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After the horse has bolted

Even as the RBI meets today, a chance to stem recession has already been lost, writes Prem Shankar Jha.

india Updated: Apr 28, 2008 20:50 IST

The country had one last chance to avoid slipping into the recession that has been gathering like a dark cloud on the horizon ever since January last year. That chance would have arisen on April 29 when the RBI meets for its quarterly appraisal of the economy. But it was lost on April 17 when, in a ‘pre-emptive’ bid to curb inflation, the RBI raised the cash reserve ratio (CRR) yet again by half a per cent to 8 per cent. This will suck another Rs 18,000 crore out of the money markets and make sure that interest rates remain stable and high. But it will also make sure that the recession will move from its first phase, a slowdown or decline in consumer demand, to the second, an absolute decline in investment.

The government will never, of course, admit that the economy has entered a recession. It will trot out the IMF’s current definition of recession as negative growth in two successive quarters to ridicule the very idea. It will rely on the public not to know, or remember, that this definition is relatively new and was conjured up by the international community mainly to be able to describe the average 1.5 per cent growth rate of industrialised countries after 1973 as constituting progress. But there is a far older and simpler definition of recession: the back half of the trade cycle. By that yardstick India is well and irrevocably on the way down.

The justification the RBI cited for its pre-emptive move was an urgent need to curb inflation. On March 29, inflation, as measured by the wholesale price index, touched 7.4 per cent, possibly the highest rate in a decade. That was enough for RBI Governor Y.V. Reddy to forget all about quarterly reviews and announce an increase in the CRR a full 12 days before the scheduled April 29 meeting. This was not a maverick decision. Reddy only jumped the gun at the government’s urging because, a few days earlier, P. Chidambaram had promised the Lok Sabha that he would do everything possible to check inflation, including asking the RBI to take monetary measures. Since then, virtually the entire economists’ fraternity has fallen tamely in line and is shaking its collective head gloomily, saying that the raging inflation had left Reddy with no other choice. One writer went so far as to argue in the Financial Express that keeping the interest rate high in the face of falling rates in the US is a good thing as it will pull foreign money into the Indian money market, and make the rupee appreciate. A cheaper dollar, she argued, is the best way to fight inflation!

All of this reasoning is specious. The CRR was first pushed up in January 2007 to curb demand. That was 16 months ago. Since then it has been pushed up four more times and is now a full 3 per cent above its 2006 level. Each half per cent increase has taken about Rs 15,000 crore out of circulation. This has slowed down the growth of industry, caused an absolute decline in the output of consumer durables, and a 40 per cent decline in the number of new housing loans.

Then how is it that between January 13 and March 29, the rate of inflation has jumped up from 3.8 to 7.4 per cent? The answer is that the inflation we are suffering from is not caused by a surplus of demand. The rise in prices in the summer of 2006 and the sharp spike after December 2007 have been caused almost entirely by the phenomenal rise in global agricultural prices and in the price of raw materials, notably steel. The former has been caused by the simultaneous occurrence of severe drought in Australia and the diversion of 30 per cent of the US corn crop to the production of ethanol. The latter has been caused by China’s voracious appetite for steel.

But why should a global shortage have affected Indian prices? Because the price rise was allowed to enter the Indian market by the same government that is now crushing domestic growth to control inflation. Reddy began to talk about global shortages putting pressure on Indian prices as far back as his quarterly assessment in January. The economic survey took up the refrain, and Chidambaram made a mention of it in his Budget speech. But all the while Indian exporters were exporting rice, pulses, fruits and vegetables as if there was no tomorrow. Between April and December 2007, exports rose by 24 per cent, but the export of agricultural products grew by 35 per cent. The export of basmati increased by 38 per cent, but that of non-basmati rice by 91 per cent. The export of dairy and poultry products went up by 76-80 per cent, but that of ‘other cereals’ by a whopping 284 per cent. It was the same story with steel.

It was not till mid-March that the government belatedly stopped the export of non-basmati rice, following it up two weeks later with a ban on the export of basmati. By then the damage had been done. Was this only stupidity on the part of the bureaucrats? Or was the ban imposed only after exporters had signed their contracts and made their killing? There are no prizes for guessing the answer. Today the government knows that the increase in the CRR will not bring down inflation. But there is an election, so MPs from all parties are demanding that ‘something’ be done to stop the price rise. The latest rise in the CRR may be a purely symbolic, futile gesture. But the price the country is paying is already apparent.

The US financial crisis and the crash in Indian share prices have hastened the onset of Phase Two of the recession. After investors lost money on 13 out of 18 major Initial Public offerings of shares, new share issues have almost dried up. This means that private corporate investment will also decline sharply after a lag of six months to a year. If there is a single ray of sunshine, it is the bumper harvest that has begun to enter the market.

As happened regularly between 1998 and 2002, the purchasing power this will release will give the economy a temporary boost that will last till Diwali. Had Messrs Chidambaram and Reddy had the courage to lower interest rates as the US Federal Reserve is doing, India’s growth would have picked up momentum again by October. But that opportunity has been lost and it is the young and the poor who will bear the brunt of narrowing job opportunities and declining real wages.