Government’s Mid-Year Review of the Indian Economy: An Appraisal

The Mid Year review of the Indian economy was placed in Parliament on 23 December 2008. The salient conclusions of the report are the following:

· The overall outlook for the economy is that of cautioned optimism.

· The report forecasts a 7-8% growth rate of GDP for the fiscal year 2008-09

· The fiscal deficit target of 2.5% of GDP in the fiscal year 2008-09 will be missed.

· Inflation rate will ease even further

· It is projected that exports will be adversely affected.

(Source: Review calls for more rate cuts, reforms: Inflation To Continue Fall, Growth To Ease, The Economic Times, 24 December 2008)

This report comes in the background of the global financial crisis which has also adversely affected the growth prospects of the Indian economy. In this context, we have already seen that the Government has announced a stimulus package, which is aimed at strengthening the economy. It is in this context that the conclusions of the report and its recommendations have to be judged.

As far as the issue of growth is concerned, the report is somewhat optimistic because of five main factors in the Indian economy. Firstly, it is said in the report that the share of services in India’s economy is relatively very high compared to other emerging economies. Services are less affected by cyclical downturns compared to manufacturing. This will moderate the negative impact of the global crisis on India. Secondly, it is argued that the agricultural growth rate has been around 4% for the last five years. Added to this, the impact of the NREGA has increased the income and purchasing power in the rural areas. This will maintain the buoyancy of demand in the domestic market. Thirdly, the savings rate in India is quite high which can sustain a higher growth rate of GDP. Fourthly, the ambitious infrastructure requirements laid down in the XI Year Plan will offset any tendency to slow down by increased investment in infrastructure on the part of the Government as well as the private sector. Fifthly, tight monetary policy was pursued for the first half of the year 2008-09 because of rising inflation in the economy. Now that the inflation rate has subsided and is expected to decline even further, the Government or the RBI has got the space to pursue a pro-active monetary policy to sustain growth in the economy. (Source: http://pib.nic.in/release/release.asp?relid=46057)

Based on the above analysis of the functioning of the Indian economy, the following policy prescriptions have been deduced:

• Since, the threat of inflation has subsided, based on a tight monetary policy, the need of the hour is to pursue an expansionary monetary policy. It is argued that the RBI should announce further cut in the different interest rates. The basic logic behind this is that with the loosening of the monetary policy, money supply or liquidity will increase in the economy on the basis of which, demand will increase.
• It has been mooted in the report as well as several other policy documents of the Government, that infrastructure is a very important element in the overall growth strategy. Therefore, it has been argued that all policy and institutional impediments to private sector investment in infrastructure sector should be removed.
• A logical part of the previous strategy is the Government’s advocacy for accelerating all the pending policy reforms. This is supposed to induce the animal spirits of the investors which will sustain the growth process in the economy.

(Source: The Economic Times, 24 December 2008)

Let us now look into each aspect of the abovementioned points. Before going into the policy issues, let us first highlight the problems that are plaguing the Indian economy. As a result of the global financial crisis, the Indian stock market has been extremely adversely affected with FII pulling out money. This has resulted in a crisis of confidence in the Indian economy. In this situation nobody is willing to lend other than to those who have very high creditworthiness. On the other hand, as a result of the credit crisis, two situations have developed. Firstly, the producers are not finding enough credit to finance their investment decisions. Secondly, the prospective consumers, who indulged in debt financed consumption, are not finding credit to sustain their consumption needs. As a result, demand is getting adversely affected both from the investment as well as consumption side. In addition to this, there is the problem of a situation like a liquidity trap, where people prefer to hold on to money and stay liquid rather than indulge in investment or consumption expenditure.

The second important aspect of the crisis in India is the negative effect on the exports. For the first time in many years, Indian exports registered a negative growth in the month of October. This slow down in the exports is because of the slow down in the world market, where the demand for Indian exports has decreased. As a result the export sectors of the country, IT or textiles have been adversely affected. There are reports of massive job cuts in the textile sector and other sectors in the economy which can be directly traced to falling export demand. It is in this overall economic context that the conclusions and policy prescriptions of the mid year review needs to be judged.

Firstly, it is clear from the above that there has been a general problem of demand in the Indian economy, with services also facing a problem of demand. For example, the IT sector, which is the fastest growing sector within the services sector has taken a hit because of the global financial crisis. It is also wrong to visualize the services sector as a homogeneous block, which it is not. While IT is a part of services sector so are housemaids. In case of economic slowdowns it might so happen that people unable to find meaningful jobs crowd in lower end services. This will show itself as a bulging service sector but the well being of the people will hardly increase. So, the argument that since India’s major part of the GDP comes from services and hence the impact on India will be less is misplaced. It should not be forgotten that the advanced countries which are facing the brunt of the crisis have much larger shares of Services in GDP compared to India. Even then these countries have not been spared the threat of recession.

