Risks to consider

In recent public statements, Mr Chidambaram and RBI Governor YV Reddy have painted very rosy pictures about the state of the Indian economy.

And, going by the configuration of macroeconomic indicators, they appear to be entirely justified. High growth, low inflation, a fiscal deficit coming under control and forex reserves high enough to assure even the most sceptical foreign investor that he can take his money out come what may, are the stuff of which economic managers' dreams are made.

And, he who is at the helm when good things happen can legitimately claim credit, because, if things start to go wrong, he will surely be the first one to be blamed.

However, as is usually the case, and perhaps specially so in today's circumstances, every silver lining has a dark cloud lurking and it would be prudent to consider the potential consequences of a sudden thunderstorm.

Today, the most obvious trigger for a possible economic deluge is the price of oil. It has reached its highest levels in real terms and, on a day-by-day basis, is extremely sensitive to any local event in and around the major oil-producing regions.

One may speculate endlessly on the causes of this situation, but there are very few people who do not believe that these levels are here to stay for a while.

In the past, these levels have triggered global recessions; this time around, the world economy, including India's, seems to have a far greater degree of tolerance for these prices.

Despite their not having manifested yet in appreciably slower growth and higher inflation, oil-importing countries could be in for a rough ride in the near future.

India's current account deficit was around 1 per cent of GDP last year, entirely sustainable, indeed desirable, given the level of capital inflows.

Higher oil prices, combined with buoyant demand for non-oil imports as a result of both accelerating industrial growth and lower tariffs, will surely push that number up. If capital inflows continue at current rates, a larger proportion of these will be used up to finance the trade deficit.

Even if industrial production and, consequently, fuel demand and non-oil imports, slow down, the higher oil prices could stretch capital inflows; the strain will be exacerbated by a slowdown in investment inflows as a result of changing investor perceptions about the attractiveness of returns.

In the worst case, balance of payments pressures could re-emerge, resulting in a drawdown of reserves. Even if this does not happen, declining net inflows will impact on domestic liquidity and reinforce the upward pressure on interest rates.

All of which, at the end of the process, will result in slower growth, higher inflation driven by oil prices, a depleted forex buffer and, possibly, a reversal in the fiscal deficit.

Admittedly, the gap between the current account deficit and capital inflows (around 5 per cent of GDP) is still quite comfortable and makes the sequence of events described above seem unlikely.

But, as we have seen so often, most recently during the East Asian crisis of 1997, what may seem like big numbers for India are, in reality, tiny morsels for global investors. If the tide turns, the outflows could be rapid and highly dislocating.

As remote as the possibility sounds right now, it may be wise for the country's economic managers to let people know how they might deal with such a contingency.