|
special issue: federations and the economic crisis
Global meltdown hits India’s poor the hardest
REUTERS/Stringer India
Indian employees at work at a call centre in the southern city of Bangalore. India’s call centres offer inexpensive English-speaking workers and high-speed telecoms to customer service helplines for companies around the world. Even India’s booming tech sector has felt the impact of the global economic crisis.
By Jayati Ghosh
When the global financial and economic crisis began to erupt in the United States, some experts argued that India’s economy, like that of China, was “decoupled” from the rest of the world and might not be affected by the downturn.
This rosy picture was based on the belief that India’s recent strong growth arose from a low per capita income base and a young population, which meant fewer retirees to support. In addition, the domestic financial sector was considered immune to shocks from the international system.
But these experts were wrong. India’s recent strong economic growth was dependent upon increased global integration and financial deregulation.
These factors, combined with tax concessions, had another result: a consumption boom for the top twenty per cent of the population, especially in urban areas. This “boom at the top” continued while deflationary fiscal policies, unemployment and an agrarian crisis restrained consumer demand.
A substantial increase in corporate profits and the proliferation of financial activities combined with rising asset values, including for real estate and stocks, to enable a credit-financed consumption splurge among the middle classes and the wealthy. This helped generate stronger investment and output. However, this consumption binge could not continue indefinitely. Bubbles of market speculation also made the growth process more vulnerable.
Capital leaves
By mid-2008, even before the global crisis really hit India, the phenomenon known as the “boom at the top” was also reaching its limits. The crisis made matters much worse by causing a sharp decline in manufacturing exports and a reversal of capital flows. Capital was now leaving India, rather than flowing in. Foreign investment started leaving the country, banks reduced lending to Indian companies and the country’s investors shifted more of their capital abroad.
By March, Indians were importing much more than they exported, causing a trade deficit estimated at 12 per cent of gross domestic product. The current account deficit was less than this because of the mitigating effects of India’s software exports and money sent home by workers abroad. But this was not enough to prevent the current account deficit from rising to five per cent of GDP.
Added to this, for the first time in two decades, the capital account turned to a deficit position of about 1.5 per cent of GDP. Foreign investors, who had to meet commitments and cover losses in their home markets, sold in India and repatriated their capital. The net outflow was as great as $56 billion from April to December 2008.
One result of this capital outflow was a collapse of India’s stock markets, whose woes were associated with companies having greater difficulties raising money for investment through public share offerings. The flight of capital also sparked a rapid and dramatic depreciation of the rupee.
External commercial lending dried up, and even turned negative, affecting the exchange rate and domestic credit market conditions. For the year ending in March 2009, the exchange rate fell 30 per cent against the U.S. dollar. Even so, exports continued to fall because of adverse world market conditions.
In a scenario that occurred in many other countries, richer investors were afraid to borrow even at low interest rates, while small producers and farmers were unable to gain access to even modest loans needed for working capital.
Growth rate slows
Difficult financial conditions and the global slowdown have caused a substantial reduction in the growth rate as well as a drop in production and employment in some sectors. Besides employment losses in export-oriented sectors, surveys by the government’s Labour Bureau indicate there have also been job cuts in sectors catering to the domestic market.
Workers’ incomes were also hit, with reports of falling real wages – and sometimes falling wage rates – hitting workers in the industrial and services sectors. Moreover, incomes declined for self-employed workers, who constituted more than half the work force in 2005.
Agricultural producers, especially those with export crops whose prices had collapsed, faced growing difficulties on top of their existing financial problems, reflecting rising input costs and large debt burdens. Small-scale producers in all sectors were squeezed by falling demand and the credit crunch. As these producers account for the bulk of employment in manufacturing and services, and typically hire workers on informal casual contracts, their economic difficulties translate directly into reduced employment. Surveys of home-based workers reported rapidly declining orders and falling piece-rate wages for work that was part of production chains linked to domestic and export markets.
Another significant impact of the crisis has been on general living conditions, in particular food security for households. While inflation rates were near zero for the year ended in March 2009, prices for food and essential medicines have continued to increase. Unemployment has climbed, wages have stagnated or fallen and cash crop producers have faced falling prices, reducing the purchasing power for food.
Public services threatened
To a large extent, the worsening situation for basic public services reflects the fiscal crisis of state governments. India’s constitution created a federal system with states that were originally organized on the basis of language. These have since been divided to form 28 states and seven union territories that are under the control of the central government.