Secondly, the entire question of monetary policy has been exaggerated in the policy circles in India. It is true that there has been double digit inflation in the economy which forced the Government to adopt tight monetary policy. But it is unclear as to how much of the decline in the inflation rate is because of this intervention on the part of the Government. Moreover, as has been pointed out, the crisis today is a crisis of confidence. In this situation it is not enough to merely reduce interest rates, since nobody is willing to take the loans, since the future is uncertain in terms of the person’s ability to pay back the loan, given uncertainty prevailing vis-à-vis job as well as emoluments.

As far as the question of infrastructure is concerned, two points need to be noted. Firstly, it is nobody’s case to argue against infrastructure building in India. On the contrary what is required is much more infrastructure investment. But, there are sectors where the private sector cannot and should not invest, for example, infrastructure in the form of nuclear power plants and other such sensitive projects. However, what is being aimed at in the name of higher infrastructure is complete subversion of these strategic interests. Secondly, it is also the case that infrastructure built by or with the help of private players entails a higher user cost for the consumers. In this case then, a large number of people are left out of the benefits of the infrastructure while private players reap a profit out of it.

The suggestion for even more liberalization of the Indian economy is completely untimely and misplaced. A majority of the problems of the Indian economy today is not in spite of but because of globalization. This is evident from the fact that the problems in the global economy have been imported into the Indian economy as a result of the policies of globalization and liberalization. Even after this, the fact that India has fared better than other countries is simply because of the fact that the Indian economy is not as integrated into the global system as soundly as other countries. The slogan for even more reforms essentially will eliminate this window that the Indian economy has. This is most evident in the decision of the Indian Government to increase the FDI in insurance from 26% to 49%. At a time when the entire financial architecture of the world dominated by finance capital is trying to cope up with its own crisis, the Indian Government has opened up another avenue to import this crisis into India. In the aftermath of this crisis, the biggest insurance company in the world, AIG, went bankrupt and had to be bailed out. In spite of this, our Government wants these companies to have greater stake in Indian insurance companies. As a result any problem of companies like AIG will instantly become a problem of the Indian insurance sector and hence of the Indian economy.

The Government’s biggest lacuna in this report as well as its other responses to the crisis is the fact there has been no concern for the unorganized workers and other marginalized sections of the population who are facing the brunt of this crisis. There is very little or no effort on the part of the Government to put purchasing power in the hands of the poor through higher Government spending. The biggest impediment to this is the FRBM Act. In the absence of Government spending as well as higher purchasing power of the poor, the role of the engine of economic growth and sustaining demand automatically goes to the rich and the corporate sector. Thus if the Government is not concerned enough about the rich and their well being and still wants to ensure higher growth, then it is bound to rely more and more on the rich and the corporate sector. As a result the policies of the Government are aimed at wooing the corporate sector to invest or the rich to consume more. The interest cuts on homes, car loans, the demand for removing all constraints on private sector investment in infrastructure are aimed at precisely this. While this may or may not improve the growth in the country, the poor are clearly left out of its benefits. This is because even the employment generated on the basis of the demand pattern of the rich is low and the infrastructure projects in India more often than not displace the poor rather than provide them with better livelihoods.

Industrial Growth in India: Where are we heading?

The latest data for IIP has been released. Click here to view the analysis of the data.

Inflation and Growth in India: Policy Responses of the Government

Double digit inflation returned to India after many years in the middle of this year. The inflation figure for the various commodities is shown in the graph.

From the chart it is seen that the overall inflation rate in India increased from a low level of around 4% in first week of January 2008 to more than 10% by the first week of June 2008. Subsequently, the inflation rate continued to increase crossing the 12% mark in the first week of August. Thereafter, while the inflation rate decreased, it continued to be above 10% till the last week of October. Since, then the overall inflation rate has declined to 8.4% in the week ending 22-11-08. Before going into the policy responses to this high inflation in India, let us first look at the inflation rates of major commodities.

From the above graph it is clear that all major commodities like primary articles, manufactured products, fuel, power, light and lubricants, registered significant increase in the inflation rate. These three sets of commodities more or less comprise the overall price index. Thus, the movement of these three sets of commodities explains the overall inflation rate in the economy. From the graph it is clear that the commodity group fuel, power, light and lubricants witnessed the highest inflation rates touching 19% in the week ending 02-08-08. Subsequently however, there is a large fall in the inflation rate of this group of commodities as is seen in the above graph.

