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Dilip M Nachane
T
While evaluating the Indian policy responses to the he genesis of the current global financial crisis, its
global crisis, this article focuses on the likely extent of the unfolding in the United States (US) and the European
Union (EU), and the official responses (the revised Paul-
spread of the crisis to India and how it will affect the
son Plan, the Bush and Obama bailout packages and similar
domestic economy. In India, exports have declined, huge fiscal stimuli in the other developed economies) are by
foreign institutional investment has fallen, and share and now too familiar to bear repetition here.1 In this article, there-
real estate prices have crashed. The social cost of the fore, I confine myself to the likely extent of the spread of the
crisis to India, how it will af fect the Indian economy (especially
slowdown has been unemployment. India’s policy
its vulnerable sections) and then evaluate the policy responses
response has so far addressed the issue of reviving the attempted so far.
real economy but has done little to build firewalls While descriptions (of the milestones in the crisis) abound,
around the financial sector and provide safety nets for analytical explanations are fewer and more controversial. Some
explanations try to locate a common thread between the current
the vulnerable sections. Some measures which could
crisis and notable past crises such as the Kondratieff of 1873,
go a long way towards attainment of the last two the Great Depression of 1929 and the more recent Japanese
objectives are outlined. (early 1990s) and Asian crises (1997-98). Others tend to view this
crisis as fundamentally different (the mother of all crises) and
see the financialisation of global capital as the single most impor-
tant factor responsible both for its precipitation and its unprece-
dented severity. The latter group interestingly includes both
those who view the current crisis as a systematic crisis of capital-
ism (a la Marx) and those who contend that it is a Minsky
moment (Minsky 1982) when liquidity dries up as unsustainable
financial exuberance runs its course, in the wake of deteriorating
credit standards.2 In contrast, the first group of explanations
shares the common view of crises as typifying Schumpeter’s
process of creative destruction (from which will emerge a
rejuvenated capitalism). While some of these issues are
viewed as of mere academic interest by policymakers, there
is no denying that such theoretical writings often contain
valuable insights for practical policy design, and hence it may
not be wise to neglect them altogether in evaluating alternative
policy options.
Decoupling Theory
As soon as the first signs of the crisis became visible in the US, the
top economic leadership in several emerging market economies
(EMEs), including India, hastened to reassure their citizens as
well as foreign investors that their financial systems were safely
insulated from that of the western economies and that the recent
impressive growth that many of them had experienced was most
unlikely to lose its sheen. The basis of this robust optimism was
located in the fashionable decoupling theory, which was then
The views expressed here are personal and do not reflect those of the doing the rounds of the Ivy League academic circuit in the west
institution that the author works for.
and the International Monetary Fund (IMF) – see Akin and Kose
Dilip M Nachane (nachane@igidr.ac.in) is Director, Indira Gandhi (2007) – and was strongly endorsed by The Economist as late as
Institute of Development Research, Mumbai.
6 May 2008. Since policymakers in EMEs tend to view these
Economic & Political Weekly EPW march 28, 2009 vol xliv no 13 115
the crisis and india
sources as infallible, the theory had quickly acquired in their eyes 2009, translating into a decline of 0.8% in the total exports of
an almost hallowed status. The decoupling theory simply asserted emerging and developing economies. While separate forecasts
that growth in Asia was driven mainly by domestic factors, that for India within this framework are not available, the latest
these factors were decoupled from trends in the west, and that data emanating is far from reassuring. Exports in January 2009
the growth engines in Asia (ASEAN-5, China and India) would not at $12,381 million were lower by 15.9% when compared to the
only continue to chug along but also serve as shock absorbers for corresponding figure last year. The commerce ministry now ex-
the western economies and might even help to pull them out of pects total exports in 2008-09 to be between $170 billion and
the recession. The strength of the Asian economies was seen to $175 billion, that is, a growth rate of between 5% and 8%.
stem from their recent (that is, the last two decades) shift to Among the sectors worst af fected are gems and jewellery, tex-
market-oriented policies in a big way, their regional consolida- tiles (and within textiles the handloom sector), leather and
tion via trade and investment relationships, and the benefits they leather products, cotton and manmade yarn, tea, oil meals, ma-
derived from global inflows of capital.3 However, recent data rine products, carpets and handicrafts. As all these industries
stemming from sources such as the IMF and other international are highly labour intensive, the impact on employment is bound
organisations, as well as national sources, is seriously at variance to be substantial. About 1.5 million jobs have already been lost
with the decoupling thesis. The IMF’s World Economic Outlook or are in jeopardy in these sectors.
(WEO) (January 2009) concedes that “Financial market condi- The trade impacts are, however, not confined to merchandise
tions have remained extremely difficult for a longer period than trade alone but have spilt over into the exports of invisibles. As
envisaged in the November 2008 WEO Update, despite wide- jobs shrink and incomes contract in the US and EU, private trans-
ranging policy measures to provide additional capital and reduce fers and remittances from non-resident Indians or NRIs (which
credit risks”. Growth estimates for 2008 and projections for 2009 are shown on the current rather than capital account of the bal-
and 2010 have been scaled down considerably vis-à-vis the ance of payments in India) are likely to decline. Currently these
November 2008 update. The advanced economies are estimated stand at Rs 1,63,709 crore for the year 2007-08 (RBI Bulletin,
to have grown at 1.0% in 2008 and projected to grow at -2.0% in December 2008) or about 3.48% of the gross domestic product
2009 and at 1.1% in 2010.4 As far as the Asian EMEs are concerned, (GDP) and represent a substantially significant item of the bal-
the growth of ASEAN-5 at 2.7% in 2009 and 4.1% in 2010 (in con- ance of payments. Another important category in the invisibles
trast to 6.3% and 5.4% in 2007 and 2008, respectively), of China section of the current account is “Miscellaneous Services” (with
at 6.7% in 2009 and 8% in 2010 (13.0% and 9% in 2007 and 2008, software services as the major component followed by communi-
respectively) and of India at 5.1% in 2009 and 6.5% in 2010 (9.3% cation, financial and business services) accounting for about
and 7.3% in the previous two years),5 are far from the comforting 3.32% of the GDP. This category is facing the prospect of a huge
levels that the decoupling theory would lead us to expect, and decline in exports as the major demand for these services (about
instead speak of a substantial deceleration in 2009 followed by a 60%) is from the US (and especially its financial sector), which is
tepid recovery in 2010. in the vortex of the storm.
