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Global Recession and the Indian Economy - Myth and Reality

There has been a clamour for action by the government to prop up certain sectors which are experiencing a slowdown. What should be the real priorities of the government and central bank?



luxurious salaries and amenities and a

Global Recession and the Indian
drop in the abnormal rate of employment

in the white goods sector is not a signal of

Economy – Myth and Reality

a countrywide recession. If excess capacities are built up with the expectation that we shall have a 9% growth ad infinitum, Sugata Marjit it is not the social responsibility of the

There has been a clamour for action by the government to prop up certain sectors which are experiencing a slowdown. What should be the real priorities of the government and central bank?

Sugata Marjit ( is with the Centre for Studies in Social Sciences, Calcutta.

Economic & Political Weekly

february 28, 2009

his commentary is really in response to an interview I watched the other day and also to the continuing allegations that the Reserve Bank of India (RBI) is not doing enough for the recession-affected industries. The interviewer pounced upon a noted economic dignitary of the government alleging that there should be a stricture as to why interest rates are not coming down further when in the recession-hit developed world it has a lready touched zero. The ensuing response was dignified and logical, though apologetic. This has moti vated me to reflect on b usiness politics, lobbying and almost a mandated objective of manipulating public sentiment with wrong perceptions.

I shall be brief and to the point justifying what the RBI has done and in the process try to elaborate certain basic economic facts we all should be aware of.

It is well recognised by now that even if India hits a low 6% rate of gross domestic product growth in 2008-09, it will be still an all-time high on average compared to the periods till 2000, far greater than the well-known Hindu rate of growth. In all likelihood that will be the second fastest rate of growth in the world. This is no recession and not even close to the standard definition of recession. A decline in super rates of profit, fairy tale housing prices,

vol xliv no 9

RBI that such capacities remain utilised or unanticipated costs are recovered when expectations are not realised. The RBI surely did not get a cut of the excess profits and salaries in the good times and mother India should not be dragged to serve the cause of faltering markets. At least those who have always preached about the divinity of the invisible hand surely know that bad times are as much a reality as good times in capitalism.

Talk to any economist without vested i nterests and she will argue that there have been bubbles everywhere – in the share market, real estate, and white-collar top end salaries. When the inflation rate was close to 12% to 13%, the annual inflation in real estate prices in the metros was close to the tune of 70% to 80%. Was 70% a reasonable real rate of return? It is a child’s guess that extra liquidity was funding a massive upsurge in the stock market with a whopping rise in Sensex and with very l ittle impact on the overall rate of i nvestment. This also spilled over to the real estate m arket’s rising prices all around. It has been demonstrated that a lthough private corporate investment is positively related to stock market activities, such a link is very superficial, econometrically speaking. All the hype of the Sensex falling to the floor and the demand to pump it up with extra liquidity is simply wrong. We have shown

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Economic & Political Weekly


earlier (Marjit 2008) that the real interest rate has been on the decline for quite some time even when the nominal rate was rising. The current real rate is pretty close to what it was at some phase of the good times. We should also remember that a gap between the local real rate and the global level reflects a risk premium and is also a factor that will not let the capital flow dry up.

Healthy Adjustment

It is also to be noted that if the global recession leads to a decline in the demand for housing, we should allow its price to come down and more so when the price was high not only due to the pressure of real demand but due to the bubble generated by excess liquidity. We must allow it to adjust to the right level. If buyers do not have the cash to buy, housing prices will come down. That is healthy. If cars are not selling, their prices have to come down so that excessive future investments in bad lines of business get restricted to a reasonable level. Why does the RBI have to cater to the need to a bunch of sectors whose forward and backward linkages with the rest of the economy and society are often in question? We must allow excessive debt-financed consumption to fall in line. The decline in the interest rate often leads to a profit cover rather than growth in investment. Interest benefits for sectors such as exports should be welcome, but one must be careful to make sure that it does lead to some sort of social externality, rather than just protect profits.

