Is fear of slowdown real?

Is fear of slowdown real?

The article seeks to analyse possibilities for Indian economy in the backdrop of falling rupee, high current account deficit, persisting inflationary pressure and most importantly, the lower than expected growth figures seen in the latest IIP (Index of Industrial production).

Indian economy embarked on the path of liberalization from early 1990s in wake of world wide changes taking place at that time. The path adopted required opening up of the economy so as to integrate it with the world economy over a period of time. It also required streamlining the economy by adopting program of ‘structural adjustment’ which entails larger role for the market by resorting to privatization and India being a developing nation, was subject to reduce its fiscal imbalance. The economy also saw  role back  of public sector from commanding heights of the economy as envisaged in model of Nehurivan Socialism. Thus an important feature of liberalisation is the State’s withdrawal from economic activity for giving more space to free market forces. It also leads to increasing globalization of the national economy over a period of time. As the state’s capacity to invest declines (concurrent with the reducing role of public sector) so does the effectiveness in reviving the economy in times of distress by generating employment for driving aggregate demand. Thus, Keynes economics principles (based on English Economist John Maynard Keynes) which emphasized how State can play a prominent role in reviving economy during slowdown gradually becomes less effective.

National economy also becomes more vulnerable to changes taking place at international level in such a way that the possibility to insulate it becomes difficult. Credit fuelled nature of growth unleashed due to such policies is vulnerable due to possibilities of reversal in flow of hot international finance. Present global financial system is integrated like never before to command big influence on real economy decisions. Crisis in the finance system as evolved thus tends to impact real economy in crucial ways. Many economists believe that liberalization policies open the national economy to these risks and uncertainties by subjecting it to global economic cycles of boom and bust. And it can thus turn out to be double whammy at times. 

High growth phase

Without going into the contentious question of the nature of growth and what does it entails for large segment of the population as pointed out by eminent economists like Amartya Sen, it can be said that the liberalization policies adopted resulted in comparative higher rates of economic growth in last two decades. The economic rate cloaked by Indian economy especially after 2003-04 got a further push due to favourable worldwide economic situation when it averaged more than 8 percent for next five years. It was even above 9 percent in last three years of the boom phase. The growth backtracked in financial year (FY) 2008-09, when it slipped to 6.8 percent in wake of global recession which started from early 2008 due to sub-prime loan crisis in the US. The crisis spread like contagion to catch economies of the whole world in no time. Due to integration of global finance the crisis whichemergedin the domain of financial world of one country impacted the real economies of many countries of the world to the extent that world economic output went negative for the first time after Second World War.? Fiscal stimulus in form of tax break and cheap money policy was resorted for getting economic growth on track. Indian economy revived to some extent due to measures adopted in FY 2009-10 and FY 2010-11 to register rates of 8.0 and 8.5 percent respectively.

Fear of Slowdown in current year

The persistent fear of Euro zone crisis that it will spill its tentacles further to curtail role of global finance capital in fuelling credit finance growth has hit the business confidence. The investors are thus seeking safety of US fed securities resulting in strengthening of US dollar against major currencies of the world including Indian rupee. The fear is also reflected in the talks doing the round lately of possibilities of double dip recession hitting the prospects of world economic growth. India’s economic growth too has decelerated in the first two quarters of current financial year in the backdrop of prevailing uncertainties and insecurity at global level. In the first quarter of FY 2011-12, the growth declined to 7.7 per cent and fell further to 6.9 per cent in the second quarter which is in fact slowest in over two years, against the government's budgetary target of around 9 per cent. The deceleration of the economy was also reflected in the industrial output when it slumped into negative territory to the tune of 5.1 in October 2011 as against healthy number of 11.3 percent in same month last financial year. The rupee also continued on its downward slide to record its historical low of INR 53.52/ per US$ on December 12, 2011 ringing alarm bells on forex counters. Persistent inflationary pressure in the economy has resulted in Reserve Bank of India raising key interest rates thirteen times since early 2010, raising borrowing costs in the process. These not so comfortable numbers have raised the fear of overall slowdown in the economy. The stock market reacted to these worries when it plummeted to two year low of 15379.34 on December 16, 2011 amidst heavy selling on persisting concerns over slowing growth and weakening rupee in backdrop of declining global markets.

In late October, the RBI too cut its growth forecast for the current fiscal year from 8 percent to 7.6 percent. Though, amidst this gloomy scenario, good news for the government came in the form of lower inflation figure on food front. Food inflation fell sharply to a near four-year low of 1.81 per cent for the week ended December 10, 2011 as prices of essential items like vegetables, onion, potato and wheat declined. This certainly gives some policy leeway to the government and RBI to take some action to combat fear of slowdown. Traditional economics teaches us that monetary and fiscal policy tools can be deployed to raise or reduce demand in the economy. The increase in aggregate demand than  is likely to ease downward pressure on the economy. But in the evolving complex scenario, the conventional economics concepts and understanding are unlikely to make much headway when it comes to combating fear of downward direction of economy. Fiscal and monetary stimuli, classical prescription of copy book economics, have failed to return the advanced economies to their normal growth rates. The present bleak state of global economy as witnessed at the moment seems to be a continuation of the 2008 crisis, rather than a repeat of it.