What seems to have happened is that the channels of conta-
gion have been substantially underestimated. As is well known Foreign Capital Flows: Ever since the crisis started showing
from the literature (see, e g, Van Rickenghem and Weder 2001, signs of surfacing in Asia, foreign institutional investors (FIIs)
Forbes and Rigobon 2000, etc), there are at least four major have been withdrawing from the region on a noticeable scale. As
potential channels of contagion, namely, (i) trade channel (com- against a total inflow of FII funds of $16,040.20 million in
prising both merchandise and invisibles), (ii) foreign capital 2007-08, there has been a net outflow of $8,268.70 million
flows, (iii) contamination of financial assets, and (iv) inter between April 2008 and December 2008 (SEBI Bulletin, January
dependence of asset markets, especially equity, bonds and hous- 2009). Further fears of capital flight have been raised in the wake
ing markets. We examine each of these briefly in the Indian of global rating agencies downgrading India’s sovereign rating,
context below. in response to the burgeoning fiscal deficit and lower than
expected growth in the third quarter of 2008-09.6 A plausible
Trade Channel: As demand contracts in the affected economies, risk of capital flight and steep rupee depreciation certainly exists
exports from other countries are adversely impacted. The con- at the moment.
traction in demand would stem not only from reduced incomes in
the US, EU and Japan but also from the wealth effect arising out Financial System Contamination: It is indeed a matter of solace
of substantial asset deflation currently under way in the US. A that in this critical time the Indian financial system, by and large,
substantial proportion of our exports of key merchandise items is continues to be robust. Thus there is a fundamental difference
to the western economies (and Japan) which are in the grip of a between the crises in the US and EU and India. In the US, the crisis
recession-cum-depression situation. If we term these vulnerable originated endogenously within the financial system and then
exports, then as a proportion of our total exports they constituted spread from Wall Street to Main Street (to use President Barack
nearly 22% in 2007-08. The prognosis for Indian exports in 2009 Obama’s famous expression). In the EU and other western coun-
is rather gloomy because of the expected unabated fall in tries, the financial system was first affected largely by contami-
incomes in the economies of the US, EU and Japan. The IMF WEO nation from the US financial system and the crisis then spread to
estimates imports in advanced economies to decline by 3.1% in the real economy. In India (and some other Asian countries), the
116 march 28, 2009 vol xliv no 13 EPW Economic & Political Weekly
the crisis and india
primary source of contagion has been the trade channel. So the and ill-planned move. The presumption that FDI would help solve
real sector has been affected to a great extent but the financial the chronic mass urban housing shortage problem has turned out
system has remained intact. It is true that sporadic evidence of to be a pipe dream. The fact is that exactly the reverse of this
the exposure of domestic private sector banks, as well as some process is at work. Foreign investment in real estate development
nationalised banks and foreign subsidiaries, to so-called toxic has actually aggravated the shortage as the funds have gone into
assets and collateralised debt obligations (CDOs) in the US and EU financing real estate development that involves constructing con-
has come to light, but the extent of total exposure is likely to be dominiums catering for the tastes (and budgets) of the small
limited to something like $1.5 billion (on a mark-to-market basis). upper crust of Indian society (comprising a motley group of multi
A substantial share of the credit for the robustness of the Indian national corporation executives, corrupt politicians, businessmen
financial system must go to former Reserve Bank of India (RBI) and criminals) and, of course, NRIs and persons of Indian origin
Governor Y V Reddy, who carefully monitored the securitisation (PIOs). Such estate development has actually blocked off the
process in India and forestalled the emergence of asset bubbles supply of effective housing space for the poor and the middle
feeding on indiscriminate credit expansion. The New York Times class. This phenomenon is rampant in most least developed coun-
(20 December 2008) came closest to the mark when it described tries (LDCs) and EMEs, and India constitutes a prime example.
him as “the right man in the right job at the right time”. Thus, the stratospheric property prices that were witnessed over
2005-08, far from reflecting genuine demand trends, actually
Asset Markets: Indian equity and currency markets have experi- reflected collusion between builders, criminals and politicians.
enced considerable volatility in the wake of the crisis. The Bom- Lower and middle class home seekers (whose salaries would be
bay Stock Exchange (BSE) Sensex stood at 8,325.82 on 6 March indexed, if at all, to a price index which does not incorporate
2009 (compared to its average value of 15,644.44 over the year housing prices) were subject to tremendous strain as they found
2007-08), largely due to sizeable FII outflows. September 2008 themselves rapidly priced out of the housing market. Hence, the
saw several mutual funds experiencing losses and liquidity pro recession in the housing sector is characterised by an excess
blems on redemption pressure, and there was a sharp decline in supply of high-end residential and commercial accommodation,
the volume of the assets under their management, from coexisting with a huge backlog of unsatisfied demand in the basic
Rs 5,44,534 crore in August 2008 to Rs 4,83,270 crore in Septem- economy residential category.9
ber 2008. What could have been a potential crisis was staved off It is interesting to note that even though real estate developers
by the RBI’s prompt response. First, the cash reserve ratio (CRR) and real estate companies are facing acute liquidity shortages,
was reduced in two steps (6 and 10 October) and then banks and they are steadfastly refusing to bring down prices to affordable
other financial institutions were permitted to lend to the funds levels. This is often justified by them on the grounds of high land
on the basis of the certificates of deposit (CDs) held by them. acquisition and construction costs (though, in fact, the latter have
There has been at work a wealth effect related to the declining come down sharply in recent months owing to falling steel and
values of equity and other assets. This decline has largely affected cement prices) but the truth seems to be that their speculative greed
the demand for goods (such as consumer durables and fast- makes them reluctant to let go of the high profit margins that they
moving consumer goods) by those who typically own such assets, have got addicted to during the boom. Ironically the low interest
namely, the middle and upper classes. regime that has come into operation as a response to the crisis,
The real estate market in India (and perhaps in south Asia as a and other measures (such as rescheduling of loans to developers,
whole) has certain special features marking it off as distinct from and reduction of risk weights on commercial real estate lending by
the markets in the west. As a country still experiencing very banks) are helping builders postpone the inevitable price adjust-
strong demographic as well as urbanisation pressures, shortage ment that is necessary to get this industry out of recession.
