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Navigating the Future in the Midst of Global Uncertainty

Thanks to the central bank's relative caution on the financial sector, India is somewhat protected from the full force of the global meltdown. Yet, there is no doubt that the economy will be affected by the fallout. Policymakers need to take advance action in four areas: growth (moderating a slowdown by picking up the slack in investment), liquidity (the central bank stepping in) when needed, solvency (improving intelligence) and inflation (using quantitative controls if necessary).

COMMENTARYEconomic & Political Weekly EPW october 11, 200815sides of a transaction are financially moti-vated to see the transaction completed, then no amount of transparency will result in greater stability.Of course reducing informational in-efficiencies can often be worthwhile and may result in greater market efficiency. And ensuring that complex instruments come with “full disclosure” at least places some responsibility on buyers to under-stand what they are buying. But transparency has nothing to do with the systemic risk that is the proper object of regulation. Indeed the persistent emphasis on transparency is a dangerous diversion from the massive task of regula-tory reform that is now required in the United Kingdom and the United States. Unfortunately, for the past 20 years or so the regulators have swallowed the argument that superior market sensitive risk management by firms would result in greater overall stability. They must now abandon their belief in the tired trinity of greater transparency, more disclosure and better risk management by firms. Surely it must now be recognised that that regulatory model has failed? Instead they must turn to finding ways to develop a systemic approach to regulation, including pro-cyclical provisioning and system-wide stress testing, and confront the vicious market cycle of rising asset prices accompanied by rising leverage, and the even more vicious cycle running in reverse. Those who argue that greater trans-parency is the answer, do not understand the question.Navigating the Future in the Midst of Global UncertaintyD N GhoshThanks to the central bank’s relative caution on the financial sector, India is somewhat protected from the full force of the global meltdown. Yet, there is no doubt that the economy will be affected by the fallout. Policymakers need to take advance action in four areas: growth (moderating a slowdown by picking up the slack in investment), liquidity (the central bank stepping in) when needed, solvency (improving intelligence) and inflation (using quantitative controls if necessary).Arecession is a merciless killer, but like a hurricane it gives clear warning well before it strikes. No one can complain that the Wall Street catastrophe came without notice. An assessment of the International Monetary Fund, made just six months ago predicted a loss of $ 1,000 billion in the financial sector and a sharp downturn in the global economy. Disturbing trends had surfaced well ahead of the current crisis, in particular, of a massive increase in leverage. Indebt-edness in the household sector in the United States jumped from 50 per cent of gross domestic product (GDP) in 1980 to 71 per cent in 2000 and then to 100 per cent in 2007. And in the financial sector, indebtedness jumped from 21 per cent of GDP in 1980 to 83 per cent in 2000 and then to 116 per cent in 2007. If these were not warnings enough, what else could have been?I have two reasons for starting with this preamble. The first reason is that so far as the financial sector is concerned, we in India are fairly insulated, having built up several strong firewalls in the past. Per-haps a bit of self-congratulation may be in order. It is good to go over the thought that the ongoing US crisis would have created terrible uncertainties for our financialsector had we opened ourselves to the full blast of free flow of capital and free capital account convertibility. That cautious approach seems to have paid dividends, as of now. For this, the Reserve Bank of India (RBI) richly deserves credit, thanks to the stubbornness with which the just retired RBI governor Y V Reddy held out against pressures from powerful quarters and against the uncharitable crit-icism that the central bank was wallowing in the backwaters of chauvinistic nation-alism.Thesecond is the politics of policy-making. We have to be watchful in the real sector, and if that sector starts wob-bling, any policy measures to deal with that will have to have strong political underpinnings. But achievingpolitical consensus is, more often than not, quite a daunting task. Note the recent happenings in theUS. Even in a country with a tradi-tion of bipartisanship, resolving the push and pull of various pressure groups that have inevitably surfaced in the run-up to the presidential elections while devising a bailoutpackage has by no means been easy. Here, with the shadow of national elections looming largeandregional interests raising their voices, we are in for difficult times. Failure to act quickly may have unpredictable consequences.Against this backdrop, I make a few quick guesses in four areas: growth, liquidity, solvency, and inflation. First, on growth. The major countries in Asia, namely, China and India, will continue to report moderate growth. Our exposure to theUS economy is not that large, but as the Wall Street financial crisis spreads to the real sector of that country, certain vulner-abilities in India’s growth trajectory will show up. If the information technology (IT), D N Ghosh ( is the chairman of ICRA.
