shankar acharya on the economic crisis

Shankar Acharya, who earned his PhD in economics from Harvard in 1972, was India's chief economic adviser from 1993 to 2001. Currently he's an honorary professor at the Indian Council for Research on International Economic Relations. I spoke with him last week about how India will be affected by the current global economic crisis.

JO: What's your latest read on economic growth for next year?

SA: All these things change very fast these days with the changing situation in the world economy and in India, but with that caveat I would say that there's a reasonable chance that our growth rate in the coming financial year, 2009-10, will be in the region of 5 to 6 percent.

JO: Does it continue to get more negative?

SA: I think so, but I think that's true the world over. If you look at IMF projections for the US or the UK or Europe or Japan, the IMF puts out these projections normally twice a year, and in the last five months tehy've done four sets of projections and each has been significantly worse than the preceding one. That's the way the world is going at present. What you're seeing in the world is what you're seeing in India. With the passage of every month, this is a more serious problem for all parts of the world than they thought a month ago.

JO: Does this 5-6 percent take into account the projected job losses?

SA: Job losses will be there, and they will continue to be there. A lot of the job losses have to do with the direct export sectors, like textiles, leather, garments and all that sort of stuff, and there are a certain amount in the software/IT space as well, and in the fincl sector certainly. A generally scaling down of expectations among busiensses across the board, barring one or two here and there. So I think the job losses are there. We don't know how long it's going to continue, or just how large and how bad it's going to get.

JO: I'm assuming, correct me if I'm wrong, that you expect a slowdown in exports and foreign investment. Does that account for the entire slowdown in growth?

SA: No, there are other things at work. The slowdown in exports is a strong factor, because exports account for 22-23 percent of India's GDP. And as you know the most recent data that we have, for the month of October, shows a 12 percent drop in exports—at least goods exports. And a similar number is expected for November. But it's not limited to exports. Exports are linked to the rest of the economy. Also what has happened is that growth of investment is slowing very fast. There's a lot of cancellations or postponements of projects across the board, as people realize that there is a very substantial slowdown of growth in India – it's not a recession, but it's a substantial slowdown, where we're going from over 9 percent growth to possibly under 6 percent growth in the span of a year or so. That's a sharp, sharp correction, so all the businesses that had geared up their investment and employment plans are having to rescale quite swiftly. Some companies here and there are of course facing negative growth, so that's leading to job losses. And even the ones that are growing in output terms may be undergoing job losses because they hired people last year on the premise that there would be continued rapid growth. That is no longer a tenable premise.

JO: From the rest of the world's perspective, 5 or 6 percent growth looks pretty good. What accounts for India's continued strong domestic demand?

SA: I think there are several reasons. One is of course is that domestic demand, if you take the aggregate of the Indian economy, is over three-quarters of the total, whereas in, say, China, domestic demand would be perhaps 50 percent because so much of the demand comes from exports. That's one reason why relative to East Asian economies India is somewhat insulated from the global trade slowdown—but only relative to them. I'm not saying we're insulated. Then of course from a sectoral point of view, nobody expects the rate of agricultural growth will be changed one way or the other by what is going on because it's somewhat autonomous. It's more dependent on monsoons and things like that. So if we get a reasonable monsoon next year, we'll see agricultural growth on the order of 3-4 percent, as we've seen in the past two or three years. Of course that accounts for hardly 20 percent of the overall economy, but it's good to know that part is insulated. And the services part of the economy, which accounts for over half of the Indian economy, it's up to about 55%, is expected to be more resilient in how much it slows down. Areas like telecom are expected actually to grow quite fast. With all this 3G and things like that. There are similar areas in services. Govt services will show some growth because of the pay increases that went through 3 mos ago with the sixth pay commission. And there are a few other things like that. I think that there will be a slowdown in some service sectors, like finance, externally oriented IT and software, airlines and restuarnants and hotels and all that. But the rate of change downward will be more moderate than in industry, which will take a sharper hit. It has already done so: the industrial production data for October points to a – after 15 years it dropped for the first time by about 1 percent. It's never been in negative territory before that. But it's all consistent with what we know about the various sectors, commercial vehicles, autos, textiles – they're all being affected.

JO: To get simplistic, are these companies that are still growing investing on the basis of future speculation or is the number of people who are able to buy some of these products and services still growing?

SA: It's hard to pinpoint. Basically, when you've had an economy growing at 9 percent for several years, that has a lot of momentum, and it takes a while for everybody to adjust their plans and activities. And that's just as well. I think we'll have a better idea a few months down the road when we have clearer data about what's happened to which sector.

JO: Are there any sectors that are very important to domestic demand? For example, construction, which employs a lot of people who are coming from agriculture, and creating a new class of wage-earners?