of urban housing is chronic in India.7 Hence it is a safe bet that
real estate prices have a strong upward secular trend, and realty Employment Dimension
investment is thus an attractive option for parking long-term The major social costs of a recession are those associated with the
funds. What really set the market on fire, however, was the gov- enforcement of job cuts, lay-offs and significant upheavals in
ernment’s decision in March 2005 to permit 100% foreign direct (organised as well as unorganised) labour markets. The Inter
investment (FDI) in the construction business.8 Foreign capital on national Labour Organisation’s (ILO) Global Employment Report
the lookout for medium-term capital gains soon discovered the for January presents a rather dire picture. Considering three alter
attractiveness of the Indian housing investment option. As a native scenarios,10 it projects an increase in world unemployment
result total FDI into housing and real estate which stood at $0.39 ranging from 18 million (optimistic scenario) to 51 million (worst-
billion in 2004-05, shot up to $0.87 billion in 2005-06 and to case scenario) over the years end-2007 to end-2009. The corre-
$2.12 billion in 2006-07 – an unprecedented fivefold increase in sponding figures for south Asia range from 4 million to 17 million.
three years. Further, funds were also channelled into the sector Even though separate figures are not presented for India, on the
via the establishment of real estate mutual funds (REMFs) and basis of the relative distribution of the workforce in south
real estate investment trusts (REITs). Even conceding that the Asia, one could estimate job losses in India to be between 1.3
government acted from the best of motives, it cannot disclaim million and 6 million over this period. The Indian government’s
responsibility for initiating one of the worst property bubbles in official survey of the unemployment impact of the global
recent history in India, by what stands out in hindsight, as a hasty crisis was conducted by the Labour Bureau, with a focus on
Economic & Political Weekly EPW march 28, 2009 vol xliv no 13 117
the crisis and india
eight sectors (mining, metals and metal products, textiles and of the crisis. With this end in view, it introduces two supplemen-
garments, automobiles, gems and jewellery, construction, trans- tary concepts, (i) working poverty, and (ii) vulnerable employ-
port, and information technology/business process outsourcing). ment. These two classes are not mutually exclusive and may be
The survey estimated a total job loss of 50,000 over the quarter found in both the organised and unorganised sectors.14
September-Decemeber 2008. Extrapolating this trend in conjunc-
tion with the official growth projections in the EAC (2009), the Working Poverty: This is defined with respect to people who are
estimated job losses (on a rough calculation) would be about 1.5 employed but still fall below a threshold income level. The ILO
million over the entire recessionary phase (September 2008 to Report uses two threshold levels – $1.25 per day and $2 per day.
December 2009).
Both the ILO regional estimates and the EAC’s estimates for Vulnerable Employment: The ILO does not go into a formal defi-
India are likely to prove substantial underestimates because they nition of vulnerable employment but for all practical purposes,
neglect several important factors, of which the most important is the following definition given by the UK government suffices. We
the rise of global protectionism. may define a vulnerable worker as “someone working in an envi-
ronment where the risk of being denied employment rights is
Rise of Global Protectionism: Ever since the eruption of the high and who does not have the capacity or means to protect
crisis in the west, there has been a sharp hardening of the fort themselves from that abuse” irrespective of whether “an em-
ress mentality across the globe, especially in the US and Europe. ployer exploits that vulnerability” (Department of Trade and
Since October 2007, about 66 new trade restriction measures Industry, UK). The UK Commission on Vulnerable Employment
have been introduced, including alterations of tariffs and stiffen- cites the following as examples of vulnerable employment,
ing of non-tariff barriers (NTBs) to trade (involving licensing agency workers, casual workers, freelancers, young workers (less
requirements, product standards and intellectual property than 22 years), industrial homeworkers, unpaid family workers,
rights). There has, in addition, been a huge increase in anti- and recent migrants.
dumping claims and actions (up by 20% in 2008 over the previ- What typically happens in a crisis is that workers laid off from
ous year), and new cross-border taxes (such as carbon border their regular jobs may not find other regular jobs even if they are
taxes11). Several bailout packages targeted at export-oriented prepared to accept wage cuts. Unemployment in countries which
units are tantamount to export subsidies12 and hence trade dis- have no unemployment insurance schemes is not a viable alter-
torting. US bailout packages are often linked to Buy American native as there are no accumulated past savings for the workers
clauses and employment restrictions on foreigners.13 Restrictive to fall back upon. They have thus no choice but to join the army
clauses on foreign lending by banks getting government support of vulnerably employed at lower wages. These lower wages, if
are becoming quite common (for example, Switzerland) and this, below the threshold poverty level, could put the worker in both
in turn, is aggravating the drying up of international trade credit the vulnerably unemployed and working poverty categories.
already under way in the wake of the crisis. Hence, the above two classes are not mutually exclusive and can
Let us briefly turn to some other potential causes for the down- be found in both the organised and unorganised sectors.
