Saturday, October 11, 2008

Is Indian economy really strong?

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.


RisingCitizen said...

Good blog Anju.

However the cause of this financial turmoil is not entirely a result of unregulated activity by wall street banks! It is also not due to increased competition that the banks collapsed!!! you are wrong there.

There is a world of difference in cultures: east vs west!

Americans primarily live on credit, where as Indians and Chinese live primarily on the $$ they make! They don't rely on their govt. to support them nor do they go out and buy houses that they know cannot afford. In the US people are not very street smart. If a bank offers a 300k loan for a house people take it without thinking if they really can afford a 300k house. Of course the banks did significantly push to get these sub prime mortgages out on the hope that the economy would expand but they never foresaw that the economy would explode!

So not only the folks at Wall street are to blame but American public bear a huge brunt of this crisis.

To say Indian economy is strong is also incorrect. World economy to a large extent depends on US economy. Indian economy is where it is today primarily due to huge investments from US tech sector. If there is a financial melt down in US, India will be affected dearly!! What you can say however is that the Indian banking system is relatively immune to the crisis. There definitely will be banks that will be affected due to this but this crisis will not be the primary cause for any Indian banks to completely shut down. Lehman & AIG both have a huge presence in India and everyone who is associated with these companies will be hit.

In US, people rely on their Govt. to take care of them (unemployment, Social Security, health care, etc), in India and China its the opposite- People take care of their own finances without relying heavily upon the Govt!

In US, people are scared where their financial institutions (banks) will shut down, while in India they don't really think the same way. In US though there are very few people actively trading in the stock market, 70% of working class with 401k /IRA's will be dependent indirectly on the stock market as most funds will be invested there! So if the companies fail, banks fail, stocks fall, public savings disappear into thin air! in India, most people still use fixed deposits in banks for their savings. They don't have anything like a 401k or IRA ! Each individual is responsible for his own future.

In the US, people are preached on how to spend where as in India and China, people are taught how to save!

Anyways, this discussion can go on for days and this slump will take years if not decades to fix itself.


RisingCitizen said...

Thank you for the comment...I believe that this cultural difference w.r.t money is what always made finance ministers of india cautious of radical changes in economic reforms..This applies to Yashwant Sinha (BJP) and Manmohan Sngh and Chidambaram who have consistently worked in unison wr.t economic policies...

And as u said this discussion can go on..but just to say that in my article i clearly articulated that services sector and stock markets are vulnerable to global meltdown..

RisingCitizen said...

Why do you say it is only the services sector? Isn't USA the largest export destination of Indian goods? When the American people cannot buy wouldn't the exports decline?

It is a different story that Rs50 for $1 can make Indian tech labor very cheap. Wouldn't Indian outsourcing companies love to see that rate? (Of course as long as there is work in America to be outsourced.)


My reply:
You raised some very interesting questions. Some of the startling statistics are as follows:

India is still an import driven country than exports
Although services sector contributes 60% of GDP, only 28% of the population is involved in this

The manufacturing sector which contributes 19% of GDP has 12% of population

Agriculture although occupies 19% of GDP, has 68% of population under it. So, net exports of agricultural products even if decreased can be easily matched with the fact that Indian population is so high that the food grown in India can be consumed and farmers can still make money even if exports are reduced. This is how we have been living for almost 30 years till 1991 when agricultural sector was exposed to external markets.

In case of textiles and apparels EU is a major importer than US..So, if EU stops consuming we are going to be affected.

Moreover, India, today trades more with US and EU in huge volumes. So, unless both stop buying we won't collapse. Moreover, any non-consumption of goods in US will impact China more than India as they are an export driven economy...