In December 1933, Felix Frankfurter sent to US President Franklin Roosevelt a copy of an open letter from the economist, John Maynard Keynes. Keynes had sent an early copy for FDR before it was to appear in the New York Times and other American newspapers on December 31. His advice resonates for today’s India.
He started by telling the president that he had two tasks, Recovery and Reforms; recovery from the slump, and the passage of long overdue business and social reforms. The first demanded speed and quick results. The second could wait because doing both might over-strain the bureaucratic machine. Recovery required the raising of output and employment, for which the starting point was an increase in public expenditures, leading to a rise in purchasing power, so that individuals and businesses began to spend more. He made it clear that output and incomes would not rise merely because of more liquidity. He also argued for intervention to prevent the depreciation of the dollar.
India’s crisis has not yet affected agriculture or rural incomes. It is primarily in corporate and urban India, in manufacturing, exports and related services, and in the financial sector. Already it has led to the first decline for 15 years in industrial production, in continuing reduction in growth estimates, growing layoffs and employee remuneration, and precipitous falls in private investment in industry and trade.
When an economic setback looked likely, the demand from industry and government was for expansion of liquidity and reduction in interest rates. But cuts in SLR and CRR had little effect, because increased liquidity was set off by the borrowing by oil companies and others on the security of government bonds issued in lieu of cash due to them. There was also the necessary RBI intervention to protect the rupee from further decline by selling dollars and thus taking in rupees. Industry therefore found the money market more, not less, restrictive.
Meanwhile, the risk aversion of banks increased with declining demand for many industrial and consumer durable products, and falling prices, while the small-scale sector suffered even more on account of organised sector payment delays. The RBI rightly resisted interest rate reductions while inflation was rampant. Reductions came with declining oil prices. But neither interest rate reductions nor extra liquidity have helped meet the demand for money by industry.
Keynes’ letter was about the West in 1933. Since then, there have been many changes. One, there are the vast financial flows in relation to trade flows; two, the huge dollar reserves with countries like China, Japan, oil-producing countries, Russia and even India; three, many banks and financial institutions have revenues far above most countries and can move big sums between countries instantaneously; four is the high trade dependence of many countries (even Indian exports multiplied seven-fold over 15 years).
India, in addition, has had massive inflows of volatile funds due to policies like exempting funds from Mauritius from the short-term capital gains tax, and allowing “participatory” notes (anonymous inflows enabling Indian funds to profit from round-tripping). Also, Indian companies arbitraged the interest rate differential between other countries and India, as it enabled cheap funds to be brought in. The appreciating rupee made the bargain even better.
But with the collapse of the large American and European banks, these funds dried up and old loans are not being rolled over. Not surprisingly, foreign and many private banks in India have become cautious lenders. At the same time, growing job losses and reductions in remunerations to well-paid white collar workers in the services sector (IT, BPO, financial services, tourism and real estate), rather than high interest rates, have made them poor credit risks for housing loans, consumer loans and credit card debt. There is also growing aversion to fresh borrowings on these items as people insecure about the future cut back on their expenses and borrowings. Related industries declined—real estate, cars, travel, etc. The fate of laid-off blue collar workers in textiles, garments, automotive components, etc, and casual workers in these and the unorganised sector is even worse.
After the failure of monetary stimuli, the government has announced a substantial additional investment package. However, governments do not spend even funds allotted in their Budgets for infrastructure projects and social programmes.
Keynes wanted Roosevelt to raise public spending. In India today we must first enable the bureaucracy to spend the funds allotted for schemes, and do so honestly and efficiently. Only then do we need to increase public investment. We cannot postpone reform. It must accompany the policies for economic recovery. We have to build on Keynes. Sadly, we seem to take one step at a time, and always too late.