This weight of this group of commodities is 14.23 in the overall index. Thus, such large inflation in this group is bound to affect the overall inflation rate in the economy. Moreover, fuel being a key input in almost all the commodities, any hike in the price of fuel consequently leads to a cascading effect on the prices of all other commodities. Now, the question is what explains the huge rise in the inflation rate in this group of commodities. Firstly, this increase is largely because of the increase in fuel, particularly oil prices in the global market. This increase in the oil prices in the global market was largely on the basis of speculation. There was no discernible decrease in the supply of oil or a sudden increase in demand. Still, the oil prices increased based on speculation. (See ‘Is the Present Crisis Ricardian?’, Prabhat Patnaik, http://pd.cpim.org/2008/0615_pd/06152008_9.htm). Indian economy being a part of this globalized world had no option but to allow for an increase in prices. This however was compounded by the fact that the excise duties and custom duties on crude oil in India are high compared to other countries.

As far as manufactured products are concerned, it is seen from the above graph that this set of commodities also witnessed double digit inflation, which later on decreased. Manufactured products’ weight in the overall index is 63.75. Thus the overall inflation rate is decisively influenced by the inflation rate of the manufactured products. The inflation rate in the manufactured products has been largely driven by the increase in raw material prices as well as increased demand for steel and other metals in the international market driven by the construction boom in China and India. The good news however is that the inflation rate for the manufactured products has also declined from its very high level.

The most worrying aspect is the inflation rate of the primary commodities. It is seen from the above graph that like every other commodity groups, the primary commodities too have witnessed double digit inflation. Food is the most important component of this group of commodities. Now, food being the most important item in the consumption basket of the poor, such high food inflation adversely affects the poor to a great extent. It must be conceded at one level that this high inflation in food prices was also an international phenomenon, where many factors contributed to the increase in the food prices. The most important of these reasons being the shifting of land from food production to the production of bio-fuels, drought like conditions in Australia and Ukraine and also speculation. In the case of India however, what is most worrying is the fact that while inflation rates for all other commodities have decreased below the double digit mark, the same for primary commodities remains around 12% showing no declining trend. In other words, it can be said that while the overall inflation rate has declined in the country, the poor are still facing a difficult situation because of the continuing higher food and other primary commodity prices. The question is what explains this overall movement in the inflation rate of all the commodities? This brings us to the issue of the Government’s response to the question of rising inflation in India.

Government’s main response to the question of inflation has been to try and manage it through monetary measures. This is reflected in the fact that the RBI increased all key rates (like Cash Reserve ratio, repo rate etc) in the economy which was followed by the banks raising the interest rates for home loans and other loans. This was done with the basic assumption that with an increase in the interest rate, the demand in the economy will decrease and this will lead to a reduction in the inflation rate. On the face of it, this remedy seems to have worked, given the decrease in the inflation rate as has been discussed above.

However, there are some problems with the overall policy of the Government, which are enumerated below. Firstly, conceptually speaking inflation can hurt the poor only in a situation where all prices other than the wages rise, which is a reflection of excess demand for the commodities. In the case of India, the most obvious example is food price which has continued to increase even when other prices have more or less subsided. This increase in the food prices clearly has not been checked by the policies of the Government. This is because the root cause of the increase in food prices in India lies in the fact that with prolonged years of demand depression particularly in Indian countryside, agricultural supply has been adversely affected as a result of a squeeze on the peasantry. Added to this is the issue of futures trading and other speculative activities introduced in the market for agricultural commodities. The solution to this food price increase cannot be merely some rate cuts announced by the RBI. Rather, what is needed is additional expenditure on the part of the Government in the rural economy of India to resolve the agrarian crisis afflicting the Indian economy. Only then can there be sustained growth in agriculture reducing the food prices. Universalisation of the Public Distribution System and proper enacting of the Rural Employment Guarantee Act should be undertaken in order to ease the burden on the poor.

It is however the case that the prices of other commodities excluding food have decreased significantly as compared to the double digit inflation figures. It cannot be ascertained how much of this decrease in the inflation rate is directly because of the policy announcements of the Government and how much is because of international factors. Since the month of September, an unprecedented financial crisis having the potential of turning into another Great Depression has hit the world economy. As a result of this crisis, there are recessionary trends in all advanced countries including USA and Europe. As a result, the world economy is currently facing very low growth potential. With the slowing down of the industrialized economies, the price of oil has drastically reduced. This is because it is expected that the world economy will slow down even further, which will result in further decrease in the price of oil with its demand slowing down. This expectation is forcing speculators to sell oil for some other commodity, notably gold, which is resulting in a fall in the prices of oil. At the same time, the price of steel has also witnessed a fall because of the lack of demand in the world economy. In short with the possibility of a global recession, the international prices have actually fallen. This would have surely impacted the domestic price level in the economy. So, it is unclear as to how much of the decrease in inflation is a result of the policies of the Government.

