New Year Lessons

Every New Year stands on the shoulders of the previous year; broad and strong shoulders give it solid support, while shaky legs can topple it over. The Delhi government was shaken in the past year: the Lokpal movement seemed at times to be aimed at the parliamentary system which so long survived and to some extent performed. Since the movement claimed to be peaceful, a compromise seemed feasible and was clearly indicated. Whilst the path to it was not smooth, the bandwagon is well on the way now. Just in case the reminder was necessary, the Bombay high court told the followers of the mercurial leader that parliament also had a job to do. So it looks likely that the rulers and the agitators will work together, and there is a chance that they will together reach a constructive solution. Politically, therefore, the new year has had an encouraging start.

That cannot be said with confidence of the economy. Industrial growth has seen a precipitate decline in recent months; it is difficult to avoid the conclusion that a great episode of industrial upsurge has come to an end. Just how long the downturn will last is a question which cannot be answered with confidence at this stage. Some indication can be sought in the reasons for the downturn. The forgoing upturn was particularly marked in capital goods and consumer durables; young people driving off in natty little cars were its best advertisement. Unfortunately, they did not consult their passbooks before going on a spending campaign. Banks were willing to help them forget. Now the financial institutions are overstretched; they have braked hard on credit. That itself cuts down demand and puts businesses at risk; when they start looking for credit to tide over the sudden slump, there are no easy sources to turn to. So businesses are running into trouble; and there is no early end in sight to their woes.

This is the kind of financial crisis that it is the duty of the central bank to prevent. Our Reserve Bank is normally very cautious. It can point to the stepladder of increases in the bank rate it effected. But when people see a golden future ahead of them, they forget the cost of borrowing. Conversely, when the future darkens, they cannot always repay however often the lenders remind them. And since the government has more or less abolished bankruptcy, borrowers have nothing to fear. They know that the banks belong to the government, which will rescue them whatever bad debts they run up. The taxpayer will have to pay for the rescue. But taxpayers are always in a minority; they can only pay and mourn quietly. So borrowers will not be in a hurry to square their accounts. It is true that the government compensates banks for whatever folly they commit. But this is an Indian government; it is against its principle to act quickly. So the entire process of resolution, to use that wonderful euphemism, may be long drawn out.

The best that can be hoped is that while the people go through the pains, the government will learn something from them. Reserve Bank blindly follows its foreign comperes; it keeps raising interest rates when the economy is overheating. That is clearly not enough; it needs to make much more active use of its other two weapons, namely money supply and the exchange rate. On money supply, its policy can best be called accommodative: if banks run short of cash, Reserve Bank gives them money because it cannot bear to see its daughter banks in pain. Whilst its tenderness is understandable, it should remember that it is Reserve Bank of India, not only of banks. On the exchange rate, its policy is costive. When foreign exchange is flowing into its vaults, it buys up all that is offered; when the exchange rate depreciates, it just cannot bear to sell foreign exchange. The result is a policy of jerky, unpredictable devaluation.

This is not to say that the ensuing downturn is all Reserve Bank's fault. The government has its own foibles. It loves to spend on populist programmes which spill over into micro-corruption; that is its way of buying popularity. They are expensive, so it spends far more than people pay it in taxes. However much they pay, they cannot satisfy its hunger; it must borrow ever more from banks, depriving legitimate businesses of credit, and when it cannot, it prints money. The result is that India has the highest and most chronic inflation amongst all major countries; tough as it was, it has even beaten the Latin American countries. No wonder that the people took their lesson from the government and borrowed as if there was no future. But there is still 2012; we shall now find out what it holds for us.

(This story was published in Businessworld Issue Dated 09-01-2012)