COMMENTARYoctober 11, 2008 EPW Economic & Political Weekly16business process outsourcing (BPO) and export sectors (among others), not to speak of finance, shed a fair number of people, as is likely, there will be a visible break in urban prosperity, the rise of which has been a notable feature of the last decade. Naturally, that will do no good to India’s booming consumer indus-try. Also, the steep slide in the stock mar-ket prompted by the outflow of invest-ments by foreign institutional investors (FIIs) will affect consumer spending in the upper end in a big way. The growth rates for manufacture and trade will probably slacken, exacerbating declining trends. However, even as these narratives unravel, we will have to do our best to keep the growth story going. Despite all that has happened during the last decade, I believe our growth story has been built to a significant extent on investments, both public and private. This will receive a setback, given that the private sector is already finding it very difficult to raise resources from the market. Many infrastructure companies have deferred risingmobilisation of resources for their expansion and diversification plans. Now that private monies will be harder to come by, the government must be prepared to step in and not allow the pace to slacken. Public sector companies, particularly in the infrastructure sector, should be made to act as national champions for accelerat-ing investments. The conflicting pulls on maintaining financial discipline, contain-ing inflation and spending monies on investments at the same time will have to be faced and managed. Plan expenditure must be pushed vigorously.Second, on liquidity. This is the life blood of any economic system. It is true that theRBI has been closely monitoring the flow of liquidity through the main arteries of the economy. Currently, bank credit is growing at about 22 per cent, something that one can be comfortable with in a normal year. But pressure on bank credit is bound to go up, may be in a few weeks, for, as of now, some of the big houses still have a comfortable cash cush-ion. Other sources of credit are fast drying up. The equity market is under stress and FII inflows have reduced to a trickle. The extent of liquidity stress will vary widely across sectors, depending on how they are affected by the recession in the real sector in the advanced economies. It is important that theRBI sharpens its focus on intelli-gence gathering in several key areas. In times of crisis, staying ahead is the mark of a wise central banker. Perhaps, periodic meetings with the corporate and financial sectors, leading analysts, mutual funds and credit rating agencies will help the central bank make informed guesses on where clogs in the wheels are likely to de-velop, needing quick intervention. It will also comfort the market and its partici-pants to know that theRBI is keeping a close tab on the flow of liquidity, and that it is in a position to act swiftly to relieve any market stress.Third, on solvency. The ticklish issue of separating solvency from liquidity is a perennial bugbear for policymakers. In the case of a good number of units in the IT, BPO and export sectors, the issue of sol-vency may come up. These will be difficult cases for banks to handle. Illustratively, some industrial units with large exposures to western markets, such as automotive components, will feel the pinch. This impact is bound to spill over to the ancil-lary suppliers. Primarily, banks will have to closely interact with these units, and accommodate and help them in their re-structuring efforts. The medium and small sectors will find the going tough. Rating downgrades will become inevitable, jeo-pardising their borrowing lines. (In 2007, for the leading rating agencies, the number of rating downgrades was more than the number of rating upgrades.) With all these developments, there will be mounting pressure on banks for accommodation, but then they may be unable to be saviours even if they wanted to. There can be no ready-made solution to any solvency crisis. A few things from here and some from there may have to be put together. Is it then possible for theRBI to keep handy some kind of a contingency plan for regulatory forbearance? Could we think of a regular forum for consultation with the major industrial houses and the leading companies in the mid-cap and small-cap sectors where suggestions from the units likely to be affected may be con-sidered? Would it be useful if a research and monitoring unit is set up under the auspices of the National Council for Applied Economic Research, with a man-date for intelligence gathering from across the different sectors of the economy in a manner that may be useful for policy-makers? In any emergency, a delayed response is worse than the crisis; let not the better be the enemy of the good.Fourth, on the risks of inflation. Infla-tion, in all likelihood, will abate on the strength of a good agricultural crop and favourable oil prices. The authorities may also have to think, if need be, in terms of stricter quantitative anti-inflation meas-ures and be ready for direct interventions in the marketplace, especially on essential items. We have to be prepared for heavy doses of deficit financing. Of course, one would have to choose investments carefully, preferring the ones with the least inflation-ary impact. They will have to be prioritised to dampen the inflationary impact, and also to pave the way for redistribution of incomes at the grass root levels.A word of caution in the end. Markets have wounded themselves by taking excessive risks, but no solution should in any way stifle risk taking and thereby snuff the life out of any market-based system. We must resist any ideological urge to plunge headlong into overhauling the system. Regulatory authorities whom the country expects to monitor the market-based system have to be more responsible and careful in future.For the Attention of Subscribers and Subscription Agencies Outside IndiaIt has come to our notice that a large number of subscriptions to the EPW from outside the country together with the subscription payments sent to supposed subscription agents in India have not been forwarded to us.We wish to point out to subscribers and subscription agencies outside India that all foreign subscriptions, together with the appropriate remittances, must be forwarded to us and not to unauthorised third parties in India.We take no responsibility whatsoever in respect of subscriptions not registered with us. MANAGER

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