Now, with the financial crisis hitting the Indian economy and the possibility of a global slow down, the policy direction is again focused on ensuring that the growth rate does not fall too much. In order to ensure that the Indian economy is not hit by a recession, the Government has come out with a stimulus plan, the salient features of which are the following:

• The Government has proposed to increase the Planned expenditure by Rs 20,000 crores.
• To ensure additional spending to boost demand, the Government has reduced the Cenvat tax by 4%.
• Interest rate on export credit has been reduced. Additional funds of Rs.1100 crore will be provided to ensure full refund of Terminal Excise duty/CST. An additional allocation for export incentive schemes of Rs.350 crore will be made. Government back-up guarantee will be made available to ECGC to the extent of Rs.350 crore to enable it to provide guarantees for exports to difficult markets/products.
• Public Sector banks will announce a package for the housing sector loans while the RBI will put in place a refinance facility worth Rs 4000 crores for National Housing Bank. There are also plans to finance the textile sector.
• The Government has decided to boost infrastructure through Public-Private Partnership. The Government has also decided to raise Rs 10,000 crores from tax free bonds.

(Source: Government Announces Measures for stimulating the Economy, http://pib.nic.in/release/release.asp?relid=45377)

The above mentioned measures are aimed at boosting domestic demand through direct government expenditure, excise duty cuts and infrastructure projects. At the same time, the package also entails to boost the export sector in India. Whether or not this package will solve the recessionary trends in India will be clear with time. However a couple of points need to be made at the outset.

Firstly, the fiscal stimulus of Rs 20,000 crores is too small and it is also not clear as to under what heads will this money be spent. Secondly, there is no announcement on the part of the Government to protect the interests of the workers directly, while they are the ones who are facing the brunt of the crisis with massive lay-offs as a result of the global crisis. Thirdly, the finances of the state governments are completely ignored in the package, a point which has been made by the Finance Minister of Kerala. (Central Package Ignores States, Says Minister, The Hindu, 8 December 2008).

There is however a more fundamental point regarding the entire approach of the Government. We were told during the days of high inflation that it is a result of overheating of the economy. Hence interest rates were increased to reduce demand. This however did not result in a decrease in the food prices, while overall inflation came down aided by international factors. Again, with the global financial crisis, the Government decided to cut the interest rates to boost demand. This also did not have the requisite impact because the crisis was a crisis of confidence with the banks refusing to give loans. So, even with an interest rate cut the problem could not be resolved. This over reliance of the Government on the monetary instruments to resolve every problem of the economy stems from the basic position that the Government should maintain fiscal prudence. However, as has been discussed earlier, what is needed to tackle the problems of the Indian economy is to increase the purchasing power of the poor and by increasing Government expenditure particularly in the rural areas. In order to do so, the Government has to come out of the overall hegemony of international finance capital and neo-liberalism reflected in the FRBM Act and the policy of fiscal prudence. Given the neo-liberal commitment of the Government it is improbable that it will tread on this path. The answer therefore lies in the struggle for an alternative set of policies challenging the hegemony of finance capital.

Financial Crisis and India: Who Pays the Price?

On November 3, the Prime Minister of India, Dr. Manmohan Singh urged the Indian industries, not to cut jobs. He said, “While every effort needs to be made to cut cost and raise productivity, I hope there will be no knee-jerk reaction such as large scale layoffs, which may lead to a negative spiral.” Things are however not turning out as advised by the economist PM.

Job loss in the Indian Economy

Already, we have seen that the performance of the Indian corporate sector has been adversely affected. The results of the second quarter for this fiscal year show that the aggregate profit growth for the corporate sector as a whole has come down. The main reasons for such decline in profits being rise in interest costs and raw material prices. In the wake of such decline in profits, the Indian corporate sector had to cut down on costs. In this regard, retrenchment of workers was thought to be an effective way of cutting costs. The move by Jet Airways to retrench 800 workers was done primarily on the basis of the above thinking on the part of the Jet management. However, due to much public outcry and political pressure, the Jet management had to withdraw its decision. This was however only the beginning of the story. Almost all the sectors of the economy have resorted to job cuts or a cut back in the production in order to cope with the economic crisis. We give some of the major decisions of job cuts or production cuts on the part of the Indian corporate sector in the wake of the financial crisis.

• India’s leading truck maker, Tata Motors, announced the shutdown of its Pune unit for six days in November, which will follow a three-day closure of its Jamshedpur plant.
• Ashok Leyland, the second largest producer of trucks, drove in tandem, slashing its weekly working days to three.
• JSW Steel opted for a 20-per cent cut in output this month.
• Another steel maker Essar also has decided to reduce capacity utilization.
• Tata Steel’s UK subsidiary, Corus, has also affected a similar cut in capacity utilization. It has also decided to axe 400 jobs.
• DBS has decided to cut 900 jobs
• Cement manufacturers have reduced capacity utilization to about 85% because of a sharp fall in demand from the realty sector, which consumes about 55% of the total production of 200 million tonnes.

