To say that the economy is in crisis is not news any more. In these columns I had expressed the hope a few weeks ago that the Budget would provide a stimulus that would kick start the economy. That expectation was clearly belied. The market still lives in the hope that the government would turn quickly to addressing macro economic problems. The stock markets, which provide an index of hope in industry and in the marketplace has been gyrating wildly in the past couple of weeks, sometimes rising madly, as rumours float about changes to the Budget announcements on direct taxation or serious efforts to pull out damaged industrial sectors, then lapsing back into gloom and depression when nothing materialises.
The growth rate, which was 7.9% in the first quarter of 2018, fell in succeeding quarters to 7.7%, 6.9%, 6.3% and 5.9%. Even this rate was made possible only by increased government spending, which constitutes 10% to 11% of GDP. The Index of Industrial Production grew at 2% in June this year as compared to 7% in June 2018.Capital goods production declined by 6.5%, infrastructure and construction goods by 18%. Consumer durables fell 5.5% and only 8 of 23 industry groups showed positive growth. Consumer price inflation declined, which could be a disincentive for industrial production. Unemployment rates are higher according to government data. It is reported that car and motorcycle manufacturers have laid off 15,000 workers, employment in downstream automotive component manufacturing has declined by a lakh, while the Federation of Automobile Dealers Associations says that 2 lakh auto sector jobs have been lost. All this happened in the wake of 23% contraction in automobile sales in the April to June quarter and 40% sales decline in July. Fast moving consumer goods grew 5% in the April to June quarter against 12% last year and there is said to be a stock of 1.28 million unsold houses. Announcements of new investment projects fell 79.5% and of completed investment projects by 48% in the quarter April to June, the lowest since September 2004.
As Aditi Nair, Principal Economist of ICRA put it in India Infoline (16/8/2019): “Although the sequential dip in industrial growth is partly on account of the base effect, the anaemic June 2019 IIP as well as the yoy contraction in 15 of the 23 sub-sectors of manufacturing, reinforce the evidence of a slowdown emerging from various sectors. In our view, the outlook for domestic consumption, exports and private investments remain tempered, although Central Government spending may gather momentum in the post-Budget months. The recent surge in rains, that has caused flooding in parts of the country, may pose more of a risk than a benefit to the Kharif harvest. We are apprehensive that GDP growth in FY2020 may print as low as 6.6% unless policies and reform measures are undertaken expeditiously to address various constraints to a pickup in economic activity, and boost business and consumer sentiment.”
Yet, hope remains and this is reflected in the Purchasing Managers Index remaining at 52%, which is indicative of the confidence of managers that we will pull out of the crisis, something that is reinforced by the reluctance of bulls in the stock markets to yield ground totally to the bears. The improvement in exports is another hopeful sign. Perhaps the most significant change has been effected by the RBI, which is showing growing determination to lower interest rates and provide more liquidity in the market. After many years, the RBI is showing concern for the larger economy beyond inflation rates. The increase in Bank retail loans and non-food credit is another encouraging sign, perhaps on account of easier liquidity. Hopefully, this is not a consequence of the drying up of credit from non banking financing institutions.
As the situation has a parallel in the economic crisis of 2008, it would be interesting to recall what happened then. The crisis started in the United States In 2006–2007. It started in the sub-prime mortgage market and grew into a full-fledged global phenomenon that engulfed India among other countries. The prelude to the crisis was a prolonged period of calm, stability, sustained growth and low inflation in the global economy over many years. A mild recession in 2011 sparked off a series of interest rate cuts by the Federal Reserve, as many as 11 times, lowering interest rates from 6.5% in May 2000 to 1.75% in December 2001 thus substantially injecting liquidity into the market. With so much of cheap money sloshing around, banks and financing institutions chose housing mortgages as the favored channel for funneling credit, particularly since affordable housing had become a prime policy objective of the Federal Government ever since the founding of ““Fannie Mae” by Roosevelt in 1938 and “ Freddie Mac” in 1970. “In the US, benign macroeconomic conditions sparked off a housing boom through an increase in mortgages originated by banks and non-banks.” ( “ The Global Economic Crisis through an Indian Looking Glass”; Adarsh Kishore, Michael Debabrata Patra and Partha Ray).This also induced speculative activity as real home prices rose by 85 per cent from 1997-2006.The underlying expectation was that real prices will continue to rise and rise, facilitating an upward growth spiral. It was also expected that if at all the bubble burst, the bits and pieces would be picked up by Fannie Mae, Freddie Mac and the Federal Reserve.
This seemed to be too good an opportunity for big finance to pass up. Housing debts were repackaged with other high risk debts and sold to eager financial investors creating financial instruments called CDOs or Collateralised Debt Obligations, a form of mortgage backed derivative. The risk was thus passed on manifold through derivatives trade. The entry of big finance into the mortgage market was on the back of high leveraging. Derivatives trade in financial markets, supported by low interest debt of a high order, replaced genuine house buying and selling activity, thus making the bubble grow and grow, until inevitably it burst. As Alan Greenspan, former Governor of Federal Reserve and a votary of animal spirits in the economy, put it, “The very nature of finance is that it cannot be profitable unless it is significantly leveraged….and as long as there is debt, there can be failure and contagion.”
