The Financial Crisis Reaches India

Experts recast expectations for more vulnerable economy

Surjit Bhalla, TN Ninan, Subir Gokarn, Sunil Mehta, Shankar Acharya, Udat Kotak

MUMBAI, March 1, 2012 — As the effects global financial crisis are finally catching up to India, commentators and policy-makers are adjusting their forecasts and reform agendas around a more vulnerable economy.

In a discussion centered on the growth path India should chart in the wake of changing external and domestic environments, Asia Society India Centre convened panelists Shankar Acharya, author of India After the Global Crisis and Member of Board of Governors ICRIER; Subir Gokarn, Deputy Governor of the Reserve Bank of India (RBI); and Surjit Bhalla, Director of Oxus Research and Investments; and moderator T.N. Ninan, Chairman and Chief Editor of Business Standard.

Acharya affirmed that the global crisis isn't over — despite recovery in 2010, 2011 saw economies faltering again, with the financial crisis morphing into a sovereign fiscal and debt crisis, especially in Europe. He observed that growth in the U.S. and Japan is slow, and negative in Europe. This, coupled with the possibility of a major Eurozone crisis, a possible crisis over Iran and other potential shocks, portend a rocky year for 2012.

Acharya said that India's vulnerability to external shocks has grown, given its decreased growth rate of 7% in the past year, high inflation and rising external debts and deficits. Acharya also noted that the so-called fiscal stimulus of 2008-2009 was actually a surge in populist policies such as subsidies and entitlements, politically difficult to withdraw and fueling inflation and pushing the RBI towards contractionist monetary policies. Further, he said that investment and growth in India have been hurt by a prolonged lack of reforms since 2003, and that a mishandled exchange rate policy after 2009 allowed the rupee to appreciate too much and didn't build up sufficient foreign exchange reserves. Because of this, India's external sector was more vulnerable.

Video: Highlights from the March 1 discussion (14 min., 10 sec.)



Acharya predicted that India is building towards four possible types of crises if it continues on its current path of weak governance, lack of reforms and fiscal profligacy — a balance of payments crisis in the next couple of years, a medium-term crisis of slow growth at or below 7%, a long-term crisis of unemployment and underemployment, and growing problems of national security as India's economic strength falters.

Bhalla argued that the RBI and some other commentators underestimated India's potential GDP growth rate as 7%, and that the government should make policy based on the assumption that it is 8.5%. Bhalla also lamented the extreme populism he said the UPA government had practiced over the past seven years, and predicted that 2012 would be remembered as the year when the second-generation reforms started and as the beginning of the end of populism. Now, he said, technocrats would be allowed to make policy, because a necessary condition for a political party to return to power is to increase growth. Political compulsion would then force them to get India to 8.5% growth, which he said could be achieved without any additional reforms.

Gokarn looked back to the 2003-2008 growth period to better understand today's position. He explained that a combination of domestic factors that increased capacity in the system (in which growth was high and interest rates and commodity prices were low) took India to 8.5-9% growth from 2003 to 2009. But seeds of the slowdown were already sown then, as was revealed by India's vulnerability to rising commodity prices in 2007 with respect to oil and food.

He further explained that macro circumstances today are almost the opposite of those seen in the lead-up to the 2003-2009 growth phase, but the question of capacity is crucial in determining the road ahead. India should push forward its reform agenda, he said, with attention to agriculture and food, land acquisition and public ownership of resources, urbanization and management of large cities, and employment and labor productivity. The focus, Gokarn suggested, should be on long-term capacity creation.

Event supported by Kotak Mahindra Bank and Orient BlackSwan