ward bias in the unemployment estimates. Many of the export In the Indian context, considerable information about the
sectors facing adverse demand (and in some cases supply) shocks informal sector is now available thanks to the efforts of the
have strong backward linkages to the rest of the economy (for National Commission for Employment in the Unorganised Sec-
example, automobiles, engineering goods, chemicals and allied tor (NCEUS). Its definition of the informal/unorganised sector as
products, construction, and tourism). It is not clear whether “all unincorporated private enterprises owned by individuals or
either the ILO Report or the Labour Bureau estimates factor these households engaged in the sale and production of goods and
into account. The latter in particular being based on a single services with less than 10 total workers” would mean that em-
snapshot survey is most unlikely to reflect the indirect ployment in this sector could be considered as a close correlate
impact on employment in sectors vertically integrated with the of the ILO concept of vulnerable employment. The informal sec-
sectors surveyed. tor (as per the NCEUS definition) accounts for about 50% of the
There are at least two other factors which seem to have been GDP, and employs 393 million out of a total workforce of 457 mil-
ignored. The banks’ safety-first syndrome in an impending crisis lion (about 86%). According to the NCEUS, about 45% of the
situation involves a flight to safety with a disproportionate axing labour in the organised sector would be denied access to basic
of credit to small and medium enterprises (SMEs) where employ- workers’ rights and would thus come under the ILO classification
ment is most concentrated. Reinforcing this credit crunch is the of vulnerable employment (in the unorganised sector this pro-
well-known pro-cyclicality of capital requirements, which arises portion would be nearly 99%). As the crisis unfolds, this section
owing to general downgrading of enterprises by credit-rating is the first to be hit (for example, in the construction sector). In a
agencies in a recession and where once again the largely bank- memorandum to the government of India, the NCEUS has given
dependent SMEs are the ones most prone to facing stiffer terms several pointers as to how the crisis could affect this segment of
on their access to credit. workers (NCEUS 2008). Small producers and traders dependent
A major contribution, however, of the ILO Report is that it rec- upon export markets have already been badly affected in indus-
ognises the need to look beyond unemployment rates per se to tries such as handlooms, textiles, apparel, leather products,
get a more accurate assessment of the social distress dimension gems and jewellery, metal products, carpets, oil meals, marine
118 march 28, 2009 vol xliv no 13 EPW Economic & Political Weekly
the crisis and india
products, and handicrafts. The NCEUS estimates that prior to the Evaluation of Policy Measures
onset of the crisis, enterprises with investment in plant and ma- The policy measures so far adopted in India may be summed up
chinery below Rs 25 lakh used to get a mere 5% of formal sector in a single phrase – easy money and fiscal stimuli. On the mone-
credit, whereas those with investment below Rs 5 lakh got less tary policy front there has been a flurry of activity – the repo rate
than 2% of the formal credit. Even this minuscule proportion is was reduced in a succession of steps from 9% in September 2008
estimated to have shrunk to 1.2% after the crisis hit. The NCEUS to 5% in March 2009 (with a corresponding reduction in the re-
memorandum also indicates the domino dependence of the verse repo rate from 6% to 3.5%), the CRR was also reduced from
unorganised sector on the organised sector. Slowdown in the 9% to 5% over the same period, whereas the statutory liquidity
organised sector (which accounts for about one-third of the un- ratio (SLR) was brought down by 1% to 24%. Altogether, it has
organised sector’s output) thus has a twofold impact on vulner- been estimated that these measures have released more than
able employment – a direct impact in the organised sector itself Rs 4,00,000 crore ($80 billion approximately) of liquidity into
and an indirect effect via the backward linkages with the the system.
unorganised sector. Finally, the fall in international prices of There have also been three successive fiscal stimuli packages
several commodities (both agricultural and non-agricultural) amounting to a total cost of Rs 80,100 crore ($16.3 billion) to the
has impinged on small producers’ incomes via import com exchequer.15
petition as well as low prices in sectors such as cotton and The indications so far seem to be that the package of policy
oilseeds production. measures is not really having the intended impact of reviving the
real sector. In spite of the more than Rs 4,00,000 crore of liquid-
Indian Policy Response: An Assessment ity released into the financial markets, the credit offtake has
As mentioned above, the recessions in the US, EU and India repre- been remarkably poor. An RBI press release of 4 March 2009
sent three distinct patterns. Given that the recessionary charac- (announcing a 50 bps reduction in both the repo and reverse repo
teristics in India are of a fundamentally different hue from those rates) is revealing in this regard.
obtaining in the US and EU, the nature of our policy response
...credit expansion during the period between December 19, 2008 and
should not necessarily track theirs, but be specially designed to
13 February 2009 at Rs 8,091 crore was sharply lower than that of
account for the specificities of our situation. In particular, three Rs 86,978 crore in the corresponding period of the last year ... The
concerns should be paramount in the Indian context. total flow of resources to the commercial sector from banks and non-
banks during 2008-09 so far (up to February 13, 2009) at Rs 4,98,136
Triad of Objectives crore was lower than Rs 6,08,351 crore during the corresponding
period of the last year.
(1) Revival sans stagflation: First, there is the need to revive
the real economy without, in the process, unleashing forces that Whether the low credit off-take reflects a reluctance of banks
could trigger a future asset and/or commodity price inflation. to supply credit or a deficiency of credit demand becomes a moot
(2) Firewalls around the financial sector: As mentioned above, question. Considering, however, that the liquidity adjustment
since the Indian crisis is largely an imported one (primarily via facility (LAF) window of the RBI has been in continuous absorp-
the trade and investment routes) and further, since the financial tion mode over the past few weeks (with banks parking about
sector has been more or less secure so far, policy should empha- Rs 40,000 crore at this window on a daily basis), and that both
sise the insulation of the Indian financial sector from adverse bank lending and deposit rates have softened appreciably in the
shocks originating either in the Indian real sector or in the finan- past few months, there is reason to believe that the liquidity situ-
cial systems of the US and EU. ation is fairly comfortable. Low demand then seems to be prima-
(3) Safety nets for the vulnerable sections: As successive ILO rily responsible for the poor credit offtake.16 This is not to deny
Reports point out, in a classic moral twist to the global crisis tale, that at least part of the explanation for the poor credit offtake
those who had the least to do with the perpetration of the crisis would lie in credit rationing by banks rendered extra cautious in
(the vulnerable sections of society across the globe) are being an uncertain environment. Hence, further monetary easing at
forced to bear the brunt of the consequences. India is no excep- this stage would be somewhat akin to pushing on a loose string,
tion and hence a necessary third pillar of any anti-recessionary and the continuous clamour to this effect by a determined group
strategy should be to build extensive safety nets for those at max- of economists in the business press seems to be quite misplaced.
