While it would be naïve to suggest that in a globalised world India would not be affected, it would be equally wrong to transfer the global doom and gloom in its entirety to India.
We are now in the midst of the worst global recession in living memory. What started as a financial crisis has moved to the real economy. It is here that the differences in the impact on different countries will manifest itself.
The root cause of the current problems in the west is the high debt levels of the private sector and households. The problem has been aggravated by uncertainty and consequent fear of the unknown. A look at Japan shows how difficult it is to power a recovery after a bubble bursts. Therefore, these economies will go through:
• The de-leveraging of households and the private sector with its impact on demand
• The painful rebuilding of the financial sector. We are yet to see the unwinding of credit default swaps, the refinancing of speculative grade debt, the refinancing of regular local and international trade debt and the problems regarding non-housing related consumer lending.
• Rebalancing of country financials. The deficits of the US, etc., and surpluses in Asia.
• A real economy that is deteriorating way faster than expectation and will create further troubles for the financial sector.
• Politics: we will see debates on everything — globalisation, free trade, role of government, etc.
Asia’s economies have been growing at an annual rate of approximately 7.5% on the back of an export boom fuelled by debtladen western consumers. These economies were, therefore, bound to be hit hard by slowdown in the west. The problem was aggravated by the credit crisis which made trade finance harder to get. Trade within Asia, consequent to Asia’s slowdown, also dropped. In the long run the Asian economies will need to boost domestic demand (consumption). The root cause for the lack of domestic demand is the composition of GDP in terms of proportion of exports and wages. They will have to shift from a capital-intensive manufacturing model to a labour-intensive services dominated one.
We in India were happily chugging along at an 8% plus growth rate till the world decided to ruin our party. The surge in the price of oil and commodities resulted in us importing inflation. It forced us to employ a tight money policy and a rising interest rate to curb demand.
The global financial crisis froze international liquidity and shifted Indian demand, met through international resources, to the local markets. Also FIIs sold and remitted money overseas, pressurising the rupee and aggravating the local liquidity scenario.
The transmission of the financial crisis to the real economy led to a major global economic slowdown, which has affected our exports as well. A combination of these factors resulted in a slowing down of GDP to around 7%. While it would be naïve to suggest that in a globalised world India would not be affected, it would be equally wrong to transfer the global doom and gloom in its entirety to India. Because we have a few things going for us:
One, the financial tsunami of toxic asset and crazy market regulation which flattened the financial systems of the west passed us by. Indian banks are safe, secure and profitable. Currently, as a banking system we have gross average NPAs of around 2% odd and net average NPAs of 1%. At worst, we can see average NPAs go up to a gross of around 3% and a net of 1.5%. The Indian banks can by and large afford these from the profits. More importantly, there is no stalling of the banking system. Credit by Indian banks has been growing at 24% plus. That industry is crying about shortage of funds is consequent to sources of funds (other than bank finance) drying up — that is global and local equity markets, international, trade finance, ECBs, etc.
Clearly,what is needed is the development of bond, currency and derivative markets in India so that long-term finance is available. However, this is a solution for the medium to long term. A near-term solution would require a split of the problem into short-term funding (i.e., up to 12 to 18 months) and long-term funding. The short-term funding issue has been solved. There is enough money available, banks are parking money with the RBI at 4% (reverse repo rate has since been cut to 3.5%). Interest rates have dropped drastically. Today, housing loans are at 8-9%, car loans at 12-13.5%. AAA corporates are borrowing at sub 10% and small and medium enterprises (depending on risk) at 13% onwards.
The focus on banks’ PLR is pointless because between 50-80% of bank loans (depending on composition of lending) are not linked to the PLR. In any case, given changed conditions globally, the concept of PLR has become irrelevant.
In order to enable banks to lend long term we have to allow them to raise longterm funds which are not subject to SLR and CRR. The RBI pays no interest on CRR and the yield on SLR (risk free government borrowing) is by definition lower than what banks will pay to raise money and this results in pushing up costs for the banks and corporates to unacceptable levels.
Two, about 60% of Indian GDP is domestic consumption and our percentage of exports is 23%. So, we can, through fiscal and monetary measures, coupled with government spending, pump prime our economy.
Three, the fall in the price of crude and commodities will provide the government with some fiscal spending leeway because at current prices we should not need oil or fertiliser subsidy.
And, four, inflation is falling and will fall further as the effect of oil and commodity prices passes through the economy and company balance sheets. Interest rates are falling and are set to fall further.
Basically while we cannot avoid the pain we can surely ensure we suffer less. Any crisis leads to anxiety and uncertainty, which affects individual and corporate behaviour. Compounding the problem is subjective uncertainty: we tend to imagine the worst. This leads to paralysis of consumers, companies and investors.
The only solution to this is to pull out all stops at one go — reduce SLR, CRR (interest rates) cut duties, oil price, spend on job creation, provide incentives for spending, etc. It will work and will get people to focus on India’s structural positives — rising productivity, high savings, working financial system, low import barriers, high export potential, GDP growth of approximately 6%, rising per capita income, and rural demand.
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