On slippery grounds – Will we go back to the 1980s?

The vital signs of the Indian economy and its financial health are a bit more worrying that it was a few months ago. It is even more worrying that the people in charge are now beginning to realise the gravity of the situation and unable to arrest the downward spiral. The economy is on the verge of going into an ICU – intensive care unit in medical parlance. But they are afraid to admit or even talk about it honestly or take appropriate and harsh steps because elections are looming large. There is a real danger that the country may slide into a series of scary financial problems sooner than later. There is even talk in certain circles that the country may have to go with a begging bowl to the IMF like we did several years ago. That is scary.

All the tricks that the economic and political mandarins have played so far with promising growth numbers and financial stability have seriously damaged the trust, confidence and above all the perceptions about India as an emerging growth market with promising prospects. High scale and rampant corruption in high places and irresponsible political conduct have aggravated the pain and exposed the underbelly of our leadership. The sheer lack of a coordinated direction across the nation has cost us dearly. Their inability to arrest the vital signs from deteriorating any further is fraught with the danger of large scale destruction of wealth, well being and the prospect of a decent livelihood for the millions of aspiring and young citizens. The so called demographic dividend of the nation can well turn out to be its nemesis with angry and unemployed youth taking to the streets if our leaders do not behave responsibly and intervene urgently.

I don’t want to sound pessimistic. But it is important for serious citizens to understand the ramifications of a sliding economy and its fiscal profligacy. Greece, Spain, Portugal and other nations that have had economic nightmares are still reeling under the heavy burden of debt and unemployment. Look at some of the vital signs and its interpretations. Like the diagnostic report of any individual who has subjected his/her blood or other body fluids or solids to tests or undergone a MRI /CT or such scan in a laboratory, there are many credible agencies in India who produce various kinds of statistical data on the Indian economy. Just as many individuals do not know how to interpret these lab reports with its own unique terminology and units of measure, the statistical data on the economy also needs specialists to interpret them. Many of the politicians who use these data glibly are only as good as quacks who read lab reports. Every citizen should have some basic understanding of these vital health indicators and their complicated interplay to make his or her own assessments about the state of the economy fortified by assessments made by independent professionals who have no political agenda.

The growth story that India was spinning a few years ago seem to have a tragic end in sight. There are leading and as well as lagging economic indicators that determine the state of financial health of a nation. For those of the readers interested in gaining a rudimentary understanding of these, the footnote at the end of this article will give a quick overview to demystify some of these indicators.

Today’s weekend ruminations of my friend T.N. Ninan in the Business Standard ( 10 August 2013) – Back to the 1980s – is even more telling than what I had heard from him when we were having lunch last week. His weekly columns are not astrological predictions or weather forecasts but an incisive analysis of data. Look at some of his observations. The average growth rate now looks to be in the region of about 5.6% for triennium 2011-14 and beyond. The industrial output numbers average about 4% growth in the last five years. (the figures are on a sliding trend with negative numbers in the first few months of the year) Exports fell last year and continue to fall again where as imports have grown. He says that corporate sales and profit numbers are turning flat. The overall current account deficit (CAD) has trebled in the last four years and now much higher than the pre 1991 crisis levels. The CAD has been financed by foreign debts. Our foreign exchange reserves were higher than our foreign debts but the situation is reverse similar to the pre-1991 era. The worrying fact is that ratio of short-term debt to reserves has doubled since 2005 from 27.5% to 59%. This is similar to the situation we had in the 1980s. The situation of fiscal deficit is also alarming and mimics the earlier era of troubled times. There are many other revealing data in his musings and the revelations are indeed disturbing.

India borrowed from the IMF thrice in the past; once in 1981 and twice in 1991. The forex reserves were at rock bottom levels and we even pledged our gold reserves to get the loan. Given the size of our capital inflows, the sustainable CAD was about 2.6% of our GDP as per the 11th Five Year Plan. But It was 4.8% of GDP for 2012-13 and is putting a huge pressure on an already weakening rupee.

Ninan’s column mentions about the exchange rates. The rupee’s dollar value remained unchanged in an entire decade. The exchange rate was 45.68 in 2000-01 and 10 years later it was 45.58. Now it hovers around 61. He says this is not a loss of national honour, the fall is basically a correction. But I cannot refrain from saying that it is clearly a reflection of past failures.

The argument that a weaker rupee will make imports expensive and fuel inflation is correct. But a strong rupee doesn’t signify economic strength. China has been deliberately allowing its currency to depreciate and still maintain comparatively high growth. Inflation in India is high and higher than a falling inflation in many other countries. To tackle inflation, we need to work on the demand and supply strategies. There are arguments that conditions for manufacturing must be made conducive and that indiscriminate imports of electronic goods and gold should be curtailed to conserve precious foreign exchange reserves.