(The above data is taken from: More Companies Opt to Trim Man Hours, Cut Production, Business Line, 8 November 2008)

• Nearly 150 trained pilots and hundreds of trained airhostesses have been rendered jobless as the economic turbulence is forcing airline companies to ground a significant part of their staff. (150 Airhostesses, Pilots Get Grounded, The Economic Times, 8 November 2008).
• Even in the Finance or the IT sector, the threat of job loss is looming large. For example, Fidelity National Information Services (FIS) has given pink-slips to over 100 employees at its Chennai operations, which constitutes more than 10% of its staff in the metro. (Over 100 FIS staff get pink-slips, The Economic Times, 8 November 2008).
• L&T Infotech, the wholly-owned subsidiary of the country’s largest engineering company Larsen &Toubro (L&T), is trimming down its staff by asking some employees to resign. It is estimated that the number of forced resignations till now is around 100. (L&T IT Arm Starts Trimming, The Economic Times, 8 November 2008).
• At the same time, the international banks’ offices in India are significantly down sizing their work force. Goldman Sachs slashed its workforce by close to a dozen in its Mumbai office. Credit Suisse, another recent entrant in India, has also slashed some jobs in the country. (These Are Mean Cruel Times, Indian Arms of I-Banks in Lay-off Mode, The Economic Times, 8 November 2008).
• The most severe job cut however has been witnessed in the textile sector. It is estimated that over the last six months there have been 7 lakh job losses in the textile sector. The textile sector is particularly important because it provides employment to more than 3.5 crore workers. It is also projected that this number can increase to 12 lakhs in the next three months. (Textile Cuts 7 lakh Jobs in Six Months, The Economic Times, 8 November 2008).

Why Such Job loss?

The question that naturally arises is what accounts for such across the board and massive lay-offs in the Indian economy? There are several reasons for this. Firstly, as has been already mentioned, job cuts is a way of reducing costs to the companies, which they are resorting to in the wake of rising interest and raw material costs. However, the malaise goes deeper than this. This is evident from the fact that not only has there been a job cut, but many companies have been forced to suspend or reduce production in the recent times. This points to the fact that the companies are trying to reduce their capacities. Such reduction in capacity utilization is symptomatic of the fact that there is not enough demand in the economy. For example, for the auto manufacturers like TATA Motors or Ashok Leyland, there is just not enough buyers to buy their products. In this context, to carry on production will only result in accumulation of inventories, which these companies do not want- hence the decision to suspend production in their plants. As far as the steel sector is concerned, the biggest demand from steel in India comes from the construction and the real estate sector. Now, in the wake of the financial crisis, the realty sector has been substantially adversely affected. As a result the demand for steel in the country has been hit. Moreover, since the crisis is global in nature, there is not even enough external demand for steel, which can compensate for the drop in the domestic demand. In the absence of demand for steel, the companies have been forced to cut back on production.

The case of the textile sector is particularly worrying. This is because this sector employs a very large number of people. Moreover, the people who are particularly losing their jobs in the textile sector are those workers who are daily wage earners. The question is why such severe job cuts are being witnessed in the textile sector. One of the major sources of demand for the textile sector is the external demand. In other words, there is a strong export demand for the Indian textile sector. In 2006-07, the textile exports comprised of 12.9% of the total exports from India. (Economic Survey, 2007-08, Chapter on External Sector). Now, with the global financial crisis and the impending recession in the advanced capitalist countries, there has been a slow down in the export demand for Indian textile sector. With such decline in the demand for the Indian textile sector, there have been severe job losses.

Lessons for the Prime Minister

The economist Prime Minster needs to learn proper lessons from this. His argument to industry not to retrench workers is nothing short of a hogwash. This is because, as the Finance Minister and now the Prime Minister of the country, Dr. Singh has presided over a systematic entrenchment of the Indian economy into the logic of the market. Today, the organized sector employment growth rate has reached minimal level, with the employment in the Public sector turning negative. (Economic Survey, 2007-08). On top of this, there is the new mantra of labour market flexibility supposedly to increase the efficiency of the Indian industries. These are nothing but euphemism for doing away with whatever little social security that the workers have in this country. Now, when the workers have been subjected to the tyranny of globalization, Dr. Singh is now paying lip service to them, on the eve of the elections.

