Suman Bery: Animal spirits

After the recent bullishness sentiment may be about to change.

April is the cruellest month ... mixing memory and desire, T S Eliot

India's chattering classes are prone to swing from euphoria to despair, and back again, linked only slightly to changes in fundamentals. At the peak the tendency is to believe that things have always been and will always remain so good; at the trough we cannot believe that things can ever get better.

The period from the balance of payments crisis of 1990-91 till the Harshad Mehta scam, the Babri Masjid destruction and the Bombay blasts of early 1993 was an extended and extremely gloomy trough; yet by 1994 we were into the midst of an investment and foreign exchange boom that lasted till 1996. The descent into the next funk was associated with the political instability following the 1996 elections and the first BJP government. It continued with the sanctions following our nuclear tests and with Kargil and reached its nadir with Musharraf's Agra visit, the attack on Parliament in December 2001, the Gujarat riots and the stand-off with Pakistan in 2002. At that time we were deeply concerned about our fiscal position and slow growth. Yet magically here we are, in early 2006 with the Sensex past 11,000, a nuclear deal on offer from the Bush administration and India the darling of the international investment banks.

As my fellow economists are fond of pointing out, there has not actually been much change in underlying economic performance. The long-term growth rate of the economy has been around 6 per cent since the mid-1980s and has not convincingly moved out of this range. Certainly, the economy has become more resilient, largely reflecting a much stronger external sector. As a result, growth has been less affected by sanctions, drought and high oil prices than would have been the case in the 1980s. Our domestic private sector has flowered over the last decade in a way that it could not in the period of controls. But it is debatable whether these changes, important though they are, completely justify the current levels of hype.

On my reading of the periodicity of these cycles, it could be time for sentiment to turn bearish once more. Certainly there is enough kindling around to catch fire. Politically, the Congress and its allies are both restless. The recent announcement on extending reservations to the other backward castes (OBCs) in central institutions has the smell of political panic about it. As many press commentators have noted, the memory and desire of past triumphs seems to be animating both the Congress and the BJP at the present time. The present round of state elections is unlikely to provide much comfort to the Congress party while perhaps strengthening the hand, or at least the rhetoric, of some of its coalition partners.

On the economic side, despite urgings to the contrary from Delhi, it seems very likely that the Reserve Bank will announce further tightening in the monetary policy next week. Although fortunately now settled, the State Bank strike is another bellwether, both in itself and for what it tells us about the mood of the union movement and the political support it once again feels it enjoys in the corridors of power.

Internationally as well, the risks and auguries are now more on the downside. Although world growth currently remains extremely strong in both the developed and emerging markets, many analysts see a marked slowdown in both the Chinese and US markets by year-end. This will be partially offset by recoveries in the eurozone and in Japan, but the adjustment in the US current account deficit could well involve some hiccups, and the markets are likely to want to test the new chairman of the US Fed, Ben Bernanke.

Rising US interest rates are likely to cause some reversal of the money being thrown at emerging markets, notably India, where valuations are already quite rich. The low opinion ratings of the Bush administration put it in a poor position to provide strong leadership in the multilateral trade talks, which are approaching a decisive stage. (This weakness and the impending Congressional elections could also make approval of India's nuclear deal that much harder, although most informed observers feel that it will ultimately pass on the basis of strong US corporate support). All in all, the international mood could well be more sombre by the time of the Fund-Bank meetings in Singapore this September.

Adding all this up, two questions arise. First, can we identify any underlying driver of elite India's emotional cycle? Second, are these shifts in sentiment of any lasting consequence? Or, as my friend and fellow columnist Surjit Bhalla now wearily observes, it just doesn't matter.

On the first question, one might be tempted to argue that sentiment is positive at the beginning of a new government and erodes with experience. While that may characterise the present situation, in both the 1991 Rao government and the recent Vajpayee government, sentiment improved only towards the end of their terms. Clearly, economic performance is important. But, as the experience of President Bush today suggests, a strong economy is at best a necessary, and by no means sufficient, condition for strong approval ratings.

One might also argue that a general sense of "grip" is important, a sense that the government of the day is shaping events rather than being buffeted by them. It would be difficult to argue that case persuasively for the present coalition, given its fractious allies; but as we have seen, that doesn't seem to have affected domestic and international sentiment adversely. My conclusion is that sentiment is a mysterious and fickle thing which has its own cycle, influenced by outside developments, but also carrying its own dynamic within it.

On my second question above, I can do no better than refer to Keynes's discussion of animal spirits and their effects on the willingness of private agents to invest. In an uncertain world, confidence is a key ingredient in the investment decision, and private corporate investment has been particularly slow to recover after the slowdown of the late 1990s. While we should welcome less frothiness in the equity markets, a slowdown in corporate investment, were it to occur, would be unfortunate.

The author is Director-General, National Council of Applied Economic Research, New Delhi. The views expressed here are personal