How did we get into this mess? The vulnerabilities of economies like India to the US Monetary policies are well known. But we have to take a large share of the blame on ourselves. Our growth recorded a decade’s low of five percent in 2012-13. Industrial production has declined substantially. Exports have been contracting continuously. The housing market is slowing and inventory pile up is visible. Every vital sector of the economy is facing trouble. We have been scaring away investors with fickle minded policy makers and an overzealous set of regulators who are bent on killing the golden goose. Then there are the politicians and business enterprises who are first interested in filling their coffers even if that means jettisoning national interests.

Will we have to go back to the IMF? If we do, then we will keep company with Pakistan that has just negotiated last month a deal to borrow $5.3 billion from the IMF to avoid a balance of payment crisis and to boost its rupee.

No one can envy the position of Mr. Raghuram Rajan, the new Governor of the Reserve Bank of India who will assume office on 4th September 2013. The Governor designate is the author of the book Fault Lines – How hidden fractures still threaten the World Economy – It is a brilliant book that arrays lessons to be learned from the financial crisis. I was at his book release in Delhi on the 29th July 2010 organised by the Chicago’s Booth School of Business. One thought that resonates well in his book is the last couple of lines in the chapter – What lies ahead for India “The battle lines are laid out. The choice between self-interest and public interest is clear. And if all of us join the battle, I have no doubt who will succeed.” Will he be able to walk the tight rope and keep his reputation as a brilliant professor and the Chief Economist of the IMF for four solid years during the period from 2003 to 2007? Only time will tell. If India somehow avoids the impending dangers of a financial tsunami, then Mr. Rajan will have to thank his stars and we Indians will have to thank our stars too!


Notes for the novice!

Some of the key leading indicators of an economy are:-

The Stock Market – because stock prices also reflect on what companies are expected to earn. But reliability on this alone is dangerous as stock markets can be manipulated and therefore not fully reliable. It is like your diabetic reading – before food, after food, stress levels etc.. But nevertheless it is an indicator.

The Housing Market – One has to look at both the volume of sales and the prices. If sales fall the inventory builds up and if prices of home fall, wealth of citizens fall, construction jobs reduce and create unemployment which affects the economy.

The Inventory Levels – Build up of inventory is both good and bad. If it is in anticipation of surging demand, then it is good for the economy. If inventory is building up because of lack of demand which again is because of lack of disposable income, then it is an indicator that consumer confidence is low. Higher inventory pile ups will drive prices down which in the short run may seem good for consumers, but in the long run will reduce production and shut down businesses and aggravate unemployment. Businesses must be profitable for it to be sustainable.

The level of Entrepreneurial Activity – Small businesses generate employment and contribute to the GDP. The quantum of new businesses that an economy is able to generate build confidence and stimulate growth. But the environment must be conducive for the seeds of start-ups to germinate and grow. But if the difficulty of doing business is aggravated by an unfriendly, offensive and suspecting regulatory regime, then you drive away the entrepreneur.

The lagging indicators are not real time. They reflect historical performance. GDP Growth rate, the Balance of Payments, Balance of Trade, Fiscal Deficit, Inflation levels, Interest Rates, Foreign Exchange Reserves, Exchange rates are some of these indicators.

The GDP growth rates reflect the state of the economy’s current health. Its calculation is complicated. Balance of Payments simply put is a record of all transactions between a country and the rest of the world. If more money is flowing out of the country than what is coming in, then there is a balance of payment crisis. Balance of trade is the difference in value between a country’s exports and imports and is therefore the largest component of balance of payments. While a negative balance of payments is a serious matter, a trade deficit need not be such a bad phenomenon if it is part of the business cycle and economy. But it is bad if the country is in a recession. So what is a fiscal deficit? When a government’s expenditure is more than its revenue it will have to resort to deficit financing. But too much of borrowing even for a nation is imprudent. Inflation is the rate at which general level of prices for goods and services rise. Purchasing power of the currency comes down when inflation rises such that if you could buy a banana for a rupee, you will not get that same banana for a rupee anymore when inflation is @10% and now it will cost you a rupee and ten paise .

One thought on “On slippery grounds – Will we go back to the 1980s?

  1. Rightly said -Mr. Rajan will have to thank his stars and we Indians will have to thank our stars too if our country comes out of the financial tsunami dangers! The elections might prove this anguish among the people to vote wisely for a working prime minister and an able finance minister!!

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