The
world economy has clearly started on Act II of the
possibly prolonged drama that began with the Great
Recession of 2008-09. But if the Government of India
is to be believed, the Indian economy is not likely
to be very adversely affected by the current round
of global financial volatility. Finance Ministry sources
argue that the Indian economic growth story is so
robust that the current uncertainty will cause no
more than a minor blip in its confident trajectory.
But this is definitely an over-optimistic prediction,
which makes one hope that the policy makers are actually
more aware of the possible downsides, whatever their
public pronouncements may be. One important downside
is the likely diminished role of the US as a net importer.
This is no longer a future possibility - it is already
a process that is well under way and is likely to
get even more accentuated in the near future. And
it means that the rest of the world - including India
- can no longer rely on exporting to the US as the
means of generating growth in their own domestic economies.
It is true that the US current account deficit increased
slightly in 2010 compared to 2009, and has been increasing
slightly in the first half of 2011. Even so, in 2010
the deficit was 30 per cent lower than it was in 2008,
amounting to $2 trillion less.
More significant for countries like India, which have
put so many eggs into the service exports basket,
is the pattern of US imports of services. They fell
quite sharply in 2009 compared to 2008, recovered
in the following year but were still below the 2008
level. In the first six months of 2011, US service
imports were only 5 per cent higher than they were
in the first six months of 2008, which implies a fall
in real terms because of the depreciation of the US
dollar in the intervening period.
All this occurred while the stimulus packages still
included some amount of fiscal expansion in the US.
Unfortunately, the political charade around the debt
ceiling that just played out in Washington has almost
completely ruled out the possibility of more government
expenditure to combat the current fragility - instead,
the current watchword is austerity and budget cuts.
Quite apart from the implications for employment,
welfare and inequality in the US, this is a further
constraint on import expansion in the US economy.
And the growing resentment among the people that is
bound to be associated with these cuts will generate
further protectionist pressures that will rebound
on outsourcing and related tendencies.
Since fiscal measures are being ruled out by the politics,
the only means left for the US to come out of this
current stagnation is through monetary policy, though
the effects of this are unlikely to be very positive.
The real problem with the expansionary and low interest
monetary policy being followed by the US Fed in the
wake of the crisis is that it has contained no measures
to make sure that banks actually lend out in ways
that improve economic activity, employment and the
financial condition of the mass of consumers.
But still no such actions are planned. Instead, Federal
Reserve Chairman Ben Bernanke has just announced that
interest rates will remain at their very low levels
(close to zero) for the next two years at least. This
may be fun for banks, but is not likely to stimulate
domestic output or demand in the US directly, especially
because thus far the banks have shown little appetite
for lending to small producers or distressed householders
who are being forced to cut consumption. But this
policy will surely contribute to a weakening of the
US dollar, which indeed may be part of the intention.
And it will lead to yet another problem for emerging
markets like India: the increased tendencies for inflow
of mobile capital, in the form of carry trade to take
advantage of interest rate differentials and because
of perceptions of greater growth potential in these
countries. In Brazil this is already seen as a major
economic concern, as inflows of hot money push up
the currency despite some attempts at capital controls.
But policy makers in India are not necessarily as
wise, and they may rather interpret the renewed inflows
of footloose capital as a sign of the continued economic
strength of India.
That would be a mistake, because financial inflows
in the current context will push up the exchange rate
and further increase the trade deficit, which is already
of significant proportions. It will further shift
incentives in the economy away from tradable goods
to non-tradable activities including real estate,
construction, stock markets and debt-based personal
consumption.
These are classic signs of a bubble economy. As long
as the bubble is in progress, it feels like a boom,
but all bubbles do burst eventually. In the Indian
case the bursting is likely to be even more painful,
because even in the boom the growth process is simply
not generating enough productive employment. So a
quick ''recovery'' from the current volatility need
not be something to celebrate in India if it is because
of renewed capital inflows, with their attendant unfortunate
consequences.