When markets are on the upswing, all hell breaks loose if there is an interventionist policy, but in bad times there is a deluge of socialistic ideas. A case in point is the late 2008 reduction in excise taxes, a direct consequence of pressure by the business lobby, so that the prices of cars could be adjusted downwards. The burden of a decline in profit, a natural textbook fallout of a slowing market, has been mitigated by a decline in the tax rate. That is how the public exchequer was drained to make room for market adjustment. A high return in good times might be reflective of risk that was involved, but that does not mean if risk materialises it should be someone else’s headache. We should not forget the fact that we have already earned a premium for countering this. If we make profits worth crores for the last five years, a loss of 50 lakhs for the next two

Economic & Political Weekly

february 28, 2009

years will not take away all the gains. Why hold the RBI hostage for that?

The additional sops provided earlier this week in the form of a cut in indirect taxes are going to reduce tax collections substantially. This is bad since we need more resources to spend on many announced programmes. Will tax cuts sustain employment and halt the slowdown when demand is the real problem or will it protect profits? Implementation of the Sixth Pay Commission’s recommendations will infuse extra demand. Should not that be an automatic support to the market?

Priority List

There could definitely be a reason if the entire country or at least the vast majority of it was reeling under recessionary pressure. But there is no white paper on the real effect of the slowdown on all segments of society. Moreover, there are nagging questions which still need answers even after we had achieved 9% rate of growth. We have to constantly remind ourselves of the priorities. The following is a list of areas which did not benefit in the high growth phase. Is the business lobby truly concerned about all of them?

  • (1) More than 90% of our workforce is in the unorganised sector. How is it doing now? To what extent does the support to the white goods sector and white-collared jobs help their livelihood? If there is a drop in the growth rate of the top 5% of the income classes, how is it going to affect the bottom 30%? If prices of white goods come down a bit, is there any substantial effect on employment and real wages in the unorganised sector? This is a matter of serious research which has not been c arried out much.
  • (2) Agricultural investment, irrigation in particular, has not shown a revolutionary upturn in the last 15 years. We are still very much dependent on Mother Nature. Moreover, agriculture has been performing very poorly, abysmally in some r egions with more than 50% of the population stuck in this sector. What will extra liquidity from RBI do for these people? We are yet to see the true impact of the loan waiver by the government which is often reluctant to initiate impact studies of core public policies that waste a vast amount of tax payers’ money. But that is another problem.
  • (3) What was the record of employment during the booming growth phase? Is it
  • vol xliv no 9

    not true that restructuring often meant sacking people lower down while the top end continued to enjoy huge perks? Who keeps a tab on that?

    (4) If it is an effective demand problem, an interest cut will not do much. This is a simple Keynesian argument, although I do not believe that we are in a truly Keynesian situation. But the fact is that even if interest rates are down, people will be cautious in spending. If income of those whose marginal propensity to consume is very high, rise substantially along with the hope that such a rise at least partly will be sustained in the future, there will be a demand upsurge (via the life c ycle/permanent income argument) and that will be truly beneficial

    – slowdown or no slowdown. How are we faring on that count?

    (5) Out of every 100 children that are admitted at the primary level only seven pass out. Such an average has not changed much in the entire high growth phase. The dropout rates are remarkable. We are running short of good quality engineers and scientists. What will a further drop in the cash reserve ratio and the repo rate do to mitigate such problem?

    Without a recession share prices would not have fallen in line at least, to some extent, with the fundamentals. The run away rise in the Sensex without any res pect for real indicators is an economic menace the society has been paying for. I am sure the price/earnings ratio will be much more in line now than before. The same is true for the housing market if the banks are not pushed to the brim to refinance risky assets in the name of rescuing the national economy.

    This is the time when corporate malpractice will not be sustainable, be it excessive reporting of profits or issuance of securities with no real cover. We have seen plenty of that. Surely we do not wish to live in a fool’s paradise for ever.

    A noted economist, also a Nobel laureate, was recently asked in an interview to summarise the effect of the US recession in one sentence. He said that the world will definitely be a lot less unequal due to the meltdown. To some this is good news, for the rest, it is time to reflect in humility.


    Marjit, S (2008): “Inflation and Public Policy – Contemporary Dilemmas”, EPW, 6 September.

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