imum risk of exposure to collateral damage. If the possibilities of monetary policy are near exhaustion,
Indian policy in the aftermath of the crisis has been addressed what prospects does fiscal policy have to offer? The three fiscal
almost exclusively to the first objective, with attention to the stimuli announced so far comprise three distinct elements:
second confined mainly towards bank capitalisation The last (i) general tax cuts, (ii) fillip to infrastructure spending, and
objective has largely languished in the domain of rhetoric. The (iii) strengthening bank capital. In addition, outlays such as
remaining part of this paper is thus devoted to (i) an evaluation farm loan waivers, Sixth Pay Commission pay-outs and the forth-
of the policy measures so far adopted from the perspective coming election campaign expenditure are all in the nature of
of meeting the avowed goal of “revival without stagflation”, fiscal stimuli. There are two groups of issues related to the effec-
and (ii) outlining some measures which (in my opinion) could tiveness of fiscal stimuli (i) macroeconomic issues, and (ii) issues
go a considerable way towards attainment of the remaining related to the relative effectiveness of alternative modes of
two objectives. applying the stimulus.
Economic & Political Weekly EPW march 28, 2009 vol xliv no 13 119
the crisis and india
As far as the macroeconomic issues are concerned, the first this complacency may not be entirely warranted. The RBI itself
and foremost bears on the size of the budget deficit. India’s con- strikes a fairly cautious note.
solidated fiscal deficit (of the central and state governments However, consumer price inflation, as reflected in various consumer
together with off-budget liabilities) is now estimated to be price indices, is in the range of 9.85-11.62% as of December 2008-
January 2009, and has yet to show moderation. Consumer price infla-
between 11% and 12% of the GDP for the current year (see Rao
tion has remained at elevated levels due to increase in primary arti-
2009) – way beyond the Fiscal Responsibility and Budget cles’ prices. With WPI [wholesale price index] inflation having moder-
Management (FRBM) rules stipulation. Fiscal slippage on such a ated significantly, consumer price inflation may also be expected to
scale has prompted Standard & Poor’s to revise its sovereign decline, though with a lag (RBI Press Release, 4 March 2009).
outlook on India to negative. This has already triggered turbu- The threat to inflation in the Indian context comes from
lence in the foreign exchange market for the rupee, leading to three sources.
steep decline and enhanced volatility of the currency. The finan- (i) Oligopolistic collusions among large firms in several impor-
cial markets also seem to be viewing the fiscal developments tant sectors, which create a ratchet effect on prices, preventing
with concern, judged by the stock markets going into a nosedive them from declining to the levels necessary for stimulating
in the immediate aftermath of the announcement of Fiscal demand in a recessionary situation.
Stimulus III. (ii) The overall liquidity overhang in a low-interest regime,
The second macroeconomic issue pertains to the raising of with low credit off-take, could mean that this liquidity could
long-term interest rates. The augmentation of the government’s gradually seep through to asset markets via non-bank financial
borrowing target for the current fiscal to Rs 2,38,000 crore has institutions and feed asset price booms, especially in the equity
meant a noticeable “fatigue for government securities in the and realty segments (going by the experience of past low-interest
market” (in the words of a senior finance executive, Business regimes in the US in 2001-04 and India in 2004-07), which later
Line, 9 March 2009). As a reflection of the hysteresis of long- inevitably translate into general inflation.
term interest rates, the cut-off yields on securities of 10 years’ (iii) A further threat in the same direction as (ii) stems from
maturity still remain at 6.5% (as of 8 March 2009).17 There is the huge liquidity which has come into the global system in the
thus some evidence of monetary and fiscal policy working at wake of the US and EU stimulus packages. To the extent that this
cross-purposes here. liquidity is not absorbed domestically (in these countries) it is
But apart from the general macroeconomic issues, as men- going to find its way into the global equity, debt and housing
tioned earlier, the specific form of the fiscal stimulus is also markets and the Asian region (especially India) would serve as a
cr ucial in determining its success. Elmendorf and Furman magnet for this footloose financial capital. The longer the real
(2008) propose three canons for a successful fiscal stimulus, recovery in the US and EU is delayed, the greater the danger of
namely, it should be well targeted, timely and temporary, to such inflows.
which one may add a fourth, that it put incomes in the
hands of people who are likely to spend, and spend quickly. Some Policy Suggestions
From the point of view of these canons, general tax cuts are an A policy package, in consonance with the three objectives set
inferior option. The tax cuts in Fiscal Stimulus III, for example, out above, would be one that would include the following
are largely expected to benefit higher income households, who specific measures.
may not spend the entire additional income put in their hands (1) Any further monetary policy easing or fiscal stimulus runs
by the tax cuts.18 Similarly, the infrastructure thrust in Fiscal the grave danger of laying the foundation for a future high infla-
Stimulus II may not be very effective as a stabilisation (short- tion phase. Given the long lags in monetary and fiscal policy20
term) measure.19 The long gestation period of infrastructure (between two to three quarters), the effects of the policy meas-
investments and the rigid sequencing of capital expenditure ures taken so far are likely to take effect towards end-2009, just
(and hence limited possibility for front-end loading of this about the time when the excess capacity in the economy is esti-
expenditure) often means that the bulk of the expenditure mated to be working itself out.
