SWAMINOMICS Dark clouds on the 2008 horizon Swaminathan S Anklesaria Aiyar Sunday Times of India 30 Dec 2007
I tend to be an optimist, but see some dark clouds on the 2008 horizon. Since 2003, India has averaged an astonishingly rapid GDP growth of almost 9% per year. But I believe India has a 50% chance of suffering a painful downturn in 2008-09, a 30% chance of a mild downturn, and only a 20% chance of continuing with rapid 9% growth.
India's economic acceleration since 2003 owes much to the global economic boom, a tide that has lifted all boats including India. If the global tide ebbs in 2008, India will go down along with others. India may prove more resilient than others, but no downturn is painless. Given the risk of a serious downturn, Sonia Gandhi should consider a mid-term election in early 2008, before the global slump hits hard. However, she seems determined to complete a full term, even at the cost of compromising with the Left Front on the nuclear deal with the US. Some analysts say Narendra Modi's electoral victory in Gujarat proves that the Congress is not on a good wicket today. Maybe, but i suspect the wicket will worsen rapidly in the coming year. Congress may face a really sticky wicket in May 2009 when the next general election is due. I am not alone in pessimism about economic prospects for 2008. Many analysts have listed reasons to be downbeat -- the global housing slump, the credit crunch arising from the subprime mortgage crisis in the US, record oil and food prices, and a possible cutback in US consumer spending. High food and fuel prices have a big impact on inflation in developing countries like China and India, where central banks will keep interest rates high to control prices. But this will hit industry. Credit card defaults are rising in the US, a logical corollary of the defaults on mortgage payments. Household consumption is influenced by the "wealth effect". When housing prices boom, home-owners feel wealthier and so spend more, often more than their annual income. But when house prices fall, as is the case today, owners feel poorer, and slash spending. US spending has kept the world economy booming for five years, and reduced US spending could mean a global downturn. However, stockmarkets the world over positively brim with optimism, and stock prices are at record highs in many places (including India). Global productivity has been rising fast, in China and India no less than in the US. Rising productivity has enabled the world to grow at the fastest rate in history with very limited inflation. Optimists believe this will help overcome all problems. Central banks in the US and Europe are pouring billions into the banking system to avoid a credit crunch. The housing slump in the US has so far not deterred consumer spending. Some slowdown may indeed take place, but optimists expect that the US will have a soft landing with 1% GDP growth, not outright recession. This muted slowdown will also reduce commodity prices and help tame inflation. Besides, many optimists now think that emerging markets (like India, China and Brazil) have ‘decoupled' from the US economy, and their growth is no longer critically dependent on rising exports to the US. If so, a recession in the US will have little impact on emerging markets. I agree that emerging markets are much less dependent than before on the US economy, yet the decoupling is partial at best. A US recession will mean less US imports from Asian manufacturers like China and India, which will then import fewer components from Japan and Korea, and fewer raw materials from Africa and Latin America. Thus, there will be downward multiplier effects globally. A US recession should reduce India's GDP growth rate from the current 9% to 7% or a bit less. Now, 7% growth still constitutes a miracle economy. So, you might think there is little cause for worry. But a cautionary tale comes from the 1990s. After averaging 7.5% growth in the three years, 1994-97, India slumped to 5.5% in the next few years. That was a decline of only two percentage points, but industrial growth fell to almost zero in 1997-98, and remained weak for years thereafter. Many companies were stranded with excess capacity and huge debts, and went deep into the red. Banks ran up huge losses because borrowers defaulted. Stock markets crashed.
Remember too that in 1997, the Pay Commission award exacerbated the impact of the Asian financial crisis. Another Pay Commission award is due in 2008, again on the heels of a possible global downturn.
Optimists are right that Indian industry and banks are much stronger today, and better able to withstand shocks. If indeed we suffer a serious downturn, it may be sparked by political factors that cannot be forecast. For instance, an Israeli attack on Iran's nuclear facilities could double the price of oil to $200/barrel. Al-Qaida could launch another attack on the US. Such political events, rather than purely economic ones, could be the triggers for the next downturn.