To hell and back

Financial Express, 27 December 2009

The last 12 months have been a period of huge uncertaintly all over the world. At the beginning of the year, the world appeared to be at the brink of collapsing into a long and deep recession. The journey to hell and back, has been one where, governments and central banks all over the world took huge risks with unconventional measures, but in the end, it seems, managed to avert the terrible crisis that could have resulted. While it can be argued that the problems have primarily been postponed, we can surely say that 2009 was not as bad as we feared. Not for India, at least.

Indian growth could have collapsed very badly when global trade and financial markets froze. Yet, despite all the bad news from all over the world, India survived much better than one feared. India was perhaps very fortunate. A pay commission comes only once in 10 years, and an election once in 5 years. When the recommendations of the pay commission came along with the big spending they implied and when the farmer debt waiver threw all sound principles of public finance and public policy to the winds, it looked like India was setting itself up for a fiscal disaster. Fiscal deficits and public debt would look large and borrowing by both the government and firms would become more expensive. Who would have imagined, at that time, that all of a sudden, countries like the US and UK would see such large increases in deficits, that India would almost look good by comparison. Moreover, had the government not already budgeted the bulk of the increase in expenditure, it might have found it hard to provide a fiscal stimulus considering its limited capacity to spend through projects. Suddenly increasing spending on infrastructure projects, or roads, which require bids to be made, and procurement procedures to be followed, would have been hard.

On monetary policy as well, India was lucky. Just a few days before the crisis a new RBI governor, Dr Subbarao had taken over. He was perhaps not as constrained by the baggage of a conservative central banking approach as someone who had been in the RBI for a longer time, might have been. Within weeks of the crisis he took decisive and unconventional steps to ease monetary policy. Equally crucial to India's growth was that throughout the year, despite plenty of pressure from the hawks, he did not risk hurting India's growth recovery by tightening monetary policy.

Apart from the huge fiscal deficit, which helped avert a disaster, but does have to be dealt with, sooner or later, the other big source of concern, which followed freak weather, a drought and flash floods, was the bad performance of agriculture, and the pressure on food prices. Inflation suddently started rising, especially consumer price inflation, as a result of the sharp rise in food prices. The rise in food prices has been attributed not just to the drought but also to sudden increase in the ability of the poor to buy food in areas where the NREGS was providing employment. Food inflation has been very sharp, especially in the second half of the year.

While the rise in food prices is unfortunate, the fact that the NREGS provided jobs to people at a time when the industrial or agricultural growth would not have supported job growth was a boon, and prevented people from falling into deep poverty. Again, India was lucky on the timing of the NREGS. One of the worst crisis of the century came when India had at least set up (even though it was nascent and immature) a social security net, that helped prevent large scale poverty and deprivation. India was, however, plain unlucky that the drought came in the same year as the global recession.

While the good news was that the electorate did not return a hung parliament, and the UPA government came back without the support of the Left, which had blocked all reform, the new government did not take up even those issues which had been blocked by the Left. While financial sector reforms were easily a causalty of the the fear of modern finance, created by the crisis, the UPA seems to have lost the drive and leadership to undertake even governance and administrative reforms. The Mumbai terrorist attacks, the elections, the finacial crisis, the drought and the recession pushed long term goals on to the back burner. As a consequence, the 100 days reform agenda of each ministry, the FRBM and the GST are no longer in place as they should have been. The only thing that was on the reforms agenda, and that came through, was disinvestment of public sector enterprises. But, this too was more out of pragmatism and a need to bring the fiscal deficit back on track, rather than a commitment to privatise and get the government out of business in which it has no business to be in. So, the government will continue to hold majority shares in hotels, airlines, and manufacturing, hardly things that need to be the government's job. Still, even partial privatisation is good for the country and for the PSUs.

Export growth in 2009 was sharply hit by the recession in the world economy. This was not a time when the exchange rate could help. The rupee had witnessed depreciation by nearly 25 percent. Yet, due to the decline in world demand, there was a sharp drop in the value of exports. The government stepped in with subsidies and incentives to help exporters and prevent job losses in export industries. These are still in place and it may be time for the 2010 Budget before they are phased out.

The other major casualty of the year has been bank credit. Since the banking sector was at the heart of the global crisis, banks have became extremely cautious. This was to be expected when loans could turn non-performing were industry to do badly. At the same time capital from overseas, which until a year ago had been available on very attractive terms, became suddenly almost impossible to obtain. This raised the cost of capital for Indian industrial. Yet, this was not a major contraint, as industry itself was reluctant to invest in this uncertain environment. The demand for credit was no less a constraint in the slow growth of credit. With both bankers and companies reluctant to take risks, by the end of 2009, despite the very difficult situation seen last year and the low base, the year on year growth in bank credit is just about 10 per cent.

What will the withdrawl of the fiscal stimulus bring? This is perhaps the one question the government cannot risk finding out the answer to. As a consequence, even though there are worries about the size of the deficit, there may be no significant reduction in the deficit in the coming year. One crucial element of the story is that it is extremely difficult to bring expenditure under control. Cutting subsidies, whether fertiliser or food, are not politically easy decisions. With the GST postponed, the hopes for an expansion of revenue depend upon a recovery in industrial production and imports. And this now, appears to be on the horizon.

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