This impasse has been created by the votaries of neo-liberal reforms in the country. Over the last few years, the Government has self-imposed strict limits to fiscal expenditure as a result of following the policies of globalization, the FRBM Act being one example. Instead of ensuring proper expenditure on the part of the Government aimed at uplifting the conditions of the poor what has been done is providing sops to the corporate sector, in the form of tax exemptions. This has allowed the corporate sector to rise to dominance in the Indian economy. At the same time, the demand for the products, primarily high end, of the corporate sector has been provided by the debt financed consumption of the middle class and the rich. Now, with the financial crisis, the banks are becoming less forthcoming in providing such easy debts to the middle classes. That is why there has been consistent demand on the part of the press as well as other stakeholders to reduce the interest rates on housing and other loans, in order to again stimulate the debt financed consumption. In fact, the Finance Minister compelled the Public Sector Banks to reduce their rates. This route of stimulating demand is however problematic because of the following reason. What is essentially done through this lowering of interest rate is to neglect putting more purchasing power to the majority of the people and lure the middle class to consume, thereby keep the demand in the economy afloat. What is missed is the fact that such soft loans in return may give rise to sub-prime loans in the Indian economy, which can cause serious problems for the banks. Already it has been seen that the largest credit card issuer, ICICI Bank has shown flat profits and significantly enhanced loan loss provisions. The second largest credit card issuer, the State Bank of India’s SBI Cards, posted net losses in the past two quarters. On December 31, 2007, its non-performing assets, or credit card debt that could not be collected by the company, stood at 16.28 per cent. This is likely to have grown since then. (Now, the Credit Card Crunch, Jayati Ghosh, Frontline, November 8-21, 2008).

Who Pays the Price?

In this context one of the most important issue is the asymmetry in the impact of the boom and the bust. When India was growing at a very high speed riding the boom, lakhs of farmers committed suicide in the country, the employment rate declined, the rate of decrease in the poverty rates, even according to official estimates declined, children remained malnourished and millions died of curable diseases. At the same time however, India produced the largest number of billionaires, shopping malls and luxury hotels for the rich, high profile jobs for the English speaking elites. In other words, during the boom in India, the rich got richer while the poor got poorer.

Now, the signs of the impending slow down in the Indian economy are global in origin. It is the speculators in the Wall Street who have manufactured this global crisis riding on greed and free market ideology. And who suffers the consequences of this in India? We have already seen that 7 lakh people have already lost their jobs in the textile sector alone, majority of them being wage earners. Factories of TATA are being shut down, investment projects are being postponed, production is being cut-the sufferers in all this are the working people, whose jobs are at stake, whose salaries, job security and other benefits are at stake.

One might actually argue that the riches are also losing out. It is reported that the collective wealth of India’s wealthiest have fallen by $212 billion. Still, the net worth of Ambani is $20.8 billions in a country where 77% of the people live on less than Rs 20 per day. Moreover, this loss in the wealth that is being reported in the financial press is more of a notional loss than any original erosion in their asset position. This is because this loss is based on the valuation of the paper assets (stocks) of the industrialists, which have indeed decreased in the market.

As far as the middle classes are concerned, yes there have been losses for this section of the population. The option of high consumption on the basis of soft loans has also dried out to a significant extent. This however might be transitory since the banks are already easing out different rates. A section of the white collared people has also lost their jobs. What is noteworthy however is the response of the media as well as the establishment to this problem of the middle class. Only 1900 people were sacked by Jet Airways, which was indeed a terrible thing, and the entire media cried foul over it. Today 7 lakhs poor people have lost their jobs in the textile sector only. The media is silent on their plight. Thus, it is seen that it is the working people of the country who are mostly paying the price in the aftermath of the financial crisis and its impact on India.

What Can be Done?

What can be done is however very simple. The Indian economy is riddled with large scale poverty and misery particularly in the rural areas. What is needed is Government expenditure in a big way in the economy, putting purchasing power in the hands of the people whose increased consumption can then be a very important source of demand in the economy. This can be done by providing employment to the masses, which will also help in eradicating poverty to a significant degree in India. One step in this regard is to implement the NREGA effectively in rural areas and expand to urban areas. Moreover, government investment should be forthcoming in major infrastructure areas like building roads, railways, hospitals, schools, colleges etc. This will not only generate employment for the masses but act as major social assets in the future. Today, China is already doing it.

The financing for these projects is not an impossible task if one sees it outside the prism of the ideology of neo-liberalism. What is first required in this regard is to do away with the FRBM Act and ensure more Government expenditure by enlarging the fiscal deficit. What is needed is a political will to implement policies for the upliftment of the poor and not merely directed at filling the coffers of the rich.

The Financial Crisis and India Inc.’s Performance: Where Are We Heading?

The recent growth scenario of India has been quite remarkable, with the economy registering 9% growth rate for the last 4-5 years. In order to ensure a higher growth rate of the economy, the Investment-GDP ratio must increase. In India, the investment-GDP ratio showed a marked increase over the last few years, starting from 2001-02.

