— Mriganka Shekhar Dutta “These are days when many are discouraged. In the 93 years of my life, Depressions have come and gone. Prosperity has always returned and will again”. These are the words of one of the greatest industrialists of all times John D. Rockefeller, shortly after the Wall Street stock market crash of October 29, 1929 painfully referred to as ‘Black Tuesday’. The ‘Great Depression’ that started in the US soon became a worldwide economic downturn devastating developed and developing economies alike. In those gloomy times too, optimism had persisted as is reflected in the words of Rockefeller, though it took a long time for ‘prosperity’ to return.
The above instance of optimism in the face of difficult times is very much similar to the optimism expressed by many in the present context. However it remains to be seen how deep will the present recession prove to be. In macroeconomics, a recession is defined as a decline in a country’s gross domestic product (GDP), or negative real economic growth, for two or more successive quarters of a year. A recession is invariably preceded by a sharp fall in the stock prices as can be seen in the current times and if the trend continues for a long period then an economic depression ensues. So it is pretty clear that the national economic planners are striving hard to stop the respective economies from nose-diving into a depression. The gravity of the present crisis is not a very elusive question since the various economic indicators convey a rather depressing message even to a layman. It is not that this was unexpected. In fact economists had started ringing the alarm bells as early as the first quarter of 2008. Nevertheless the Indian economy, which has put up a brave show till now in comparison to several developed economies, is still apprehensive if this is the worst or is just the beginning.
In theory, the response of an economy to a recession may take different shapes depending on the economic school to which the policy makers belong. While ‘Keynesian’ economists may advocate deficit spending by the government to spark economic growth, ‘supply-side’ economists may suggest tax cuts to promote business capital investment. ‘Laissez-faire’ economists will simply recommend that the government need not interfere with natural market forces, which they believe are capable of taking of care themselves. The ‘populist’ economists may suggest that benefits for consumers, in the form of subsidies or lower-bracket tax reductions are more effective and serve a double purpose including relieving the suffering caused by a recession. This precisely is what the Indian policy makers have opted to do albeit with some elements of Keynesian and ‘supply-side’ policies. This is well reflected in the recent initiatives of the Reserve Bank of India which is the key functionary in the fiscal and monetary response mechanism of the Indian government.
On December 6. 2008 the RBI cut the benchmark interest rates by 1 percentage point, a move that had many implications. It is expected to make money cheaper and give India Inc. some breathing space. The repo rate- the rate at which banks borrow from the RBI, has fallen from 7.5 per cent to 6.5 per cent. The reverse repo rate- the rate offered to banks for parking surplus money with RBI has been lowered from 6 per cent to 5 per cent. All these are aimed at nudging the banks to lower their lending rates and boost demand in the economy. These measures were closely followed on December 7, 2008 by a Rs 30,700 crore fiscal stimulus package announced by the government, mainly comprising additional government spending and excise duty aimed at boosting consumption. It is simple logic that a surge in the consumer spending shall inevitably steer away the economy from a painful slowdown. However the success of this scheme is vet to be assessed. The first set back was in the form of the reluctance of the banks to cut the retail lending and deposit rates. The State Bank of India took the first step December 20, 2008 by reducing its prime lending rate by 0.75 per cent and deposit rate by 1 per cent. This reduction came in the wake of RBI’s observation in its recently released Trends and Progress report that though banks are quick to raise interest rates when monetary policy was tightened, they are slow to ease them when the policy was relaxed. The initiative taken by SBI is sure to be followed by others, thus pulling down the interest rates across the system by January, 2009. Another important fallout of the measures initiated by the government was the reduction of lending rates by 0.5 per cent for all floating rate loans by the HDFC, the country’s biggest mortgage player. This surely is going to usher in a softer interest rate regime for home loans.
The near future is surely going to be exciting for the buyers. It is another matter that the recent measures will lift the government fiscal deficit above its target of 2.5 per cent of GDP for 2008-09. Planning Commission Deputy Chairman Montek Singh Ahluwalia has justified the move by saying that a higher fiscal deficit was tolerable in the current environment and was an appropriate ‘Counter cyclical’ policy. However one fact that Mr. Ahluwalia missed out is that there was no need to justify those measures. In fact, the call of the hour is to realize that such piecemeal measures are not enough in the light of the enormity of the present crisis. The three largest economies of the world are already in recession, and China, the fourth largest economy, is in deeper waters than expected. Thus the expected rosy days for the consumer may be short lived which is not beyond imagination, given the short term nature of the fiscal measures of the government. The situation is aggravated because of the fact that the RBI does not have adequate institutional mechanisms, as in some matured economies, through which interest rate setting can stabilize the business cycle. This fact is proved by the reluctance shown by the banks to pass on the benefits of reduction in the RBI benchmark interest rates to the ordinary consumers.
While India Inc. has so far displayed a mixed response to the fiscal stimulus package-, and would prefer a more substantial follow-up package, the government must decide to think bold and big. India has a poorly constructed macroeconomic policy framework. As such, the most decisive element in the Indian business cycle is investment. Half of the investment is by the private corporate sector which is driven by expectations about the future. The increase in the GDP of India from 3.8 per cent in 2002-03 to 9.6 per cent in 2006-07 is clear indication of the driving force behind the growth viz. the positive expectations of India Inc. from the world economy in general and the Indian economy in particular. This trend of high GDP growth without adequate stabilisation would land the economy in nastier grounds than the other mature economies.
The present response of the Indian government to the economic crisis is certainly a populist measure that is by and large influenced by political considerations in view of the upcoming general elections. Though it is understandable that the policy makers have limited options, yet it is a risky bait for the Indian economy to rely on an expected growth in consumer demands in view of the substantial volatility all around. The expected economic growth of 7 per cent for the current year may remain a mere expectation if the Indian government fails to initiate long lasting measures in the form of an overhaul of the institutional mechanism so that instances like the recent hiccups in the monetary transmission i.e. flow of the benefits of RBI rate cuts, do not hamper the stabilising process. Changes should not be kept waiting due to political interests, lest it shall be too late for lost ‘prosperity’ to return. ASSAM TRIBUNE
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