Tuesday, May 3, 2011

Economic growth slowing.....we need all hands on the deck.

As a result of the sustained spread of negativity by the media, much of the country has got distracted from the core challenge facing the country. Economic progress. A series of depressing stories came out on Tuesday, 3rd May, that should serve as a wake up call. India against Corruption, hunger strikes and morchas are all fine.....but if economic growth slows, there will be nothing left at all.

The Indian economic growth story is a bit shaken up at the moment. The RBI has stated that inflation is a very big concern for it right now. In fact, the RBI is so worried about high inflation that it has opted to raise the “repo rate” (the rate at which RBI gives money to commercial banks) by 0.5%. Usually, hikes happen at 0.25% at a time. Over the last 12 months, repo rates have been hiked as many as 7-8 times already. This last hike announced yesterday has unnerved everybody. The hike will obviously have a cascading effect on interest rates across the economy. As a result of this step, almost all stocks....especially interest-rate-sensitive stocks.....took a beating on Tuesday. The stock market was down nearly 500 points and plummeted below the 19000 mark after several weeks of staying higher. Foreign investors....responsible for a lot of the trading (liquidity) on the BSE and NSE.....sold heavily taking out nearly Rs 1200 crores in just one day.

The Finance Minister echoed sentiments similar to what the RBI spoke about. Pranab Mukherjee admitted that inflation was staying above his comfort level and hence more aggressive steps were required for controlling inflation. Inflation is like a tax which raises the prices of goods. Its impact is on one and all.....however the worst hit are the poor who simply don’t have the capacity to pay the higher prices (for the well-off, it only reduces savings). As per some reports (IMF and others), if inflation remains this high (for whatever reason....crude oil prices or otherwise), many millions could be pushed back into poverty.

Inflation today, as always, is a result of a supply-demand mismatch. One of the main types of inflation is demand-side inflation.....caused by a high level of demand and low level of supply. Economic prosperity leads to higher demand.....people are willing to pay more to get the goods they want. Food inflation is largely a result of this. As more and more poor people emerge from poverty, they increase the demand for food grains.....but agricultural supply has not increased that much. This has caused a mismatch. It’s the same with automobiles (easy financing leads to great demand, but setting up factories takes time), real estate (rising salaries, easy financing), air travel (rising spends on vacations, increased business travel; pathetic railway service....all driving demand for air travel).....even quality education (ever increasing demand). In addition to demand-side inflation, there is also supply-side inflation.....which happens largely because of an artificial shortage of supply. For eg., shortage of onion crops led to its prices going up. Petrol/diesel in India has always suffered from supply side deficiencies....since India doesn’t have adequate domestic production of crude. Worldwide, fear of reduced supplies of crude (because of the democracy movements in the Arab world) has led to prices of oil going up....even though demand has been growing at a steady and expected rate only. It’s a question of balance. Since both supply and demand are interlinked.....it’s sometimes difficult to know whether the inflation is demand-led or supply-side. Whatever the type of inflation, the response from the RBI and Finance ministry is always the same.

The RBI looks at reducing demand by its monetary policy.....basically interest rate policies. By increasing interest rates, the RBI tries to tame demand. The Finance Ministry, on the other hand, looks at increasing production through its fiscal policy....or taxation-led policies. To spur supply, the government often gives tax sops to industries in specific sectors. This leads to enhanced production, and hence, lower inflation (fiscal policies also help in raising demands in sectors which suffer from low demand....by dropping tax rates). The problem with fiscal policies is that they take time to have effect.....it takes several years to set up production capacities, hire people, train them and increase output. On the other hand, raising interest rates leads to a quicker resolution of inflation. And so, worldwide, the main battle against inflation is fought by the central bank.

The problem is that when the RBI raises rates, it cannot do so selectively. It cannot say: We are raising rates for home loans, car loans etc. But we are keeping rates cheap for industrial loans. Commercial banks are forced to raise rates across the board, since their own cost of raising funds increases (they pay higher rates to depositors). As industrial loans become more expensive, it reduces investments in that sector. This has a long-term impact on GDP growth.

It’s a bit of a double whammy really, but the end result of continuously rising interest rates is that growth slows down. That’s why the government is now talking about growth moderating to 8% rather than the 9-10% that it was talking about just a few months back. If this happens, the impact will last much longer.....going to 10% will be that much more difficult and delayed. It’s a catch-22 situation really – increasing rates tames inflation, but slows down economic growth.

I would be happy if our TV channels and newspapers focused attention on managing inflation.....rather than engaging the whole country into a continuous discussion of only one issue......corruption. The recent stories on corruption (most of them vastly exaggerated by irresponsible reporting) have paralyzed the government. Reforms have slowed down. Decisions are being delayed. The government is becoming risk averse. Is this what we wanted when we started the debate on corruption? Do we want to remove corruption even if it means plunging the country into economic disaster? Wouldn’t it be better if we went about removing corruption in a more mature, tempered way.....chastising the government where it deserves to be, but also supporting it when it does something right.....so that we could achieve both our objectives (removing corruption and continue growing)? By painting all ministers as “chor”, what are we achieving?

The real truth is that our sustained media and opposition attacks on the government are leading to serious problems.....the smallest of them being a slowing economy.....the biggest being the spread of despondency. The role of media is to galvanize the nation....to focus attention to pressing issues....not spreading despondency. Corruption must be removed....but it must be done in a planned manner.....not the frenzied way it is happening right now. It’s time we get all hands on the deck.....whatever happens; let’s not let economic growth slow down. Else, we would have lost all that we have gained in the last 20 years since economic liberalization began....

No comments:

Post a Comment