Now, the question is what has led to this massive increase in the investment-GDP ratio. In other words, which components of investment have increased dramatically during this period leading to such a huge increase in the investment rate? This has been largely due to the performance of the corporate sector of the country. Over a long period of time, it had been the case that households’ investment has been the major source of capital formation in the Indian economy. However, in the recent past, the investment by the private corporate sector has increased more than that of the household sector. In other words, the recent increase in the investment rate and the growth rate of GDP has been led largely by the private corporate sector.

In this context of a private corporate sector driven growth in the Indian economy, it is obvious that the performance of the private corporate sector is of crucial importance to maintain the high growth trajectory in India. It is in this regard that the performance of the Indian corporate sector in the last quarter is a cause of worry.

In a study conducted by the Economic Times it has been found that India Inc.’s profit growth has witnessed a sharp slow down in the second quarter of the current financial year. It is found that out of 1,450 listed firms (excluding banks and oil & gas majors), aggregate net profit growth has come down to 5.7%, which was 25.8% in Q2 of 2007-08 and 9.9% during the first quarter of 2008-09. 20% of the companies in the sample have reported net loss as against 14% during the second quarter of 2007-08. (Source: India Inc.’s Profit Drive Takes a Beating, The Economic Times, 3 November 2008).

In another separate study undertaken by the Business Line it has been found that 116 companies out of a sample of 814 companies have seen a decline in the ‘value added’ (measured as the sum of ‘net sales’, ‘other incomes’ and net addition to inventory minus the value of raw material and stores consumption) during June and September 2008 quarters compared to their immediate previous quarters. (Source: It is Recession for One in Seven of NSE Listed Companies, Business Line, 3 November 2008).

The question that immediately arises out of this is what accounts for the decline in the profit for these companies. We know that profit is the difference between total revenue and total cost. Therefore, a decline in profit must mean a decline in the total revenue of the firm or an increase in the cost of the firm. As regards revenue, it has been found that at the aggregate level, growth rate of net sales of the companies in the sample was 28.3% during the latest quarter as against 17.7% for the same period last year. (Source: The Economic Times, 3 November 2008).

Thus, the decline in profit has to be accounted for by an increase in cost. The biggest component of the increased cost has been the increase in the interest rate. It is estimated that interest costs rose by 72% in the last quarter as against 26% during the same period last year. Added to this, there has been an increase in raw material prices for manufacturing industries, which has also pulled down profits. (Source: The Economic Times, 3 November 2008).

The question is what accounts for the increase in the interest rates as well as raw material prices for the industries. There are several reasons for this. Firstly, the rise in the interest rate is due to two basic factors. (a) In order to tame the rising inflation in India, the RBI announced hikes in the Cash Reserve Ratio as well as the repo rate in August 2008. In response to this tight monetary move of the RBI, the banks also hiked their interest rates on loans. (b) With the global credit crisis looming large in the horizon, the Indian corporate sector could not find loans in the international market also.

Secondly, the hikes in the raw material prices are mainly due to the hikes in the prices of oil, agricultural products, particularly food grains and steel at a global level. Most importantly, oil is a commodity which is almost universally used by all industries. Therefore, a hike in the price of oil is bound to increase the raw material prices in a big manner. (It is however the case that the prices of oil in the international market has decreased. But this has not been translated into a decrease in the domestic price of oil because of the high tax burden that the Government continues to impose on the people.) However, it must be remembered that this hike in the raw material prices that we are talking about is really not an Indian phenomenon but largely due to global economic problems. But with policies of globalization indiscriminately followed in India, it is but natural that all these problems have crept into the Indian economy resulting in problems for the common people as well as the corporate houses of the country.

Now, with the rise in the prices of raw material and higher interest rates, resulting in higher costs, the prices of end products of the companies also increased. This is mainly responsible for the increase in the revenue of the firms. “For instance, the country’s largest automaker, Maruti Suzuki, reported a 6% rise in net sales during the quarter even as it witnessed a 2.5% decline in the number of cars sold during the period. Consumer goods firm Hindustan Unilever, which recorded a 22% growth in the Fast Moving Consumer Goods business, attributed almost two-thirds of it to price increases.” (Source: The Economic Times, 3 November 2008). In spite of the fact the companies increased their prices, they could not improve their profit because of the fact that the increase in costs had been even greater.

In addition to this, the latest figures for Index of Industrial Production (IIP) show that the rates of growth of the manufacturing IIP indicate that growth in August 2008 for industry as a whole and manufacturing in particular were 1.3% and 1.1% respectively. This number was 10.86% and 10.75% respectively in the corresponding month of the previous year. This indicates that there has been a slow down in the manufacturing and industrial output growth rates in India. This essentially signifies that there is a serious threat of an industrial recession in India.