Meanwhile, in Europe (the other major market for Asian
exports), political tensions continue to simmer over
the extent to which economic and monetary integration
necessarily require fiscal federalism and greater
protection of the ''weaker'' segments of the European
Union by the stronger countries. At present, the countries
with deficits (whether these deficits are public or
private) are being forced into massive internal deflations
based on swingeing fiscal cutbacks and falling real
wages, but thus far these are not contributing to
rapidly reducing deficits. Instead, some imbalances
are getting worse simply because GDP continues to
fall. Meanwhile the stronger surplus countries are
also intent on domestic austerity and continue to
look to external markets as the source of growth.
Obviously this is not a sustainable situation, and
something must give fairly soon. But in any case this
means that this region also cannot provide the impetus
required if global output is to be on a genuine track
of recovery, and indeed the pressure is more likely
to be downward.
There are those who argue that the US and EU are no
longer the significant sources of global demand anyway,
and that the future growth for the world economy will
come from the BRIC countries (Brazil, Russia, India
and China). Jim O’Neill of Goldman Sachs, who coined
the term ''Brics'' has pointed out (''Panic measures
will ruin the Bric recovery'', Financial Times August
9, 2011) that ''In the decade that finished in 2010,
the Brics added around $8,000bn to global gross domestic
product, equivalent to about 80 per cent of that of
the Group of Seven leading economies. The Brics will
probably add around $12,000bn more over the next decade,
double the US and the eurozone combined.'' He believes
that if domestic growth in these economies is not
thwarted by inflationary pressures, the world economy
can treat these economies as the engine of future
growth.
But this misses the point that despite some moves
towards greater stimulation of the domestic market
especially in China, these economies are also dominantly
export-driven. Manufacturing exports from China, oil
exports from Russia, agricultural exports from Brazil
and service exports from India are all crucial in
driving domestic growth in these economies, even in
the countries that are currently running trade deficits.
Any slowdown or reduction in exports to the US and
EU is bound to have some depressing effect on both
output and employment in these and other neighbouring
countries. If it also affects investor expectations,
then this can turn into a cascading effect.
The other potentially dangerous effect of the fact
that loose monetary policy in the United States has
unleashed lots of cheap liquidity on global markets
has to do with primary commodity prices. At this moment
oil prices have fallen globally, but this may be just
temporary respite, and for other important commodities
there is no clear decline. Gold prices are rising
because of a flight to safety, but investing in other
commodities may also keep increasing simply because
investors do not know where else to go with their
money, and because interest rates are so low that
there is little to lose.
This means that further increases in global commodity
prices are possible and even likely. The dramatic
increase in global food prices has already created
havoc and adversely affected consumption of the poor
across the developing world. The pressure on food
prices in India is already so intense that the country
really cannot afford another trigger in the form of
renewed global price increases. And this is compounded
by other pressures on domestic prices, so much so
that when the dust created by the anti-corruption
agitation settles, it is likely to become evident
that inflation in food and other basic goods is the
single most important problem in the perception of
most Indians.
Despite macho claims to the contrary, the Indian growth
process is a potentially very fragile one. It has
been heavily based on global integration, both in
terms of new markets for goods and services and the
effects of inflows of mobile finance capital that
have enabled disproportionate expansion of some sectors,
especially finance, real estate and construction.
The threats to this growth process are usually seen
as internal, in the form of social and political unrest
driven by the greatly increased asset and income inequalities
and the growing gap between material aspirations and
reality especially among the youth. But the extent
to which even these social variables can be affected
by signs of external vulnerability should not be underestimated.
Employment in exporting sectors in India has still
not fully recovered from the falls during the global
recession, though output barely dipped. And the large
numbers of young people who have invested heavily
in expensive private higher education in the hope
of a better future are increasingly entering the labour
market only to find that there are simply not enough
jobs being created for them, especially in the formal
sector. The pressure cooker in India is clearly simmering,
and even small signs of external vulnerability and
economic fragility can cause it to explode.
* This article was originally
published in The Frontline, Volume 28- Issue 18, August
27-September 09, 2011.
