The World Bank’s chief economist has certified that we are going through the “worst recession since the Great Depression”. Global trade is forecast to shrink for the first time in a quarter century. World oil demand, it is said, will “collapse” next year. The only thing one reads or hears about, now that the financial crisis has morphed into a broad and possibly extended recession, are job cuts, falling sales, and companies in desperate straits. You have to look hard for some corner where there is good news.
Actually, it’s staring us in the face. Every macro-economic crisis that has hit India in the last 35 years has been provoked by an oil shock, starting 1973. And, guess what? Oil prices have dropped to less than $40/barrel—the level of four years ago. That saves India next year the extra 3 per cent of GDP that we have paid to the Arabs this year for their oil. In turn, it means our trade deficit will shrink next year. And because the oil companies don’t have to be subsidised any more, it saves the government a pile of cash and cuts the fiscal deficit. As commodity prices recede, inflation too will drop to the Reserve Bank’s comfort zone of 5 per cent in the next few months. In short, the big macro-economic imbalances of this year (a stretched fisc, record trade deficits and the highest inflation in a decade) will belong to the past.
As for this being the worst recession in 70 years, that may be true of the west, not India—at least, not so far. Even if growth this year and the next average no more than 6 per cent (lower than any forecast till date), that compares with four years in the 1997-2002 phase when growth was significantly lower (down to 3.8 per cent in one year) and another stretch of low growth in 1991-94. So India’s problem is not a macro-level crisis of the kind no one has seen in 70 years; however, the news is getting rapidly worse on industrial production and exports, and doubtless this will be reflected in the corporate numbers for the third quarter.
The underpinning that the Indian economy has going for it are high savings and investment levels. The rapid growth of the past five years was the result of a spurt in the rate of capital formation—from 25 per cent of GDP in 2002-03 to an estimated 37.6 per cent so far this year. That will now take a hit—because people who are nervous about their jobs will not invest cash in long-term assets like housing; and companies with wobbly sales graphs will not invest in new capacity. With the “wealth effect” having been killed by the stock market crash and the fall in real estate prices, the watchword will be cautious financial behaviour. The trick is to engineer a return of that ephemeral quality: confidence in the future.
The tools for doing this are the standard stuff for dealing with a downturn: the government should spend more money (which is easier when fiscal pressures on account of oil have eased), and private spending should be encouraged with lower interest rates, which will also push money into equities and facilitate a stock market revival. Troubled sectors need special attention. The important point is that the better macro-economic situation today allows these tools to be deployed more freely. We need to make sure they are; the sharp drops now being reported in tax collections, auto sales and exports (all strong danger signals) and the decline in industrial production and power consumption mean that there is no time to lose.