R Ravimohan: Politics or economics?

The new government should articulate its economic policies to assuage market nervousness

Markets fell all around the world during the past few trading sessions. Higher oil prices, China slowing down, US increasing interest rates and hedge funds pulling out of most high yield markets are common refrains quoted to explain the markets' downfall.

In India there is the added dimension of a political change over. So what should we really be worried about? Indian politics, global politics, oil prices, Chinese demand, US interest rates or indeed contagion inducing herd behaviour among global funds?

Oil price hikes in the past months have freaked most observers. The only thing worrying them more than the price hike is the lack of protests, especially from the US. Given the imminent elections in the US and its delicate impotence in global negotiation, it is naive to expect a push back in oil prices.

As the markets fret over the spot price of oil, Alan Greenspan, chairman of the Federal Reserve, is looking further ahead. The price of crude oil for delivery six years hence has risen dramatically in recent years, he noted in a recent speech.

Futures prices were remarkably stable throughout the 1990s, despite wide fluctuations in spot prices. But they have risen from about $18 per barrel in 1999 to more than $27 per barrel now. Looks like higher prices of oil are here to stay for some time.

As an intensive importer of oil, we in India should be worried like hell; both of inflation and slowing down of the economy. Major markets of the world, especially the US and Europe are also likely to be sluggish. Not good for exporters.

China has been on the boil for far too long and everyone is expecting it to slow down. While authorities there assure the world of a "soft" landing, sceptics can be justifiably right in expecting the hard-ball playing Chinese to mess things up one way or the other.

Many in the know there tell us of severe restrictions on spending that are coming right away, which could actually cause a premature collapse of global demand for many commodities, sending many a steel company and the like, spiralling down.

On the contrary, they could leave the "landing" a bit too late, by which time the collapse would any way have set in. One good thing about the Chinese conundrum is we can count on them to "soft-land" their statistics; and in any case their government surplus gives them plenty of room to manoeuvre themselves out of crisis. Therefore, I am more relaxed about the impact of a Chinese slow-down.

US interest rates are a matter of greater concern. These will impact India in at least three ways. The markets and the RBI might see that as a signal for hardening the soft interest rate stance. The US dollar might stabilise in its global value.

These could slow down inflows into, or indeed cause an outflow from, our markets and deposits, causing a reversal of the high liquidity position we have been enjoying for a long time. This would in turn weaken the rupee. A weak rupee and high oil price is a difficult combination to cope with for both the system and businesses in India. This is a big mood-spoiler too, and whatever vestige of "feel-good" factor that might be still lingering has the potential to be wiped out by this development.

The world has not been more fragmented than now for a long time. Given this lack of concern for global development, it is safe to ignore any benign effect of global politics to smoothen some of these effects. Whether it is to pressure Chinese to behave responsibly or counsel Opec to increase oil production or indeed work on West Asia peace process to ease concerns of disruption of oil supply or indeed moderate its own interest rate hikes, US government's ability to do any of the above will be seriously impacted by the approaching elections in that country. Therefore, politics is certainly expected to take a back seat and give a freer reign to brute market economics.

It is in this context that markets in India have to weigh the new political developments in the country. While any change always brings about its own bout of nervousness, it is important to understand the dynamics of this political change. I believe the difference will be more borne out of the mandate that the new government has got rather than any ideology or past behaviour.

People are worrying about reforms. The Congress government in Delhi has been the most reformist as far as power sector is concerned. The Congress party also has a venerable team of economic thinkers. However, the message that comes clearly out of both the state and the central elections is that development needs to be a whole lot more inclusive than in the past. I believe that the new government will pay heed to that message.

Job creation and protection will become more central drivers of policy than in the past few years. Protecting and nurturing rural India will be another theme that will be pursued. Inflation will need to be controlled and the deficit needs to be addressed.

The new government has inherited a sound economy that is poised for a fresh bout of investment. I believe that the market's general meltdown was caused more by concentrated selling in a state of nervousness and in the next few weeks more order will be restored. It is important that the new government restores order as far as some of the important variables are concerned urgently, to prevent a more difficult situation from developing.

I think it is important to keep the exchange rate at the current level or indeed strengthen it a bit to reduce the impact of high oil prices, to mute the impact on inflation and indeed on the liquidity in the system.

Perhaps there will be no alternative to allowing the pressure on interest rates to take root. The new government will do well to articulate its combined policies on disinvestment and market orientation to assuage the nervousness at the earliest.

This suggestion is not being made as mere rhetoric. The urgency is to stem a torrid outflow of foreign exchange will put enormous pressure on the rupee value. The resultant tightness in the domestic market would also put pressure on interest rates.

These moves would also depress stock prices, putting paid to hopes of capital raising to fund investments. It is therefore imperative that political uncertainties in the Indian context be addressed responsibly to prevent a more difficult situation from developing.

It is also incumbent for all concerned including the market players that the new government needs a strong economic activity to generate employment and surpluses for investment in rural India.

It is therefore unsustainable criticism of the government that is yet to even take charge, of being anti-reformist. I have no doubt at all that reforms will continue and the economy will also make good progress.