may fall due after the economy has already transited to the (2) There is no denying that the failure of credit delivery to
recovery phase. Thus infrastructure spending could well turn micro small and medium enterprises (MSMEs) is having systemi-
out to be pro-cyclical rather than contra-cyclical. Further, cally important effects in spreading the recessionary virus and in
in frastructure spending is no longer the labour-intensive aggravating social distress due to job losses. It is now time to
type of activ ity that it was in the days of Roosevelt’s cele strike out boldly by attempting measures like government guar-
brated New Deal. Much of the infrastructure activity today antees of loans to MSMEs on the lines of the Mandelson Plan in
(such as integrated townships, highways and ports) is highly the UK (Peter Mandelson, Business Secretary, UK Governemnt
capital-intensive, with negligible multiplier spending or has announced plans to guarantee bank loans to SMEs with sales
employment effects. of up to £500 mn). Actually there is provision for credit guaran-
In evaluating the Indian policy response to the crisis so far, it is tees under the Deposit Insurance and Credit Guarantee Corpora-
also necessary to examine whether the expansionary policies do tion (DICGC) Act 1961. However this has now become defunct.21
not contain within themselves the seeds of a future high inflation The DICGC needs to be strengthened with an infusion of
phase. While many analysts seem to firmly believe that the infla- funds and entrusted with the responsibility of administering
tion genie has been securely bottled for at least the medium term, such a scheme.
120 march 28, 2009 vol xliv no 13 EPW Economic & Political Weekly
the crisis and india
(3) There already exist provisions for special treatment of risk (8) One of the most effective safety nets for the poor has been
weights on loans to MSMEs under Basel II. The provisions envis- suggested by the NCEUS. This involves the setting up of a National
age exemption of loans to MSMEs from capital requirements (or at Fund for the Unorganised Sector (NAFUS). The fund is proposed
least assigning these loans a lower risk weight than warranted by to have an authorised capital of Rs 1,000 crore and would be de-
their ratings). These provisions need to be operationalised with signed to provide
immediate effect. (i) refinance to banks and other financial institutions to supplement
(4) As a purely temporary measure, for the duration of the cri- their efforts to provide credit to unorganised sector enterprises with
sis, loans above a certain limit to industries in sensitive sectors investment in plant and machinery below Rs 25 lakh, but with a spe-
can be tied to some employment protection guarantees. cial focus on enterprises with investment less than Rs 5 lakh;
(5) Encouraging the adoption of innovative schemes like SME- (ii) microfinance support through non-governmental organisa-
CARE and SMEHELP (initiated by the State Bank of India) by other tions/self-help groups/microfinance institutions; and
banks on an extensive scale.22 (iii) venture capital for innovative enterprises in the unorganised
(6) Financial crises affect vulnerable sections of society (in- sector.
cluding labour) far more than non-vulnerable sections. Hence in This suggestion of the NCEUS requires serious consideration by
the interests of such sections, ensuring against financial conta- the government.
gion should receive top priority. The general monetary and fiscal
measures undertaken so far contribute very little to this objec- Conclusions
tive, with the possible exception of the bank capitalisation provi- At the Exim Bank Commencement Day Lecture on 13 March 2009
sions under Fiscal Stimulus II. But bank capitalisation is not an in Mumbai, World Bank Chief Economist Justin Lin gave clear
insurance against a crisis – it is at best a damage-limitation meas- indications that the World Bank was switching over from a policy
ure in the event of a crisis actually occurring. Hence there is the of global neoliberalism to one of global Keynesianism.26 Evidence
need for several prudential and “fire fighting” measures such as of this may be found in World Bank President Robert Zoellick
(i) A switch-over to a system of risk-based deposit insurance rely- proposing the establishment of a Vulnerability Fund and the “1%
ing on a system of Fair Value Accounting.23 Solution”.27 The stimulus packages in several other countries
(ii) A raising of the deposit insurance coverage from the current (most notably the US, UK, Germany and Singapore) also incorpo-
Rs 1 lakh to Rs 5 lakh. This will provide a much needed safety net rate a host of special measures to help their vulnerable sections.
for the savings of the middle classes.24 In contrast, in India, very little seems to have been done to-
(iii) The role of rating agencies in the perpetration of the current wards relieving the distress caused by the crisis to the vulnerable
crisis has come under heavy scrutiny from economists like Buiter sections of society. Making extremely clever use of the media,
(2008), Portes (2008) and Giovanni and Spaventa (2008). Such India Inc has succeeded in projecting itself as the sole casualty of
criticism has prompted the Financial Stability Forum, through the financial crisis. Since official policy finds it extremely difficult
the International Organisation of Securities Commissions (IO- to ignore media feedback in a democracy, it is not surprising that
SCO) to offer a code of conduct for credit-rating agencies. The RBI the major policy thrust so far has been on rescue packages aimed
should see that this code of conduct is accepted and adhered to, at salvaging this sector. But just as rescue operations in a ship-
by major credit-rating agencies in their Indian operations. wreck cannot be confined to first-class passengers alone,28 the
(iv) A strict monitoring of off-balance sheet items and structured vulnerable sections of Indian society (on whom the media seems
product vehicles (SPVs) of banks and financial institutions. to have virtually turned its back) need help too. The package of
(7) There is the need to recognise that substantive capital flows measures suggested above (and the list is by no means exhaus-
(in either direction) have potentially strong destabilising conse- tive) may be viewed as broad pointers in this direction, whose
quences. In such circumstances, it is necessary to reserve for our- full details need to be worked out. The fate of such measures
selves the right to impose key capital controls on a pre-announced depends, of course, on the election outcome. Though a cinematic
basis for specified periods of time. The extent and duration of slumdog has suddenly been catapulted to popularity, how long
these controls could be related to the setting off of certain macro his real life counterpart will be remembered once the elections
economic triggers. This trip-wire, speed-bump approach is elabo- are over, even by those who are singing Jai Ho paeans to his glory
rated at length in my earlier paper (Nachane 2007).25 at the moment, is anybody’s guess.
