The deceleration in industrial growth rate to 3.8% during May 2008 has made the markets jittery and a sense of deceleration in GDP growth is now palpable. With political instability at the Centre, this fear is likely to be more pervasive in the coming days. Even though the government is upbeat about a buoyant economic growth in 2008-09 too, not everybody is impressed, including this author.
The accompanying graph substantiates this anxiety of many. A closer look at the graph shows the following: There is indeed a correlation between the GDP growth rates of India and the US, even though there is a lag effect. This in turn implies that any growth or de-growth in the US has a possible impact on India?s fortunes. Given that, the US economy has expanded by a bare 0.6% and 1% during Q42007 and Q12008 respectively, there is every possibility that the growth rates of India will be significantly impacted during Q12008 and subsequently.
An interesting observation from the graph shows that the downturn in business cycle for India occurs every 2 years, and that too during quarter 3 (October-December). This is corroborated by the low GDP growth rates during Q32002, 2004 and 2006. Going by this trend, Q32008 may possibly witness a new low-down in GDP growth rate.
The duration of this downturn in business cycle varies and may be as prolonged as four subsequent quarters (Q32003 till Q32004, with only a marginal recovery during one of the quarters in between). Going by this logic, the slowdown in 2008-09 may be a little bit prolonged and recovery may not be forthcoming at least before Q12009.
Even as we brace up for a slowdown, the question is what we are doing in such an eventuality? Before we get onto a discussion of such, let me first debunk a myth, that the recent spurt in prices was to a large extent driven by oil prices. In fact, a closer look at the statistics reveals that the government should have been aware that the jump in primary articles and to some extent manufacturing prices during 2007 was a cause for alarm, even though fuel prices remained low. This increase in primary articles prices is not at all baffling, as the food grain stocks in the last couple of years had even fallen short of buffer stock norms. Thus, while domestic foodgrain stocks were completely inadequate to arrest the increase in domestic food prices, the government claimed that global food prices were rising and India could not have been isolated from outside trends.
The declining foodgrain stocks with the government reveal a very interesting observation. During mid 1990?s, when the inflation rates touched 14% and Manmohan Singh was in saddle, one of the options that the government resorted to was open market sale of wheat and rice by Food Corporation of India, in conjunction with other monetary and fiscal policies. This time, as the government grapples to arrest the surge in food prices, it is imperative that FCI supplements the open market sale.
Let us now come to the interest rate hikes. Given that the recent spurt is possibly the result of supply side shocks rather than the high M3/money supply growth, I am not certain how such monetary policy is going to be countercyclical, rather than stagflationary. For example, rationalising credit rationing on the part of lenders by the logic of asymmetric information between lenders and borrowers, Joseph Stiglitz observes wide-ranging tendencies for ?financial exclusion? of borrowers who could otherwise contribute to growth in the economy. In the context of the prudential measures like the capital adequacy ratio, Stiglitz blames these as responsible for ?exacerbating the downturn when it cuts down loans instead of trying the alternate route to ensure capital adequacy by raising capital from the market.? A reduction in loans which causes downturns has in turn an adverse effect on banks as well, an aspect that negates the beneficial effects of prudential norms like the capital adequacy.
Finally, a word of advice for the votaries of expenditure reduction and compression in fiscal deficit as a key tool to stabilisation. In broad terms, fiscal deficit of the government is analogous to the sum of revenue deficit and capital expenditure/public investment of the government. Conventionally, increased government borrowing means lower private investment as it utilises scarce and physical financial resources that would otherwise be available to the private sector. However, the other side of the story is that public investment can also be complementary to private investment if it is related to infrastructure. Public investment of this type can enhance the possibility for private investment and raise the productivity of capital, increase the demand for private output and augment overall resources through an increase in aggregate output and savings
So, what next? Brace up for an economic slowdown, perhaps a little more prolonged this time. Also, if trends are to be believed, the worst time could be possibly the end of 2008.
The author is a director with a leading MNC. These are his personal views