Crisis for India is not yet over

Category: Global Economy Sub-category: Indian Economy
Document type: news

India sailed through the Great Crisis of 2008-09 almost smoothly. But it's nothing to be overwhelmed about as the aftershocks of the crisis are also required to be dealt carefully and tactfully. At least the post crisis effects in the South European countries suggest so! No doubt, India is one of the strongest and most balanced economies of Asia but still, ignoring the ups and downs in the external world can make her pay heavily. For India this period should be viewed as a wakeup call; a time to assess and re assess its strengths and weaknesses, a time to sharpen its focus on the challenges and opportunities shaping its development journey.

The recent recession managed to hurt India a bit no doubt. But because of its resiliency, even its disadvantageous results turned out to be far better than those shown by the developed world. Industrial production troughed out in positive growth territory - barely, to be sure, at +0.3% in early 2009 - and real GDP still managed to expand by +6.7% in FY09. In both cases, these were major downshifts relative to vigorous pre-crisis growth trajectories. But against the backdrop of a world that had tumbled into the deepest recession since the 1930s, India's relative resilience deserved attention.

India's relative performance with respect to other developing countries was also quite satisfactory. This was mainly due to her more measured and highly stimulating policy actions that did not have the destabilizing post-crisis impact that resulted in property bubbles and deteriorating bank loan quality, when in China the external demand shock posed a major threat to jobs and social stability.

India's unusually stimulating monetary and fiscal policies, though managed to avoid the destabilizing effects of the post crisis period, started posing bigger risk to the underlying inflation. In this regard, India now faces the same dilemma as others - how to compose an effective "exit strategy" from the emergency policies that were put in place during the crisis. And the exit strategy needs to be executed in what still looks to be a very shaky post-crisis global climate. Simultaneously, these delicate policy measures must be chalked out in a manner that doesn't hamper the country's ongoing development program. Of course, this is not an easy feat for any nation.

Indian economy is supposed to have a better balance than others in Developing Asia mainly because a greater portion goes to private consumption and services rather than exports and investment. Still it is not immune to shocks elsewhere in the world. It's highly evident from the export share of the Indian Economy which stood at only 24% in 2008; far short of the 45% norm for Developing Asia as a whole. But interestingly, India's 2008 export share was more than double the 10.8% reading in 1998. However, it is the change in India's export share rather than its level that drives economic growth.

Again, growth in Indian industrial production plunged from about 13% in early 2007 to around "zero" in early 2009 i.e. during the period when global trade was completely shattered due to the crisis. There is, however, an important twist to India's increased exposure to external demand. In recent years, the composition of Indian exports has shifted dramatically away from the developed world towards its neighbours in Developing Asia. The US share of Indian exports fell from 22.8% in 1999 to 11% in 2009; Europe's share of the same fell from 27.6% in 1998 to 20.9% in 2009 while the portion going to Developing Asia essentially doubled from 5.6% in 1999 to 11.6% in 2008. Though these shifts in the mix of Indian exports have resulted in an increased reliance on demand from Developing Asia with lesser focus on the developed markets, they hardly eliminate India's vulnerability to lingering problems in Europe.

Even with recent significant shifts in the mix of India's external demand, Europe remains its largest export market. If this is a bad news then the good news is that even with sharp recessions in Greece, Portugal, and Spain and likely outcomes in response to EU-IMF imposed fiscal consolidation in all three countries, the shortfalls in pan-European economic growth are likely to be much less severe than what was actually evident during the crisis that occurred in late 2008-09. On balance, the ongoing repercussions of Europe's sovereign debt crisis could well be an important headache for the Indian economy for the next several years to come.

Post-crisis aftershocks deterred India from redoubling its efforts on other aspects of its development strategy. Key in that regard will be to sustain the recent improvement in domestic saving. India's gross domestic saving rose sharply to 36.4% of GDP in FY2008 from the low 20s that had prevailed since the early 1990s. This can turn out to be a major support to India's recent increases in investment spending on both infrastructure and manufacturing capacity. But due to the crisis-related increase in government budget deficit, the domestic saving rate fell back to 32.5% in FY2009 which in turn can again create constraints on spending for infrastructure and manufacturing capacity.

Again, on the heels of the recent surge in domestic saving, the corporate investment share of Indian GDP trebled in the seven years before the crisis - rising from around 5% in early FY2001 to 16% in FY2008 before falling back to near 13% in FY2009. If the crisis-induced fiscal stimulus remains in place for too long and the recent shortfall in domestic saving continues, the renewed widening of nation's current account deficit is likely to persist. That could make it very difficult for India to restart its investment-led growth dynamic. Thus the trend must be reversed if India has to sustain the investment-led growth.

Here lie the pitfalls of the "exit-strategy trap". Like most major economies, India is having a hard time restoring its policy settings to pre-crisis norms. The Reserve Bank of India has unwound only 50 basis points of the 425 bp easing that was implemented during the crisis despite a 8.6% y-o-y increase in real GDP growth reported for the quarter ending March 2010. While there are hints of more rate hikes to come, the RBI has yet to convert these hints into action. Non-food inflation is on the rise both at the wholesale and retail levels; prolonged monetary accommodation is both inappropriate and worrisome, the government's latest budget points to limited reduction in the structural deficit in the current fiscal year - with the bulk of any improvement stemming from one-off windfalls associated with divestments and 3G license fees. More meaningful fiscal consolidation is slated for 2011-12 though the feasibility of these proposals is still a doubtful issue. India, of course, is not the only country in the queue. That's very much the case across the developed world and in major economies of the developing world - notably China. Specially, emerging economies like India and China cannot afford to take the lead from the West and stick for long to crisis-induced emergency policies. Deferred exits strategies are not without destabilizing consequences. Surviving the crisis was one thing. It's now time to face up to a post-crisis reality check.