Impending Recession: India Unlikely to Escape its
ARUN KUMAR *
The world economy is faced with a downturn. The issue is how deep and how
quick it will be. The Prime Minister and the Finance Minister are trying
to keep the flag flying and rallying the troops so that the rout is
delayed. It is variously being suggested that India will not be affected
by the downturn in the US economy which, according to some analysts, is
already in a recession but since the data comes with a delay, it has not
been officially acknowledged that the recession has started. The cuts in
advertising expenditures in the US are an indication of the downturn.
The stock markets the world over are indicative of the negative mood of
the investors. Adverse news is being greeted by huge declines in the
indices. The US Central Bank, the Fed, has already cut interest rates
twice in quick succession by a total of 1 per cent (unprecedented in
recent history) signalling/acknowle
dging that indeed things are bad. In the US, for the first time in many
years, employment is falling.
The Indian stock markets have also followed the overseas markets in the
rapid fluctuations and more so because it was way beyond what the
fundamentals justified. Indian industry and exports have been showing
signs of slowing down. Due to rising inequality, the market in India is
narrow and dependent for growth on investments and exports. Without doubt,
exports will be adversely affected by the slowdown in the US.
Investments are likely to slowdown because of the industrial downturn and
also because of the international trends. Both these factors will result
in unutilised capacity appearing and leading to slowdown in investments
and in the rate of growth. The rate of growth of the economy which rose on
the back of a rise in the investment rate (from 25 per cent to 32 per
cent) can show an equally dramatic fall. We may be back to a 4-5 per cent
rate of growth which prevailed five years back.
The economy has been facing infrastructure bottlenecks, like in power and
transportation. The food prices have been rising resulting in inflationary
pressures and political problems. Oil prices have been high and even if
they moderate due to the recessionary tendency, they will cause pressure
on prices and profit margins. In other words, the problems already
confronting the Indian economy leading to its slowdown will be aggravated
by the international trends.
The optimists have been suggesting a decoupling between the US economy on
the one hand and the EU and Asian economies on the other hand. It was
being suggested that the growth momentum in the latter would compensate
for the downturn in the US so that the world economy would still sail
through with a minor slowdown. Indian analysts depending on this have been
arguing that India would not be badly hurt by the slowdown in the US
economy. They argue that India is not a large exporter and so the affect
of slowdown would be small.
This line of argument misses the central point that now many of the
markets are fairly integrated with the international markets. That has
been the central point of the Structural Adjustment Package (SAP) being
implemented in India since 1991. Even without full capital account
convertibility, we have had elements of it. FIIs and NRI funds can come in
and go out. Indian businessmen have been allowed to keep capital abroad,
etc. Thus, the financial and real estate markets have been substantially
integrated with the world markets. No wonder what happens abroad has
immediate impact on Indian markets.
We have known that energy and food markets are integrated the world over.
We have been witness to the impact of oil prices and rise in wheat prices.
Thus, many of our markets are now open to influences from abroad. While it
is true that we are not as open as many other economies (like Germany or
Sri Lanka), we are twice as open today as we were in 1991. Hence the US
economy has a much bigger impact today than earlier. Given the size of the
US economy, a 1per cent reduction in its rate of growth would be bigger
than a 10 per cent increase (to 20 per cent and that is unlikely) in the
rate of growth of the Indian economy.
It may be argued that the cutting of the interest rates in the US and
actions elsewhere will have a positive effect and prevent a downturn
there. President Bush has announced a $150 billion package. He is putting
purchasing power into the hands of individuals to boost demand. This would
be about 1 per cent of the US GDP. However, what individuals may have lost
in the sub-prime markets may be much larger and hence inadequate. Further,
the decline in the stock markets and the fall in the paper wealth is also
likely to far exceed this amount.
In other words, some feel that this effort may be too little, too late.
There is nothing unusual in this since in business cycles it has been
mostly found that in the downturn, intervention is usually too little too
late so that the downturn becomes inevitable. In Japan, in the nineties
when the interest rates even turned negative, the economy could not pull
The reason is that once the investors’ sentiments turn negative, there
is little that the government can do to turn them around. This situation
is currently aggravated by the free market philosophy where any form of
government intervention is seen to be bad and, therefore, resisted till it
is too late. Even when it does come, it is of the wrong variety.
Governments following free market philosophy give concessions to the
investors, hoping that they would invest more. However, because demand
does not rise and unutilised capacity continues to rise, they invest
little and the concession simply ends up raising unutilised capacity
further. The medicine aggravates the disease.
Usually, in the downturn, the poor and the poorer countries are affected
worse than the rich ones. For instance, the impact of the sub-prime crisis
has been the greatest on the poor and the blacks in the US. The situation
is being aggravated by the environmental consequences of the development
path being followed in the recent past. With environmental costs of growth
rising in a recession, the poor will suffer even more.
In India, where large infrastructure projects had been planned and
companies were rushing to raise capital from the booming stock markets,
there would be over-capitalisation and consequent losses. Indian companies
have also been rushing to acquire expensive overseas assets. Such
companies are likely to suffer substantial losses.
For India, the negatives seem to far outweigh any positives. Further, the
depression in the world economy is likely to be quite different than the
earlier ones since it is being driven by substantial unresolved problems
in the financial sectors. No one, not even the largest actor on the scene,
the Fed, understands what is going on so that correctives are hard to
devise. Once the economy starts going downhill, many actions that would
have been normal in a rising economy, like acquisitions through
leveraging, investments in risky instruments, turn out to be mistakes. The
various mistakes cumulatively amount to huge mistakes. Indian financial
markets, substantially integrated into the world markets, are unlikely to
be able to escape the impending crisis.
Peace is doable.
Dr. Arun Kumar is the Coordinator of the EXIM Bank-JNU
Library in Economics. He is teaching Economics in Jawaharlal
Nehru University since 1984. He has been the Chairperson of the Centre for
Economic Studies and Planning of JNU, Vice President and Acting
President of the Indian Academy of Social Sciences (ISSA). The article was
first published in The Tribune.