In this emerging perplex situation due to globally driven factors, the limitation of policy choice available can be garnered from the Finance Minister Pranab Mukherjee’s statement when he almost confirmed the fear by saying that “…even as the fight against inflation was hurting corporate investment and industrial growth, the Government is left with limited options to combat the slowdown owing to the deteriorating global economic environment”.  (The Hindu, December 14, 2011)  He added, “All these [slowdown and other attendant ills] have happened despite the aggressive use of both fiscal and monetary policy tools... it poses a serious problem for policymakers. Going forward, it limits our options in dealing with the emerging situation,” Mukherjee blamed the ongoing crisis in Europe and other parts of the world for the slowdown in the Indian economy. "Indian economy cannot remain isolated from the global developments."(Business Today, December 13, 2011).

The IIP outcome

Index of Industrial production (IIP) number of October was certainly surprising as it was not expected that it will be negative to the extent of 5.1 percent. Though, the slowdown in manufacturing sector was evident from as early as July month of FY 2011-12 itself, when it fell drastically to 3.7 percent from 9.5 percent in June, 2011. The corresponding figure for July, 2010 was 9.9 percent. In following months of August and September, the IIP grew by mere 3.6 percent and 2 percent respectively before it went negative in October. Similarly the overall economic performance in the first half of the current fiscal also pictures pessimistic scenario. The growth slowed to 7.3 percent in H1 (first half year) of current fiscal as compared to corresponding figure of 8.6 in H1 in F.Y. 2010-11. Manufacturing, Mining and Quarry and Construction were the sectors that took a major hit in the first six months of this fiscal. Headline inflation (as against core inflation which doesn’t factor in prices of food and fuel)can we state here the difference from core inflation in one sentence? ), despite easing sharply in November due to downfall mainly in food prices, continued to stay above 9 percent for the twelfth consecutive month. The seemingly call for reversal of hawkish instance on interest rates by RBI in view of this development and better than expected numbers of food inflation didn’t get favourable response from central bank in its latest review of monetary and credit policy stance. The only relaxation, so far, given by RBI was that it left the key interest rates unchanged for the time being. There has also been pressure mounting on RBI to intervene in forex market to curb falling rupee. Such intervention by selling dollars will take money in form of rupee out of the system which will further reduce capacities of banks to lend as non food credit has already dropped to 17 percent this year retarding growth.

BoP situation

Rising current account deficit (CAD) is also putting a pressure on Balance of Payment situation. In its recent financial stability report, RBI has pointed out that higher oil prices, sharp increase in imports of bullion, machinery and electronics have resulted in continued buoyancy in imports. Consequently, CAD which increased in Q1 when it  swelled to USD 14.1 billion in current fiscal first (April-June) quarter, nearly three-times the previous quarter's figure, is expected to widen further. Current account deficit (CAD) occurs when a country's total imports of goods, services and transfers are greater than the country's total export of goods, services and transfers. In the April-October period, exports aggregated to USD 179.7 billion showing a handsome growth of 45.9 per cent but failed to keep pace with the rising imports. The import rose to the tune of 30.9 per cent to USD 273.4 billion. This has left trade gap widening to USD 93.7 billion. According to the report "...it is the global developments rather than fiscal slippages that is contributing to widening CAD," adding in the process that there is a downside risk to FII inflows on account of slowdown in the euro zone and the US.

India imports almost 80 per cent of its oil and gas requirements and the depreciating rupee has made imports expensive. Rupee has depreciated 18 per cent against dollar so far this year. It is also putting pressure on inflationary front by opening the possibilities of imported inflation. India's external sector also faces risks due to decreasing growth in world trade volumes and weakening global demand. After very high double digit growths in initial months of FY, exports in November moderated and rose only marginally to touch USD 22.3 billion. "Going forward, exports may moderate further if the slowdown in advanced economies persists," the RBI report elaborated. As per Centre for Monitoring Indian economy (CMIE) report, CAD may rise to 3.7 percent of GDP (Gross Domestic Product) in the current financial year which is above comfort level for Indian policy makers. The situation on BoP front would require close monitoring by policy makers so that it doesn’t worsen further.

Concluding remarks

From India's point of view, the present conditions in the world economy may just be the reasons to address the emerging issues in holistic way. Policymakers in India have been looking to lower the growth by way of tackling inflation. It is likely to reduce the risk of excessive heating up of the economy in long run with much worse repercussions. A global slowdown and falling commodity prices may obviate the need for any further increase in interest rates. There are calls from various quarters to 'press the accelerator', 'grasp the moment' and so on. Policymakers must eschew the temptation and take informed decision. India's gradualist approach towards reforms has served it well, not just in terms of producing accelerated growth but in ensuring a broad consensus in favour of outcomes. For instance, the government’s decision was democratic when it responded to put on hold the proposal of Foreign Direct Investment in retail after nation wide protests. There is no call to discard this approach in pursuit of some illusory growth target in a challenging global environment.

By Saurabh Naruka