October, what a dramatic month! Markets crashed worldwide,
taking currencies down with them and creating what has been now been called a
?financial tsunami?. The madness of the media rivalled the madness in the
markets as anchors squeezed out stories from the minute by minute ticker.
All of this was predicted few months back, and we were among
those who did so as far back as November 2007 and repeated our concerns in Feb
2008. Indian policy makers however kept up with their pro-inflationary fiscal
policies of increased government expenditure on the one hand and liquidity
tightening monetary policies on the other. This is a familiar pattern and
occurred in the 1990s as well - profligacy and inflation followed by interest
rate tightening and growth slowdown. This time it is of course much worse, with
the impact of the financial imbalances in the international economy.
This will result in a slowdown in Indian exports, and there will
also be a slowdown in Indian investment growth especially in the corporate
sector. We do not however expect any recessionary tendencies to affect India.
Some sectors will no doubt be affected adversely, and the strong growth
momentum will level a bit, India will however sail out of these troubled times
Among areas of concern, to inflation is now added financial and
macro-economic stability. Given the rapidly changing situation, to its credit
the government has approached this crisis in a mature manner. Increasing
liquidity and reducing interest rates, strengthening of some institutions that
appeared to be weak, and allowing markets to stabilize by themselves have
significantly and positively impacted the long term confidence in Indian
markets. This augurs well for the future.
Since inflation drives politics and economic policy in India, we
would need to keep a close watch on it for some time ahead. On the one hand
commodity prices have fallen dramatically, but so has the rupee, thereby
reducing its anti-inflationary impact. Combined with a high budget deficit and
potential mismatch in supply and demand of some food products (typically of the
non-food grain variety), inflation will fall but not dramatically. Economists
in the government would find it hard to convince the administrators and
politicians to reduce interest rates further.
The PM and others have meanwhile supported ?pump priming? the
economy through additional infrastructure investments by the government. Though
infrastructure investments are generally welcomed, this would not be very
helpful for the problem at hand. Since the money flows would only commence in a
few years, when the worst of the growth slowdown would anyway have been over.
Meanwhile large scale government borrowings would only reduce confidence in the
There is only one way to strengthen confidence in India ? good
fiscal management, and strong market based institutions. Improved monitoring,
quality of regulation, and policy all need to be oriented to these, temporary
PS: Alan Greenspan admitted that the Fed?s ability to forecast
the economy?s trajectory was an inexact science, he said, ?If we get it right
60% of the time, we are doing exceptionally well.? True, 60-40 sounds a bit
better than 50-50.