Lesson from India

Coordinated fiscal and monetary measures can pull a country back from the brink

By Mohan Sule
In the second half of 2013, it did appear that the developed world and the emerging markets were decoupled. The focus of central banks in the US, Europe and Japan was to wake up inflation. In contrast, emerging markets were grappling with burgeoning current account deficit, depreciating currencies despite interest rates higher than in the West, and surging consumer prices, pushing the aam aadmi to take to streets in Brazil and India. Even within the fast-growing bloc of countries, there were differences. Imports of gold were straining reserves in India, while cooling prices of commodities were hurting Russia and Brazil and unproductive expenditure in property development was haunting China. At last, it was conceded, that different hotspots have unique problems calling for customized solutions rather than coordinated action by monetary authorities around the world, as was proposed after the post September 2008 financial markets meltdown. The common thread tying up the rich world and developing nations appears to be the frothy equity markets due to the cheap money in circulation. The second is corruption. Crony capitalism is agitating not only India but also Communist China and one-man-ruled Russia.

Yet there are silver linings: home prices are spurting in the US, software services exports from India are looking up, and China’s domestic market’s consumption potential remains untapped due to the high savings rate. The crucial issue is whether they are able to capitalize on their inherent strengths to trigger another round or prosperity, the last being in 2003-07. There are two scenarios. One of the economies rebounds forcefully so as to pull up other laggards. The other is the bottoming out effect as no one is in a healthy shape at the moment. Parallels can be drawn to the four years of universal economic boom at the beginning of this century: India dreamt of double-digit growth in the years ahead without doing anything. However, both conjectures look remote at this juncture. An important component of the last season of buoyancy was cheap money in search of yields. With its likely absence, the debatable question is if the emerging markets will be able to ride on the American recovery. Central banks in these countries will have to keep their interest rates high to remain competitive against US investment options. This will slow their growth. Another possibility is of simultaneous recovery in the world economy because of coming to an end of the seven-year seasonal cycle. By this theory, global economies should start looking up by the end of 2014. Yet his does look a bit difficult because two of the largest economies, Brazil and India, are holding elections this year. Pre-poll sops are in the danger of skewering their finances, stretching the period of recovery and causing a lot of pain.

The continuing slump in commodity prices means the greenshoots are fragile. On the positive side, countries dependent on oil imports will be able to cap domestic inflation. If increasing reliance of the US on shale gas production implies that the era of high crude prices is coming to an end, the rising number of people coming out of poverty is putting pressure on foodgrain supplies in emerging economies. The inability of politicians to reach a common ground is stalling growth in rich countries as well as developing ones like India. On one hand, there is outcry over unemployment. On the other, there are shrill protests over profit-making corporations. At the forefront of this contradiction is financial services, painted either as a greedy dinosaur or a barrier to financial inclusion. Despite consensus that a booming manufacturing vertical is essential to provide jobs, companies in this sector are allowed to turn sick and ask to turn themselves upside down to return to health. But too-big-to-fall financial institutions are prepared for another round of capital infusion to clean up their balance sheets. The onus of reviving the economy has now fallen on central banks, which can only make money costly or cheap as governments with powers to formulate sensible policies have abdicated their responsibility in favour of racking up fiscal deficits. G2, G5,G7, ASEAN, APEC, BRIC are groups formed to calibrate policies but end up being just comfy retreats without any scolding to member-country for mismanagement of the economy. Monetary authorities do meet to swap ideas but are powerless to discipline their governments. How coordinated action by the government and the central bank can help the economy was best demonstrated by the action of India’s finance minister, who imposed import curbs on gold to stave off foreign exchange bleeding, and the Reserve Bank of India, which opened a swap window for banks at a predetermined hedging rate for their dollar deposits to increase inflow.