The mood in India has turned in less than a year from hubris to, well not nemesis but something strongly downbeat. The change is best symbolised by the downgrade in the rating outlook for Tata Steel to negative. This is at the opposite end of the spectrum from the euphoria that greeted its acquisition of Corus two years ago. Global takeovers by Indian firms highlighted the new India of then, marked by a new trend growth rate of 9 per cent, a scramble for talent causing compensations to skyrocket, a booming stock market and, since early 2007, an appreciating rupee.
Today the scenario is marked by falling growth rate (you really don't know where this year will end), falling rupee, falling corporate margins, firms organising early annual shutdowns, shelving of investment plans and the stock market behaving as if there is no bottom. In the case of the US, bad times were seen to be coming (definitely by those who read Paul Krugman) at least since August, 2007 when the sub-prime crisis broke. But in the case of India the rupee was rising well into the current year. The Indian downturn is not and will not be anywhere near that in the US which is clearly headed for recession but still, what needs to be asked, is: how did it happen, could it have been prevented, and what are the lessons for the future?
In examining the recent past, the first reality that emerges is that Indian regulators were so much more circumspect and conservative than their US counterparts. The stock market regulator Sebi put restrictions on the issue of participatory notes by foreign institutional investors a year ago. External commercial borrowings norms were tightened in August, 2007 and the Reserve Bank of India similarly cautioned commercial banks well in time on the growing property bubble.
Despite this the Indian economy is being severely jolted by global shocks. So the first point is, global financial integration has gone to a point where no economy of any consequence can remain insulated from environmental turmoil no matter how strong its fundamentals and how appropriate its regulation. Indian policymakers did not go the whole hog on capital account convertibility and the relaxations introduced till now can be categorised as loosening micro-management which becomes inevitable as an economy gets too big and complex.
The second point is, while Indian financial regulation and fiscal management have been largely competent (the interest rate regime may have been a bit too conservative), something needs to be done about the stock market. On almost any given turbulent day the volatility in the Indian market is greater than that in the US, although it is the US turmoil that the Indian market is responding to. There is thus an immediate need to broaden and deepen the stock market with larger investment by more diverse players so that the market does not react as violently as it does today.
Here also, it is not a problem of straightforward regulation as the payments crises of the past are a memory, and a fairly efficient regulatory system by global standards is in place. What remains ahead is a developmental agenda. A lot more people should buy stocks, they should be guided far more by fundamentals and their expectation of returns should be far more modest. There is too much of a casino mentality among Indian investors but changing this is a matter of public education and not administrative fiat. Only, that education has to be officially encouraged.
The third point is, if you cannot prevent a tsunami and hope to build a wall around you to remain unaffected by it, you have to be ready to mitigate its adverse impact when it occurs. Such action has to be two-fold. One, when a downturn happens, fiscal policy must proactively step in to boost demand and restore confidence. Despite having been good boys till now on interest rate management, India's sovereign rating itself is currently in danger of being downgraded. Since deliverance down that road does not lie at junctures like these when monetary policy loses some of its effectiveness, the new mantra must be to spend your way out of recession or slowdown.
Two, there is an urgent need to put in place a standard set of measures to protect the poor from the vagaries of a downturn when it happens, much like a manual to fight a drought. In the last several months there has been little public discussion on what to do to mitigate the circumstances of those who, as the economy falters, must be falling below the poverty line after having climbed out of it in the recent growth phase. Policy concern has till now stopped at the need to fight inflation instead of also looking at the need to protect jobs. Supply management to keep prices of essentials at affordable levels and demand management to ensure that jobs are not lost have both to be pursued.
A lesson can well be learnt from China, which has built infrastructure in good times and bad so as to be able to take the maximum advantage of the good times when they come again. This is really the time to build rural roads as also highways at an accelerated rate, raise the capacity of the railways and expand its reach, and do the same with ports. This must be the stock in trade to fight downturns and turmoils when they come as they will periodically and no country will be able to insulate itself from them.
