Re: credit rating agencies -
December 1st, 2008
Manmohan, and the 'only good news'
It does appear now that the impact of the global crisis on the Indian economy could be greater than thought earlier. We knew that exports would
be badly hit. We had also figured that liquidity would be impacted by a net outflow of FII money.
What was just not factored in was the impact on Indian firms of the collapse of international lending. As I argued last fortnight, one could not also have bargained for the magnitude of mark-to-market losses of Indian companies on international derivative exposures.
The sharp fall in forex reserves and the unusual surge in credit since August, which I documented, both suggest that these losses are larger than is generally supposed. Indian banks would have settled derivative transactions on behalf of their clients — this would explain the huge foreign outflows.
Losses on derivative exposures of Indian corporates would show up on banks' books as loans recoverable — hence the surge in credit. This 'involuntary' growth in credit must partly explain why credit for productive purposes has suddenly become so scarce and we are seeing a slowing down of the real economy.
What sort of a slowdown can we expect? There is general agreement that the full impact of the present crisis will be felt in FY 2009-10. Growth estimates for 2009-10 are being revised downwards to as low as 5%.
Given the strengths of the Indian economy, there is no reason why the impact should be as severe as that. If this happens, it will be because of a general collapse of confidence. A comprehensive policy response is required in order to prevent such a collapse and limit the damage to the Indian economy.
The response so far has been to loosen the monetary tap and to get banks to lower their lending rates. The prime minister and the finance minister have been busy meeting captains of Indian industry. The message from government seems to be that everything will be done to ensure funds for industry.
In return, Indian industry must refrain from effecting big layoffs that could prove awkward for the ruling coalition in the run-up to the general election. This approach makes sense only if the government thinks that the crisis will blow over in six months or so.
Or if the government believes that the political imperative is to ensure minimal disruption until elections are over — matters thereafter can be left to the incoming government. This is a dangerous approach to take because half-hearted measures could result in the crisis spinning out of control.
Government action must rest on the premise that the crisis will take two years to play out. Action must begin now and not be put off until after the elections. And action to arrest a fall in confidence cannot be confined to monetary policy.
We need a strong fiscal response. This does not mean cuts in indirect taxes alone. That can only have a limited impact on the economy. People may have money but they lack the confidence to spend. Confidence can be bolstered only through massive government spending and the creation of new jobs.
This means spending on infrastructure. It is argued that infrastructure projects take long to fructify and hence cannot help in dealing with the sort of crisis we face today. But we are talking of spending over a two year period. And infrastructure is not just about airports, ports and power.
We need rural roads, low-cost housing, minor irrigation, schools, warehouses, water tanks. All these create employment and can be planned and executed quickly if there is a sense of emergency all round. All we hear are plans to route soft loans for infrastructure through banks.
In today's conditions, attempts to boost infrastructure through private investment won't suffice. Government must take the lead. But this requires the government to involve politicians in the discourse on the crisis.
We need to involve the states and political parties in formulating and overseeing speedy execution of infrastructure works. This is not a crisis that can be addressed by government sitting down with businessmen in New Delhi.
The prime minister must convene a meeting of the National Development Council and ask for plans for infrastructure spending to drawn up on an emergency basis. Let the government forge a consensus among political parties on a plan for infrastructure spending for the next two years.
Forget about the FRBM Act for now. The present crisis poses a challenge but it also creates a major opportunity — to address long-neglected issues of infrastructure. Tackled properly, the present crisis could turn out to be a blessing just as the balance of payments crisis in 1991 was.
It could lay the foundation for much stronger growth once the crisis is resolved. All political parties have a stake in rising to the challenge because the consequences of inaction — escalating social strife in a country already reeling under terrorism — are too frightening to contemplate.