disorder and the Indian economy
Given its heavy dependence
on service exports, there is no way India can avoid the adverse impacts of an economic
slowdown in the US
and EU, says Jayati Ghosh. Besides, it faces the risk of high
commodity prices if the US resorts to a loose monetary policy
as a response.
THE world economy has
clearly started on Act II of the possibly prolonged drama that began
with the Great Recession of 2008-09. But if the Government of India
is to be believed, the Indian economy is not likely to be very adversely
affected by the current round of global financial volatility. Finance
Ministry sources argue that the Indian economic growth story is so robust
that the current uncertainty will cause no more than a minor blip in
its confident trajectory.
But this is definitely
an over-optimistic prediction, which makes one hope that the policy
makers are actually more aware of the possible downsides, whatever their
public pronouncements may be. One important downside is the likely diminished
role of the US as a net importer. This is no longer
a future possibility - it is already a process that is well under way
and is likely to get even more accentuated in the near future. And it
means that the rest of the world - including India
- can no longer rely on exporting to the US as the means of generating growth
in their own domestic economies.
It is true that the
US current account deficit increased
slightly in 2010 compared to 2009, and has been increasing slightly
in the first half of 2011. Even so, in 2010 the deficit was 30% lower
than it was in 2008, amounting to $2 trillion less.
More significant for
countries like India, which have
put so many eggs into the service exports basket, is the pattern of
US imports of services. They fell quite sharply in 2009 compared to
2008, recovered in the following year but were still below the 2008
level. In the first six months of 2011, US
service imports were only 5% higher than they were in the first six
months of 2008, which implies a fall in real terms because of the depreciation
of the US dollar in the intervening period.
All this occurred
while the stimulus packages still included some amount of fiscal expansion
in the US. Unfortunately, the political charade
around the debt ceiling that just played out in Washington has almost completely ruled out
the possibility of more government expenditure to combat the current
fragility - instead, the current watchword is austerity and budget cuts.
Quite apart from the implications for employment, welfare and inequality
in the US, this is a further constraint on import expansion
in the US
economy. And the growing resentment among the people that is bound to
be associated with these cuts will generate further protectionist pressures
that will rebound on outsourcing and related tendencies.
Since fiscal measures
are being ruled out by the politics, the only means left for the US
to come out of this current stagnation is through monetary policy, though
the effects of this are unlikely to be very positive. The real problem
with the expansionary and low-interest monetary policy being followed
by the US Federal Reserve in the wake of the crisis is that it has contained
no measures to make sure that banks actually lend out in ways that improve
economic activity, employment and the financial condition of the mass
But still no such
actions are planned. Instead, Federal Reserve Chairman Ben Bernanke
has just announced that interest rates will remain at their very low
levels (close to zero) for the next two years at least. This may be
fun for banks, but is not likely to stimulate domestic output or demand
in the US
directly, especially because thus far the banks have shown little appetite
for lending to small producers or distressed householders who are being
forced to cut consumption. But this policy will surely contribute to
a weakening of the US dollar, which indeed may be part of the intention.
And it will lead to
yet another problem for emerging markets like India:
the increased tendencies for inflow of mobile capital, in the form of
carry trade to take advantage of interest rate differentials and because
of perceptions of greater growth potential in these countries. In Brazil this is
already seen as a major economic concern, as inflows of hot money push
up the currency despite some attempts at capital controls. But policy
makers in India are not necessarily as wise, and they may
rather interpret the renewed inflows of footloose capital as a sign
of the continued economic strength of India.
That would be a mistake,
because financial inflows in the current context will push up the exchange
rate and further increase the trade deficit, which is already of significant
proportions. It will further shift incentives in the economy away from
tradable goods to non-tradable activities including real estate, construction,
stock markets and debt-based personal consumption.
These are classic
signs of a bubble economy. As long as the bubble is in progress, it
feels like a boom, but all bubbles do burst eventually. In the Indian
case the bursting is likely to be even more painful, because even in
the boom the growth process is simply not generating enough productive
employment. So a quick 'recovery' from the current volatility need not
be something to celebrate in India if it is because of renewed
capital inflows, with their attendant unfortunate consequences.
