The first is of course a doubling of oil prices in the last one year, with no prospect of an early slide back, or a reduction in import-dependence. This has the obvious consequences brought on by previous oil crises: double-digit inflation, a soaring trade deficit, and a skyrocketing fiscal deficit because the price increases in oil and downstream products like fertilizer have not been passed on fully, or even substantially. Not since 1991 have India's macro-economic balances been so out of whack. |
That brings on a bunch of second-round effects. The sharply rising inflation rate forces the Reserve Bank to raise interest rates (expect another round soon) even though the economic tempo is slowing and therefore argues for lowering rates. Raising interest rates at such a time exacerbates the slowdown. Yet real interest rates on the deposit side are lower than the inflation rate; logically, they have to rise or banks at some stage will face a liquidity crunch. Rising interest rates at a time of growing deficits means that monetary policy will be running contrary to the fiscal situation, and this could crowd out private sector borrowers.
The third set of factors (linked to the first) has to do with the global liquidity surge. There is too much money sloshing around, and it is manifesting itself in the commodity price boom, and higher prices all round "" construction materials like cement and steel, paper, cars and consumer durables. Once again, there is no quick remedy because the excess liquidity is a consequence of the US (both government and consumers) living beyond its means for well over a decade. Those excess dollars lie at the root of many of today's problems, and it is hard to see how anything other than tight monetary policy and severe contraction in the US can correct this.
Combine these with a cyclical slowdown in the global economy, financial crises in the US market with ripple effects elsewhere, and the backwash effects on the capital market, and you have a humdinger on your hands. The capital market is an immediate victim: share trading volumes have fallen by more than half, the feel-good factor has disappeared, the primary market has tanked, and everyone expects share prices to fall further "" India is still an expensive market compared to almost all others, and because profit margins are bound to fall, the pressure is further downward.
The final element in the cocktail is the state of denial in which many people find themselves. This is to be expected when what has gone just before is five boom years. But large swathes of the commercial world have to adjust rapidly to the new reality "" for all the surveys point to a sharp dip in both the business as well as the consumer mood. The counter-argument will be that advance tax collections are a hopeful sign, that company balance sheets are strong, and even a halving of profit margins in many sectors will still leave enough money in the bank for most companies. All that is true, of course, but anyone who does not recognise that the storm signals are flashing red is asking for trouble.
