when compared with its global banking peers) now becomes the sector which snuffs out resilience and quick recovery elsewhere in the economy.

dhiraj.nayyar@expressindia.com