In early 2008, a major US investment bank, Bear Stearns, was sold on an emergency basis. The second largest US investment bank, Lehmann Brothers went bankrupt. Another big investment bank, Merrill Lynch merged with a commercial bank. The capital adequacy of Fannie Mae and Freddie Mac came under increasing pressure. The financial markets were in turmoil and the contagion spread worldwide, affecting global capital flows, global trade and global growth severely. As credit became increasingly vulnerable, deleveraging took place almost in panic mode and a huge credit crunch enveloped the world. National stimulus packages became the order of the day in all major economies.
The years before the crisis had been great years for India. It had become a US$ 1 trillion economy in 2007-8. The rate of growth of per capita income had accelerated to more than 7% in the previous five year period as compared to 3% to 4% in the preceding two decades. Despite the conservative stance of Indian monetary policy for years, the global malaise was sure to affect a large and growing economy like India, whose global interface had been increasing steadily since the sweeping economic reforms of 1991. Liquidity seemed to disappear overnight from the market. The call money rate rose dramatically from 9% on 8 September 2008 to about 20% a month later.
“In responding to the crisis, it is essential for public policy to resist the temptation to excessively focus on measures recommended by the global fora and ignore the unique features of the Indian economy” ( Adarsh Kishore, et al, referring to Reddy 2009).To me, the experience of the economic crisis was a refreshing exercise of the Government of India and the Reserve Bank, then led by D. Subbarao, acting in sync with one another, of complete harmony and cohesion between fiscal policy and monetary policy, of mutual coordination and support between two great arms of policy in the economic sphere. As, in later years, I watched with consternation a developing conflict between the Reserve Bank and Government, as Reserve Bank Governors engaged in a battle for “autonomy “ with the Government, I could not but reflect on the unity of action displayed in those difficult days.
Montek Ahluwalia, then Deputy Chairman of the Planning Commission, prepared the first stimulus package, aimed at revving up the economy and stimulating certain affected sectors like automobiles. I worked with him to add a few elements like an across-the-board cut in excise duties. Dr. Manmohan Singh, who was also finance minister at the time, asked me to discuss the package with Pranab Mukherjee and with Chidambaram, then Home Minister, former Finance Minister. I recall that Chidambaram asked me in particular whether overall cuts in excise duty were necessary. I told him that a clean cut across all products is better than sectoral cuts, as otherwise we will be battling with problems of duty inversion for long. The package contained a slew of measures aimed at stimulating consumption, promoting investment and exports and specific measures to support hard-hit sectors like housing, automobiles, textiles and small and medium industries.
The first stimulus package was announced in the evening of 7th December at a Press Conference, taken by Montek jointly with Ashok Chawla, then Secretary (Economic Affairs) and me. Before the Press Conference, Montek requested me to call Subbarao and see if Reserve Bank could come out with a supportive package on the same day. Sure enough, an hour after the fiscal policy package was announced, Subbarao announced further measures to ease liquidity. The combined effect was electric.
The Reserve Bank played a major role in containing the crisis in India. The Bank rates were reduced significantly, the Statutory Liquidity Ratio and the Cash Reserve Ratio were cut, financial markets were given confidence and many other measures taken to infuse liquidity. In the meanwhile, commercial banks were encouraged to convert the easing of liquidity announced by the Reserve Bank into more investment and more consumption through greater outflow of credit.
Several meetings were held with industry associations to bolster their confidence.
For the automobile industry which faced a crisis similar to the one that besets them now, new demand was opened up by making funds under the Jawaharlal Nehru National Urban Renewal Mission available to States for purchase of 12,500 buses. The Defence Ministry advanced its purchase of vehicles for use by the Armed Forces.
Another fiscal stimulus package was announced a few weeks later. The net result, as stated by Stephen S. Roach, Chairman, Morgan Stanley India ( Economic Times, June 2,2010), was that ”India sailed through the Great Crisis of 2008 without barely missing a beat”. However, it is my belief that the stimulus package, intended to serve a particular purpose at a particular period of time, could have been withdrawn in phases earlier than it actually was. This is the problem with all concessions. Once given, there are political constraints and bureaucratic inertia which delay their withdrawal.
Every crisis, political, economic or military, has its lessons to teach. For the US, as Janet Yellen, Governor of the Federal Reserve, said, “New financial tools, which helped the Federal Reserve respond to the financial crisis and the Great Recession, are likely to remain useful in dealing with future downturns.” The crisis should have taught us some lessons too. First, let us not be guided in our policy responses by what we hear from international agencies or experts sitting abroad. They do not know India and Indians. We are enthusiastic people, we quickly respond in full measure to action that is being taken. The recent experiment with demonetisation shows that the people are willing even to pay for the decisions of their leaders provided they believe these actions were made in good faith. The second lesson is that there is nothing that we cannot overcome if all the arms of governance - and here I include the Reserve Bank - work in unison towards a common goal that is material to the country. The third lesson is to act when the time is ripe and to design the stimulus in such manner that it is self liquidating after a length of time.
The answers to the present crisis may not be the same as in 2008. The fiscal space for government is probably much less than in 2008. While the Finance Minister said in her Budget Speech that the fiscal deficit for 2018-19 was 3.3%, a subsequent CAG report is said to have stated that when off-Budget borrowings are also taken into account, this figure may be closer to 6%. It is also said that estimates of revenue collection in the Budget are inflated. Yet answers to these problems have to be found, and found quickly to prevent the development of a downward spiral from which it will be even harder to pull the economy out.
The facts and views expressed in the article are those of the writer.