Notes in countries like India growth estimates are for 7 Even in this period of supposedly slack demand,
1 Excellent accounts may be found in Felton and end-March. The Economic Advisory Council (EAC) when the Maharashtra Housing and Area Devel-
Reinhart (ed) 2008, Brunnermeier 2009 and so on. had initially estimated India’s growth estimate at opment Authority threw open bookings for 3,863
7.7% for the year 2008-09, which was later revised low-cost flats, the number of applications exceeded
2 This was also noted by other economists of an
downwards to 7.1%. But even this lower figure 4,00,000.
earlier vintage, such as Irving Fisher (1933).
seems too optimistic in view of the disappointing 8 Till then only NRIs and PIOs (persons of Indian
3 For a lucid exposition of the theory, reference may growth of 5.3% in the third quarter of 2007-08 – origin) were allowed to invest in the housing and
be made to The Economist (6 May 2008), while the growth of gross domestic product (GDP) in the the real estate sector. Other foreign investors
Chandrasekhar and Ghosh (Business Line, 10 Febru- fourth quarter will have to be 7.6% if the (revised) were allowed to invest only in the development of
ary 2009) provide a recent empirical refutation. growth projection of the EAC is to be realised. integrated townships/settlements, either through
4 Within this group, the corresponding figures for the 6 Standard & Poor’s on 24 February 2009 down- a wholly owned subsidiary or through a joint
US are 1.1%, -1.6%, and 1.6%, for the Euro area they graded its sovereign outlook for India from stable venture with an Indian partner.
are 1.0%, -2.0% and 0.2%, for Japan -0.3%, -2.6% to negative. Other rating agencies such as Moody’s 9 In recent months there is some evidence that
and 0.6% and for the UK 0.7%, -2.8% and 0.2%. and Fitch have also expressed concern on the realty companies like DLF in Mumbai, Omaxe in
5 IMF growth figures pertain to the end-year, whereas current macroeconomic situation. Faridabad, and Indu Projects in Hyderabad are
Economic & Political Weekly EPW march 28, 2009 vol xliv no 13 121
the crisis and india
going in for one and two bedroom, hall, kitchen 25 In direct contrast to this view, we have a substan- Fisher, I (1933): “The Debt-Deflation Theory of Great
(BHK) flats in the price range of Rs 15-30 lakh – a tially influential group of Indian economists who Depressions”, Econometrica, Vol 1 (3), 337-57.
development encouraged by the recent RBI meas- see in the crisis an opportunity for introducing Forbes, K J and R Rigobon (2000): “Contagion in Latin
ure to keep loans below Rs 20 lakh at concessional capital account convertibility. Thus Lahiri in his America: Definitions, Measurement and Policy
rates of interest (below 9.25%) (see Corporate P T Memorial Lecture (16 January 2009) says, Implications”, NBER Working Paper No 7885.
India, 28 February 2009). “The current crisis may provide an opportunity Giovanni, A and L Spaventa (2008): “Filling the Infor-
10 The three scenarios are (i) trend analysis (opti- for introducing capital account convertibility. The mation Gap” in A Felton and C Reinhart (ed.), The
mistic), (ii) incorporating the special employment dominant worry about introducing convertibility First Global Financial Crisis of the 21st Century,
coefficients likely to prevail during crises (medi- has been an upsurge of capital flows with large (www.voxeu.org/index.php?=node/1352).
um), and (iii) 2007 unemployment rate plus 0.5 upward pressure on the exchange rate of the ILO (2009): “Global Employment Trends”, January.
(largest recorded increase in unemployment since rupee followed by a sudden sucking out of such a
Kohler, G (1998): “What Is Global Keynesianism?”
1991) computed for each country separately and capital, precipitating a crisis. Risk aversion on the
(http://wsarch.ucr.edu/archiv/papers/kohler/
then aggregated (worst case scenario). part of international investors is an all-time high
kohler2.htm).
11 These are levied with the express purpose of com- now, and the risk of large inflows is limited.” Not
all of us may be persuaded by this somewhat con- Lahiri, A (2009): “Indian Financial Reforms: National
pensating domestic producers subject to carbon Priorities Amidst an International Crisis”, Sir
emission taxes vis-à-vis foreign competitors not voluted logic, though it seems to have provided
considerable grist to the mill of several profes- Purushotamadas Thakurdas Memorial Lecture,
facing such taxes in their own countries. Mumbai, 16 January.
12 An example being the French government guar- sional bloggers.
26 Lin himself did not use these terms in his lecture. Lin, J Y (2009): “Beyond Keynesian Economics: A
antee of €5 billion loans to Airbus Industries. Stimulus for Development”, Exim Bank Com-
13 Indian holders of H1-B visas face stiff hiring con- These terms are defined in Kohler (1998).
mencement Day Lecture, 13 March.
ditions by US companies in receipt of federal bail- 27 The Vulnerability Fund envisions each developed
country setting aside 0.7% of its stimulus package Minsky, H P (1982): Can “IT” Happen Again? Essays on
out funds. Instability and Finance (New York: ME Sharpe Inc).
14 In India the organised sector is defined as compris- for the fund, which would be used to address safe-
ty net programmes, infrastructure investments Nachane, D M (2007): “Liberalisation of the Capital
ing manufacturing enterprises covered under sec- Account: Perils and Possible Safeguards”,
tion 2m (i) and (ii) and section 85 of the Factories and support for SMEs and MFIs in LDCs (and pos-
sibly some EMEs). The 1% Solution entails rich Economic & Political Weekly, Vol XLII, No 36,
Act 1948. Basically these refer to factories employing 8-14 September, 3633-43.
20 or more workers (without power) or 10 or more nations allotting 1% of their sovereign wealth
funds to support African infrastructure and other National Commission for Enterprises in the Unorgan-
workers (with power). All other manufacturing units
investments in lower income countries. ised Sector (NCEUS) (2007): “Financing of Enter-
are classified under the unorganised sector.
