27 November 2008

Long pain ahead in the world

The similarities of the present crisis with the 1929 era are looking eerie (more on that later). While any comparision with the past may be misleading, this surely is not a self correcting 1987 style crash. It's here to stay. Even if one were to concede that we have only a quarter of the problem of the 1929-1934 era, we are still looking at a very deep and a long painful world economy ahead. Here is one gloomy statistic - if you had invested in the Dow at its peak in 1929, you would have had to wait 25 years to get your money back - and that is not counting inflation (the Dow reached its 1929 high only in 1954). Here is another statistic, the markets fell from 1929 till 1934 very gradually with lots of false starts of double digit increases in short bursts - but the market was to fall 89% from its peak.

With the financial markets in a complete mess, a freeze in the money markets (thankfully not yet reflected in the Indian financial markets), a complete flight from risk, expectations of large defaults in the corporate sector, starvation of all forms of equity and debt capital (Indian and overseas), the tendency to deleverage where leveraged and hoarding as much cash as possible by all, the world market doesn't look like it will turn positive for at least a few years from today. While we in India have been living in delusion for a long time about the impending crisis, I think that we do have the chance to come out of it sooner than others - provided we do lots of things right and that too within a few months if not weeks from now. A big expectation of course given our past record of reforms.

India's fundamental flaw has been, while the real economy is still burdened with red tape, it is very easy to make portfolio investments in equity (and even real estate) - and that too with no tax burden for overseas investors because of abusive tax treaties. This makes it easy to bring in and take away 'hot money' in a matter of a few minutes. While I support free flow of capital, I find the pain in productive employement of capital - combined with the ease of portfolio capital flows, perverse. We are below most parts of sub-saharan Africa in our competitive index on ease of doing business at 109th position out of 134 countries (WEF's Global Competitiveness Index 2008-09). We also have the distinction of being 127th out of the same 134 countries in terms of our fiscal deficit percentage to GDP. By the way contrary to government figures our deficit exceeds 9% rather than the 3.5% as claimed in official figures - the lower number is arrived at by excluding big ticket subsidies from the deficit numbers. This of course means that we have a very limited access to fiscal stimuli, unless the government decides to print notes and aggravate inflation.

While it would be suicidal to restrain capital outflows, like we tried some tricks with overseas borrowing and lending of stocks, we only have two tools left. One is monetary and the other is productivity enhancements. With still high levels of CRR, SLR and interest rates, there is still enough ammunition to reduce these and inject liquidity into the system. While liquidity enhancements have not worked in the past few months as corporates and financial institutions are sucking up all the extra liquidity, such enhancements will only work with bringing confidence back into the markets. And that can work only with improving productivity gains. That would result in a virtual dismantling of the large remnants of the license raj, introducing labour law reforms which are unpopular, repeal any law which requires going to more than one agency for governmental approval. Let the government deal with government bureaucracy and give a single window clearance for any project within a period of 30 days, so long as it is not hazardous etc. This is not an impossible goal, SEBI/RBI already give a single window clearance for a range of intermediaries including registration of Foreign Institutional Investors.

Whatever few fiscal tools we have left should be employed to partner with the private sector to enhance education and infrastructure. I don't see all this happening, and believe me, I really don't want to sound like Cassandra, but things are more grim ahead than we are prepared to accept.

PS: Argentina is better than us in fudging numbers. They remove from the index (for consumer price inflation) anything which moves up in double digits. The reason? If it becomes so pricey, people will find a substitute!

Please see my main blog here for the full post.

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