What then happened to make a potentially superb year for India so gloomy by the end Some of the factors that prompted the slide downwards mid-year were external. The sharp rise in international commodity prices, particularly the price of oil, which peaked at $147 a barrel in July, put a lot of upward pressure on inflation. At one time, inflation hovered at around 13%, which was bad news for an incumbent government facing general elections next year and a string of crucial assembly elections in November. The government, however, misread the situation and reacted as though inflation was a result of excess demandon the contrary, a slowdown was already setting in from the first quarter of this fiscal. RBI missed a number of important tricks. For an international commodity price-fuelled inflation, it could have allowed an appreciation of the rupee, which was the direction in which the rupee was headed in any case because of huge capital inflows. Instead, RBI used reserves to defend the currency against appreciation. Then, in what turned out to be overkill, RBI hiked interest rates and squeezed liquidity out of the market, again to tackle inflation. This policy had little impact on inflation and caused the real economy to suffer. RBIs moves looked particularly knee-jerk in hindsight as the global recession eventually softened the price of commodities, including oil, which is now hovering at $40 a barrel. Inflation is down to around 6%. But the real economy is still suffering from RBIs unnecessary squeeze.
The second half
Admittedly, not all of the gloom is RBIs fault. A lot of the misfortune of the second half of the year was not made in India. The global financial crisis and the severe liquidity crunch that followed the collapse of Lehman Brothers in mid-September hit the Indian financial system, even if it was just collateral damage. Banks and financial institutions have become extremely risk-averse and reluctant to lend, even to prime lenders, over the last four months. This is putting a real squeeze on the real economy of both producers and consumers who are in desperate need of loans. Still, even under a new dispensation, RBI seems to be in conservative mode and unwilling to make a drastic cut in rates. This, despite the emerging consensus that over-compensation is better than conservatism under the unique economic circumstances. The policy response of other government actors has been more encouraging. Sebi acted superbly even as the stock market fell below the 10,000 mark. The stock market regulator resisted knee-jerk measures like restricting short-selling, something that regulators in other parts of the world had fallen prey to. The government also acted swiftly to calm panic when the crisis peaked in September and is now moving to act strongly with a fiscal stimulus. Columnists on this page have argued how firms and corporates are much better placed to face this crisis than they were to face the East Asian crisis ten years ago. Admittedly, firms that had overextended by acquiring leverage to acquire firms overseasremember, they were much admired for this in the first half of the yearare now in a difficult position, but most firms have not overextended in this fashion. So, there are some silver linings amidst the gloom.
Perhaps the one area where we havent really had a two-in-one-year is in our experience with terrorism. Sadly, terror remained a recurring feature of life in major Indian citiesAhmedabad, Bangalore, Jaipur, Delhi and most spectacularly Mumbai. While much of the focus now is on forces operating from across the border, there is a need to look carefully at our internal security apparatus, which has been found wanting on more than one occasion. The move of P Chidambaram to the home ministry from finance may yet facilitate the process of reformhe is a proven reformer of the economy. And finally, like almost every other year in recent times, we have done consistently well as a democracy. The icing on the cake was the successful election with a record turnout in troubled J&Kremember all the turmoil that had taken place earlier in the context of the Amarnath shrine controversy But solid voter participation in elections in Karnataka, Delhi, MP, Chhattisgarh, Rajasthan and Mizoram is a great sign as we head into a general election in 2009.