In the deteriorating days of the world economy, there are several experts, analysts, strategists, planners who become jingoistic about India's economy and its fundamentals and give strong statements like "India is very strong", "It is insulated from the world economic crisis".
Can we trust these agencies after realizing that the so called credit rating agencies miserably failed in giving right ratings about a company? Can we trust those statistics whose basic premise and analysis always do not come under scrutiny of a common man? Can we really say, "Yes, Indian economy is strong enough to wither this crisis". Now, if this is yes, next question should be "why" and "how "?
To understand and answer this question, we must also bring in China and also understand the problem with the US economy. The US economy became buzz with words like "investment banking" in early 1990's. The complete deregulation of this business led to cut throat competition amongst companies. US is an example of extreme capitalist economy in which common norms and simple logics do not apply and what matters is just where a company is headed towards. With no regulation and cut throat competition crossing the limits, each major economic entity (investment bank) collapsed. This collapse is not sudden, but has been happening very frequently whenever innovations went overboard. No doubt money was in full supply with all such banks and everything appeared smooth. Deregulation always ensured that US is competitive than any other world economy and it is precisely on this premise several economy players have wanted Indian one to be deregulated.
India, no doubt, has no good infrastructure or health care system, but its banking system is rock solid. India's banking system is so strong because of a simple single reason. These banks are tightly regulated by Reserve Bank of India (RBI) which for years has been doing a tremendous job. The real impact of RBI was felt post liberalization in 1991. RBI has supreme powers in the country and never allows any bank(public and private both) to take more risks than it can handle. For this, RBI doesn't rely on credit rating agencies like in the US, but a more stronger evidence of a company's performance in meeting core banking requirements. India's major problem till 1991 was lack of external funds which could have been used for developmental purposes. Post 1991 when we opened up and till now, we have not gone back w.r.t regulation.
Every time there was a section of economists who believed in absolute deregulation while policy makers always were cautious of this approach because of already calculated and carefully calibrated risks that our economy must be mixed in the sense there should be regulation and deregulation in a balanced mode. It is as a consequence of these factors that our banks are very calculative in lending even though borrower has the capacity to repay.
Indian economy is very strong in macro fundamentals which include high growth, low inflation, sustained foreign reserves inflow which exceed its imports, and declining poverty levels. India ,of late, began to have high inflation. However, strong growth mainly driven by services sector and manufacturing have ensured that fundamentals are strong. Poverty levels are coming down and purchasing power has increased. India has also a well defined capital market system. India is very good in strong institutions which regulate both stock markets and banking. We also have very good structural parameters. What we lack is government will on ensuring fiscal deficit is low. We are very bad at this. We depend heavily on subsidies, govt funds, tax rebates for poor people and this is mainly to satisfy the election vote banks. If we can maintain low fiscal deficit, we can over power China in its economic strength. The other area we need to focus is infrastructure. This when done can match up with China. If infrastructure takes years to achieve, fiscal deficit is easy to achieve and requires policy changes.
Chinese economy is bad in everything except that it is adept in keeping its fiscal deficit low and concentrating on low cost manufacturing and sound infrastructure. Chinese banking system is extremely absymal. They don't have strong institutions like RBI which can govern independently of the government. This exactly makes China more vulnerable to a crisis than India. However, given the fact that US depends heavily on china, China is stronger than India today.
So, in answering the fundamental question, Is indian economy strong, it is very clear that we still are very strong in our macro fundamentals. However, our stock market is so much exposed to foreign ones that any impact there will affect us. Moreover, our services sector very much depends upon world economies. If we take out these we still continue to be very strong. Secondly, our foreign reserves have seen quantum jumps. This has been primarlily because our markets are giving that profits to foreign investors. This continued trust has ensured foreign direct investment to flow despite recession. Last month despite recession, there was 180% jump in FDI flow than the same month last year.
Today, our FDI reserves are much more than debts we owe to other countries. Unlike 1991, where we had shortage of money, we don't have it now. India is so strong now that if there is a need, liquidity can be pumped in very easily because of our strong reserves. Our reserves are not going to deplete as long as our demands don't decrease. A growing population coupled with increasing purchasing power parity will always ensure that we have continuous demands.
We, even today, can target our home grown goods and services to ourselves and yet end up making reasonable sales than depending upon exports for higher profits.
However, India needs serious measures to contain its increasing fiscal deficit by reducing subsidies,unwanted expenditures on sectors solely for vote banks and increase infrastructural growth. Furthermore, a factor that will continue to plague fiscal deficit is also the fact that all states don't grow at the same rate and do not maintain the same deficits. Some states are growing at twice the rate as the national one, while some don't even show signs of economic growth.
India doesn't have to depend upon foreign reserves if it can contain its fiscal deficit.