SA: Construction is a very important sector, but I suspect it's a sector that will continue to show a lot of activity. Again, not perhaps at the rates we've seen in recent times, but because quite a lot of construction is driven by govt funding, and as you know the govt is continuing to spend quite heavily and has recently done another fiscal stimulus. While I expect a considerable slowdown in construction related to private projects, it may be somewhat cushioned by things like roads and so on, which continue to be built out of govt funds. But where some of these roads are being built by private-public partnership, there may be financing issues, delays and so on. So it's still hard to tell.

JO: Things like roads and some other infrastructure projects are growth multipliers, right? Because they connect new sets of people to the market who weren't connected before?

SA: That's exactly right. It's similar to telecom. Telecom also is a great connector, we've seen in India. It's not a rich man's toy. A lot of low-income businesses and street vendors and so on find cheap mobile phones extremely useful for conducting business. That has been a big growth story in recent years, and I think it will continue quite well despite the problems we're seeing.

JO: You mentioned government spending will be important. What do you think of the stimulus package that the government has unveiled so far? The reaction seems to have been negative, but that may have been industry lobbying for sops.

SA: I think that could be. To my mind the recent stimulus that was announced a few weeks ago is a fairly modest one, but the really big stimulus I think came – it wasn't announced as a stimulus, it was more a matter of getting spending authority from parliament for decisions already taken months earlier. But in October the government passed through parliament a huge supplementary expenditure demand – without the approval of parliament they can't spend more than the budget. And this was about 240,000 crores – or about 4.5 percent of GDP. A lot of it was not instantly spent in cash. It was for things like petroleum bonds or fertilizer bonds to petroleum and fertilizer companies who had not been able to raise their prices [despite the rise in oil prices], and instead of compensating them in cash the government has given them these bonds. But what that means is that those prices have remained low in a period when international prices were going up, leading to these very high subsidy requirements. In itself, one would say that's a bad thing, and it is a bad thing, leading to high fiscal deficits and all that. But given that we were suddenly going through a period where other components of demand were collapsing, having additional spending power in the hands of those who buy fertilizers and those who buy petroleum products was a good thing. So all that fiscal stimulus really occurred in October. Some of it was in pure cash as well – roughly half of that 4.5 percent of GDP was for cash expenditures on things like the pay commission increases to government wages and salaries, like the farm loan waiver, like additional spending on the rural employment guarantee, and so forht. That was really the big additional spending if you like, for this fiscal year at least, rather than the recent 20,000 crores that we saw announced last week.

JO: One thing that seemed significant, or the most debated, was their efforts to stimulate the construction or real estate sector. The reaction was “too little, too late.” Do you think the demand for low and middle incoem housing will allow growth to continue or is something else needed to boost that sector?

SA: I think time will tell. I think the initiatives taken have been quite good. As you know they've recently announced that government owned banks – tehy've essentially said that all these banks must lend at a rate below 9.25 percent or so for housing up to 20 lakhs, and there's a special provision for those under 5 lakhs. Those are good initiatives, because it's a way of using the government's control over parts of the banking system in a useful way, because there's been a problem of on the one hand the cnetral bank is reducing its interest rates, but it's not going through the system. There's been a transmission problem, which, again, is happening all over the world. But here's a case wehre government-ownership of 70 percent of the assets in the banking system can be used to serve a good public purpose, provided of course the lending is done in a sensible way. I think a lot of the people who say not enough is being done are catering to the higher end of the housing and real estate market, and, really, that's a case of overexpansion and expecting the good times to roll forever. There has to be a correction there. They have to lower prices, and it's painful, and one or two companies may go bust.

JO: And some may need to change their business models, and they may be trying to avoid that pain...

SA: It is genuinely painful for enterprises. I'm not trying to minimize this, and it's a big adjustment. In many cases an extremely painful adjustment. But the reality is, nowhere in the world can the government bail out every enterprise simply because times are hard.

JO: To get back to the contrast between India and China, have the two central banks taken different financial policies.... In the past India was criticized for not being expansionary enough, but now they're starting to look clever.

SA: I don't know enough about what exactly has happened on that in Chian. My sense was that both these countries have been somewhat cautious in engaging with international finance, and that has stood both these countires in good stead in terms of exposure to toxic assets. But in terms of whether one has more space in monetary policy than the other, I'm not competent to comment. I think China has more space in the fiscal area, because the fiscal postion of their central and state government is much stronger, so they're in a much better position to take on additional spending. And they're usually better at implementing additional spending on infrastructure and things like that without running into problems of excessively high fiscal deficits and so on.

JO: Do you think the Central Bank will drop rates more rapidly from now?

SA: They will do that in a calibrated way because they also have to worry about pressure on the exchange rate and things like that. Too rapid a declien in short term policy rates would create problems in that arena. They will do so, and they have been doing so. They dropped policy rates from 9 to 6 or so, and tehy've dropped reserve requirements from 9 to 5.5 percent. SO both in terms of pumping in fresh liquidity and lowering rates, it's been the fastest loosening of monetary polciy ever in India.