Meanwhile, in Europe
(the other major market for Asian exports), political tensions continue
to simmer over the extent to which economic and monetary integration
necessarily require fiscal federalism and greater protection of the
'weaker' segments of the European Union by the stronger countries. At
present, the countries with deficits (whether these deficits are public
or private) are being forced into massive internal deflations based
on swingeing fiscal cutbacks and falling real wages, but thus far these
are not contributing to rapidly reducing deficits. Instead, some imbalances
are getting worse simply because GDP continues to fall. Meanwhile the
stronger surplus countries are also intent on domestic austerity and
continue to look to external markets as the source of growth.
Obviously this is
not a sustainable situation, and something must give fairly soon. But
in any case this means that this region also cannot provide the impetus
required if global output is to be on a genuine track of recovery, and
indeed the pressure is more likely to be downward.
There are those who
argue that the US and EU are no longer the significant sources of global
demand anyway, and that the future growth for the world economy will
come from the BRIC countries (Brazil, Russia,
India and China). Jim O'Neill of Goldman Sachs,
who coined the term 'Brics', has pointed out ('Panic measures will ruin
the Bric recovery', Financial Times, 9 August 2011) that 'In the decade
that finished in 2010, the Brics added around $8,000bn to global gross
domestic product, equivalent to about 80% of that of the Group of Seven
leading economies. The Brics will probably add around $12,000bn more
over the next decade, double the US and the eurozone combined.' He believes
that if domestic growth in these economies is not thwarted by inflationary
pressures, the world economy can treat these economies as the engine
of future growth.
But this misses the
point that despite some moves towards greater stimulation of the domestic
market especially in China,
these economies are also dominantly export-driven. Manufacturing exports
from China, oil exports from Russia, agricultural exports from Brazil and service exports from India
are all crucial in driving domestic growth in these economies, even
in the countries that are currently running trade deficits. Any slowdown
or reduction in exports to the US
and EU is bound to have some depressing effect on both output and employment
in these and other neighbouring countries. If it also affects investor
expectations, then this can turn into a cascading effect.
The other potentially
dangerous effect of the fact that loose monetary policy in the United States has unleashed lots of
cheap liquidity on global markets has to do with primary commodity prices.
At this moment oil prices have fallen globally, but this may be just
a temporary respite, and for other important commodities there is no
clear decline. Gold prices are rising because of a flight to safety,
but investing in other commodities may also keep increasing simply because
investors do not know where else to go with their money, and because
interest rates are so low that there is little to lose.
This means that further
increases in global commodity prices are possible and even likely. The
dramatic increase in global food prices has already created havoc and
adversely affected consumption of the poor across the developing world.
The pressure on food prices in India is already so intense that the
country really cannot afford another trigger in the form of renewed
global price increases. And this is compounded by other pressures on
domestic prices, so much so that when the dust created by the anti-corruption
agitation settles, it is likely to become evident that inflation in
food and other basic goods is the single most important problem in the
perception of most Indians.
Despite macho claims
to the contrary, the Indian growth process is a potentially very fragile
one. It has been heavily based on global integration, in terms of both
new markets for goods and services and the effects of inflows of mobile
finance capital that have enabled disproportionate expansion of some
sectors, especially finance, real estate and construction.
The threats to this
growth process are usually seen as internal, in the form of social and
political unrest driven by the greatly increased asset and income inequalities
and the growing gap between material aspirations and reality especially
among the youth. But the extent to which even these social variables
can be affected by signs of external vulnerability should not be underestimated.
Employment in exporting
sectors in India has still not fully recovered
from the falls during the global recession, though output barely dipped.
And the large numbers of young people who have invested heavily in expensive
private higher education in the hope of a better future are increasingly
entering the labour market only to find that there are simply not enough
jobs being created for them, especially in the formal sector. The pressure
cooker in India
is clearly simmering, and even small signs of external vulnerability
and economic fragility can cause it to explode.
Jayati Ghosh is
a Professor at the Centre for Economic Studies and Planning, Jawaharlal
Nehru University, New Delhi. This article was
originally published in Frontline (Vol. 28, Issue 18, August 27-September
Resurgence No. 253, September 2011, pp 32-33