The full dimensions of the economic crisis are just beginning to unfold. An easing liquidity crunch — ensuring the solvency of banks and financial institutions and mitigating redemption pressure on mutual funds — is no doubt critical. The central theme, however, must be a restoration of trust.
Confidence has been shaken and bridging the ‘trust deficit’ is our single biggest challenge. By a curious coincidence, the last big economic crisis of 1991 also came at a time when the government was fragile and in a near election mode. People have begun to equate the depth of the current crisis with the 1991 episode. This similarity is somewhat misleading.
For one, the 1991 crisis was driven entirely by internal economic mismanagement, while this one is largely exogenously driven. Second, and more importantly, India is now a much stronger economy, well-diversified and integrated, having registered high economic growth with large foreign exchange reserves. Nonetheless, we can fritter our advantages quite quickly if we don’t act decisively. Contemporary economic history is replete with instances where countries with large reserves and strong fundamentals have suffered for failing to act decisively.
First, we cannot any longer be in denial mode. The financial crisis has clearly spilled over to the real world. It has slowed down the industrial sector, with the manufacturing segment having taken the worst beating. Sluggish export markets have begun to effect export-driven sectors like gems and jewellery, fabrics and leather, to name a few. Uncertainty in disbursement of term loans and working capital is beginning to hurt the small and medium industries.
This is a large employment-intensive segment. The services sector has been affected because hotel and tourism have significant dependency on high-value foreign tourists. Real estate, construction and transport are in growing disarray. Apart from GDP, the bigger concern is the employment implications.
The layoffs in civil aviation were the outcome of poor coordination and impaired regulatory oversight. It is, however, episodic of growing employment pressures. Protecting jobs and ensuring minimum addition to the employment backlog is central for social cohesiveness.
Second, those of us who handled the 1991 crisis know that while a lot was delegated, there was greater political engagement. The present Prime Minister, who was then the Finance Minister and is a great believer in delegation, knows there is no substitute for engagement at the top. While he was the first to accept the spillover effects of this global crisis, he has since been increasingly reticent.
An excessive engagement can no doubt undercut the credibility and authority of the designated policy interlocutors. The time has now come when the prime ministerial engagement must become more visible. This will only reinforce the credibility of his team. Besides, during the 1991 crisis there was broader political engagement and important leaders, particularly Vajpayee and Advani, were in the policy loop. This vacuum needs to be filled, particularly when Parliament has been rendered increasingly dysfunctional by this government.
Third, it is necessary to accept that recessionary tendencies (if not stagflation) have set in at a time when there is little fiscal space. The fiscal deficit, reckoning for contingent liabilities, is far above acceptable levels. A decline in tax buoyancy consequent on a corporate slowdown can only heighten fiscal pressures. The pass-through effect of a decline in international prices of tradeables, particularly metals and food articles, will not be fully replicated given the continuing depreciation of the rupee.
Acquisition of dollars by the Reserve Bank has limits. Given the significant capital outflows, with little signs of reversal, would continue the pressure on the rupee and discourage inward remittances and early receipts of export earnings.
Inflationary pressures may not significantly taper early next year when, electorally, it may be late. However, any fiscal stimulus package or contra-cyclical measures would need to be increasingly unmindful of rekindling inflationary pressures. Growth must replace inflation as the main policy thrust.
Finally, in the current circumstances, action in the short run is preferable than the long run and not only in the Keynesian sense that in the long run we are all dead. In the short run we need the following:
n Not wait for the credit review policy later in the month but reduce the reverse repo rate by 150 basis points, which will effectively lower interest rates.
n Set up a special purpose vehicle with $25-30 billion from our foreign exchange reserves enabling access for institutions like ICICI and SBI. This will be mutually beneficial; save them a higher cost of borrowing elsewhere and enable the RBI to earn more than from their current deployment.
n Issue the postponed oil bonds immediately after the second supplementary.
n Allow the reverse flow from the stabilisation fund by lowering the SLR by 300 bps.
n Mitigate pressures on mutual funds and recapitalise banks wherever necessary by increasing government equity and;
n Come up with a credible commitment at the highest level that all deposits, public and private, in all these institutions are safe and have a sovereign guarantee.
Defreezing the financial and credit system is a first but crucial step in improving market sentiment. Beyond this there is the inescapable need to prevent a deeper recession, speed up implementation of public-outlay projects and monitor disbursement of term loans and working capital. Growth must become the central project objective.
Restoring confidence in a crisis needs multi-pronged action. Reversing the growing trust deficit makes prime ministerial engagement indivisible. We need help to dispel our doubts.
(The author is a Rajya Sabha MP and former member, Planning Commission)