REUTERS/Punit Paranjpe
Onlookers in Bombay watch a broadcast of India’s finance minister Pranab Mukherjee delivering his budget speech to Parliament in July 2009.
Economic powers are shared between the central and state governments, with the central government controlling all monetary policy and significant elements of fiscal policy. All direct taxes and taxes on international trade, as well as taxes on services, are collected by the central government. States are allowed to collect their own Value Added Tax and property taxes. The Reserve Bank of India, the central bank, can determine the borrowing limits of state governments. State governments that borrow from international organizations require the prior permission of the central government.
The central government and many states have passed fiscal responsibility legislation that put a limit of two per cent of GDP on their deficits. In the case of state governments such legislation, which also limits borrowing by states, was more or less imposed by the central government, which made it a condition for debt relief. However, the central government has not consistently abided by those fiscal limits. During the present crisis, they have been explicitly relaxed with regard to the central government.
Unfortunately, state governments do not have similar freedom, even though they have also been allowed to borrow more than before. They are responsible for much of the public expenditures that directly affect citizens, such as in the areas of health, education, sanitation and infrastructure, including roads, sewers and commuter transit systems. Their tax receipts have fallen well below projections because of the downswing. The tight budget constraints they face have limited their expenditures and reduced essential spending on basic services, not to mention development.
Expansionary moves
The initial responses of the government focused on the financial side of the current crisis, with four major components to the first stimulus package adopted in late 2008: reducing interest rates; increasing access to credit for companies, from both domestic and foreign banking sources; getting state governments and public sector enterprises to borrow more for spending on infrastructure; and providing credit for more consumer spending, especially on automobiles and other durable consumer goods. Even if these measures had worked, such policies would only have strengthened the same economic tendencies that generated the crisis in developed countries. By April 2008, it was already clear that these monetary measures had proved to be lacking and did not ease credit conditions in any meaningful way.
Most economists, and even governments, accepted that there is no alternative to the standard Keynesian device of using expansionary fiscal measures to create more economic activity and demand, thereby lifting the economy from a slump. Critics faulted the government of India for waiting an
inordinately long time before taking the first step in this direction and announcing what turned out to be a relatively small fiscal package of additional direct public spending worth less than 0.5 per cent of GDP. This was combined with various tax cuts, but it still amounted to a small stimulus initiative, with estimated revenue losses still less than one per cent of GDP. These moves did not include any overtly protectionist measures, although some specific subsidies were directed to export sectors.
While the overall deficit for India’s central and state governments in the 2009-10 fiscal year is likely to increase to about 12 per cent of GDP, a large part of it would be the result of tax cuts and subsidies rather than direct spending.
There are several problems with relying upon such price-based fiscal measures. First, tax cuts have an impact in terms of supporting economic activity only if producers respond by cutting their own output prices, and such price cuts in turn generate demand responses or enable firms that would otherwise have closed down to survive. But neither is inevitable, nor likely given prevailing market structures in India. Across the world, governments are re-discovering that in times of economic uncertainty, tax cuts are much less effective in stimulating activity than direct government expenditure.
Providing export incentives
Furthermore, measures that try to provide additional export incentives – such as interest reductions for export credit – to export sectors such as textiles, garments and leather do not counteract the effect of large losses of export orders as major markets start shrinking.
Direct public spending would be a far more effective way of dealing with the current slowdown, even in India. Both incentives and exchange rates – which affect prices – are less effective when globally inadequate demand is the problem. That is why quantity responses are more effective.
However, the fiscal stimulus provided until now has been too small to have much impact and also has not been directed toward expenditures that are likely to have high multiplier effects. Some of the most critical areas of potential spending that could be undertaken include increased resources for state governments, direct investment to improve housing, programs to improve conditions for farmers, expansion of the public food distribution system, enlargement of employment programs and providing social security.
While monetary policies alone are not sufficient to address the current economic problems in India, it is clear that some financial control measures are necessary, especially to prevent excessive risk-taking that destabilizes the real economy. The government appears to buck the recent global policy trend by moving toward more financial deregulation and privatization of existing public financial institutions.
It will take many more creative and imaginative policy responses to bring India out of the economic crisis. Almost all Indian economists would agree that there needs to be a change of direction in both investment and consumption. What that change should be is the subject of vigorous debate.
For this economist, the change that is needed in the home market is to emphasize wage-led growth, diversify exports and generally make moves designed to turn economic adversity to advantage. This requires employment-oriented policies that improve the living standards of the bulk of the population, as well as seeking new sources of export markets especially in the developing world. 
|