28 Remember the aristocratic lady in the Titanic prises in the Unorganised Sector and Creation of a
15 Fiscal Stimulus I (7 December 2008) mainly National Fund for the Unorganised Sector
comprised an across the board cut of 4% in movie who asks for a special seat on the rescue
boat because she is travelling first-class? (NAFUS)”, Government of India, November.
excise duty (estimated cost: Rs 31,000 crore).
– (2008): “The Global Economic Crisis and the
Fiscal Stimulus II (2 January 2009) comprised
Informal Economy in India”, Government of
Rs 20,000 crore towards bank capitalisation References India, November.
over the next two years, as well as providing Akin, C and A Kose (2007): “Changing Nature of
greater market borrowing access to state gov- Nocera, J (2008): “How India Avoided a Crisis”, New
North-South Linkages: Stylised Facts and Expla- York Times, 20 December.
ernments and the India Infrastructure Financ- nations”, IMF Working Papers, WP/07/280.
ing Co Ltd (IIFCL) (estimated cost: Rs 70,000 Portes, R (2008): “Ratings Agency Reform” in A Felton
crore). The final Stimulus III (24 February 2009) Bank for International Settlements (BIS) (2008): 78th and C Reinhart (ed.), The First Global Financial
provides a 2% reduction in both the excise duty Annual Report (2007-08). Crisis of the 21st Century (www.voxeu.org/index.
and the service tax and an extension of the pre- Bhattacharya, S (2009): “The Lending Puzzle”, The php?=node/1352).
vious excise duty cuts beyond 31 March 2009 Financial Express, 6 March. Rao, Govinda M (2009): “The 3rd Stimulus Package and
(estimated cost: Rs 29,100 crore). The total bur- Brunnermeier, M K (2009): “Deciphering the 2007-08 Fiscal Conundrum”, Business Standard, 3 March.
den on the exchequer at Rs 81,000 crore amounts Liquidity and Credit Crunch”, Journal of Economic Sengupta, A, K P Kannan and G Ravendran (2008):
to nearly 1.82% of the GDP (at cu rrent prices) or Perspectives, Vol 23 (1), Winter, 77-100. “India’s Common People: Who Are They, How
2.57% (at constant prices). Buiter, W (2008): “Lessons from the North Atlantic Many Are They and How Do They Live?” Economic
16 Bhattacharya (2009) makes a similar point. Financial Crisis” in A Felton and C Reinhart (ed.), & Political Weekly, 15 March.
17 While this does represent some softening com- The First Global Financial Crisis of the 21st Century, The Economist (2008): “The Decoupling Debate”,
pared to the figure of 8.35% as of 26 September (www.voxeu.org/index.php?=node/1352). 6 March.
2008, it only represents a fall of 1.85% in response EAC (Economic Advisory Council to the Prime Van Rickenghem, C and B Weder (2001): “Sources of
to a fall of 4% in the repo rate over the corres Minister) (2009): Review of the Economy 2008-09, Contagion: Finance or Trade?,” Journal of Inter
ponding period. January. national Economics, Vol 54, 293-308.
18 The excise duty cuts are mainly expected to ben- Elmendorf, D W and J Furman (2008): If, When, How: World Bank (2009): “Swimming against the Tide:
efit the sectors of consumer durables, commercial A Primer on Fiscal Stimulus, The Hamilton Project How Developing Countries are Coping with the
vehicles, tyres, IT hardware, cement, steel, (Brookings Institution). Global Crisis”, Background paper prepared by
textiles, aluminium, air travel, DTH cables, tele- Felton, A and C Reinhart, ed. (2008): The First Global World Bank staff for the G20 Finance Ministers
com, and hospitality. Most of these goods are for Financial Crisis of the 21st Century (www. voxeu. and Central Bank Governors Meeting at Horsham,
upper class consumption. org/index.php?=node/1352). UK (13-14 March).
19 This is, of course, not to deny the role of infra-
structure in boosting long-term growth.
20 No systematic estimates of these lags are available
in the Indian case. Some work in progress cur-
rently by the author estimates the lags in mone-
tary policy at around eight months and for fiscal
policy around 12 months. However, these esti
State Elections 2007-08
mates have yet to be firmed up. February 7, 2009
21 See DICGC Annual Report 2007-08, 1.
22 Under SMECARE, MSME borrowers (with fund Rajasthan: Dissatisfaction and a Poor Campaign Defeat BJP – Sanjay Lodha
based limits of up to Rs 10 crore) can avail them-
selves of additional working capital of up to 20% Delhi Assembly Elections: 2008 – Sanjay Kumar
of their existing fund-based limits, wheras under
SMEHELP a five-year tenured loan is extendable understanding the Paradoxical Outcome in Jammu and Kashmir – Ellora Puri
to MSMEs with a liberal margin of 15% for financ-
Madhya Pradesh: Overriding the Contours of Anti-Incumbency – Ram Shankar, Yatindra Singh Sisodia
ing capital expenditure. Both schemes offer loans
at a concessional rate of 8% during the first year. Chhattisgarh 2008: Defeating Anti-Incumbency – Dhananjai Joshi, Praveen Rai
These concessional schemes are mainly in the
areas of pharmaceuticals, food processing and Karnataka: The Lotus Blooms....Nearly – Sandeep Shastri, B S Padmavathi
light engineering goods.
Himachal Pradesh Elections 2007: A Post-Poll Analysis – Ramesh K Chauhan, S N Ghosh
23 Such Fair Value Accounting could be on the lines
of the Statement of Financial Accounting Stand- For copies write to: Circulation Manager
ards (SFAS) No 133 issued by the US Financial
Accounting Standards Board in 1998. Economic and Political Weekly
24 The concept of middle class used here corres 320-321, A to Z Industrial Estate, Ganpatrao Kadam Marg, Lower Parel, Mumbai 400 013
ponds to that employed in Sengupta, Kannan and email: circulation@epw.in
Ravendran (2008).
122 march 28, 2009 vol xliv no 13 EPW Economic & Political Weekly