This slow down in the growth rate of industrial production is particularly important because of the following. In order for the industrial sector or the economy to grow, there must exist sustained demand in the economy. In India, as has been pointed out by many economists, this demand does not come from the majority of the population. Rather the majority of the population remains impoverished but still the demand exists in the economy because of the consumption of the middle class and the rich. This consumption is essentially fueled by debts undertaken by households from the banks or credit card companies. Now, in the wake of the financial crisis, the norms for such lending have been tightened, with the banks becoming less forthcoming in disbursing these loans. In other words, the avenue for sustained demand through this route has been substantially reduced.

However, in the absence of adequate domestic demand in the economy, the industrial sector might still continue to grow if there is adequate external demand for India’s export commodities. Exports to GDP ratio has increased significantly in the recent past, indicating a better performance of the export sector. However, as a result of the impending recession in the USA, the exports of India has been already adversely affected. For the first time in five years, India’s export growth has turned negative. Exports for October 2008 contracted by 15% on a year-on-year basis. This shows that the external demand route for the Indian corporate sector is also drying out in the wake of the global economic crisis.

The question that naturally arises is how to overcome the problem of slow down in the Indian economy. It has been already seen that both the debt financed consumption as well as the external sector currently is not being able to boost the demand in the economy. This demand boost can however be provided by the Government if it takes upon itself the task of injecting demand into the economy through higher Government expenditure. In the absence of private sector stimulus to growth, the only way out is for the Government to boost demand. However, our policy makers are so entrenched in the ideology of sound finance and neo-liberalism that they are incapable of thinking about this route of advance for the Indian economy.

It is the result of the policies of the Government that the corporate sector rose to the stature of the dominant investor in the economy. This investment while generated high growth could not increase the purchasing power of the majority of the people. With the private sector in a crisis of its own, in the absence of Government boosting demand, the conditions of the people will further worsen. It is time to go back to John Maynard Keyenes and argue like him for state intervention to boost demand.

A Wednesday: Justifying Violence in the Name of Common Man

The latest bomb-blasts in Delhi and the numerous other bomb-blasts by terrorists have taken the lives of large number of innocent people. Each time a bomb-blast takes place, innocent people lose their lives. Each bomb-blast only brings out the fragility of the common man’s life in this country, the incapacity of the security system and the police to nub the terrorists before they strike and of course the ruthlessness of the terrorists who are killing at will. Each bomb-blast brings to us images of devastation and horror day in and day out through the 24 hours news channels and watching those images we thank our fortunes that we have escaped the latest terrorist attack and prepare for another day of hard work, while politicians pledge to fight terror. In this situation of insecurity and a kind of hopelessness, what can the common man do? What can be the common man’s answer to the menace of terrorism?

The film A Wednesday tries to provide answer to these questions. In the film a common man, Naseeruddin Shah, suddenly decides to teach the entire system and the terrorists a lesson. He uses the most sophisticated equipments, allegedly used by terrorists today, threatening to blow up bombs in Mumbai, unless four terrorists are released. The Police Commissioner, Anupam Kher, has no option but to accept his demands and the four terrorists are released. Three of them are then killed by a bomb-blast orchestrated by Naseerudding Shah. The fourth one is killed by the police, since Shah threatens to trigger bombs in Mumbai unless the fourth one is killed. The helpless Police Commissioner and the Chief Minister have no option but to agree, fearing a bomb blast.

This entire drama is played out by Shah in the name of the faceless common man, who has been the victim of terrorist attacks unable to get justice and security from the impotent security apparatus and the judiciary. An eye for an eye – that is the motto that Shah gives in the movie. He is doing no wrong. He is just cleaning the system of pests like the terrorists.

The movie has won accolades from critiques as well as the masses both for its technical and cinematic value as well as the politics that has been depicted in the movie. We however feel that the entire structure and the politics of the movie is deeply problematic and should be unequivocally rejected because of the following reasons:

The fact that common people are the sufferers of terrorism is undeniable. The amount of insecurity produced in the people after such attacks is also beyond dispute. But so is the case with victims of communal violence, like the Gujarat pogrom. Can anyone in Bollywood dare to make a movie where a common man suddenly decides to avenge the death of hundreds of people in Gujarat and kill somebody like Babu Bajrangi (a man accused of committing large number of murders during the Gujarat carnage)? The answer is an unequivocal no. The fact that the premise of the film was chosen as common man’s revenge against terrorism and not as common man’s revenge against communal violence shows that the film tries to play upon the deep prejudices against Muslims. That is why in the film, all the terrorists are Muslims and they say that they are proud of Mumbai-1993 and other such acts of violence. Nobody in the film talks about the plight of the Muslims after the Gujarat carnage. Even though the film is based in Mumbai, Naseeruddin or anybody else never mentions the wounds inflicted on the Muslim community in the post-Babri demolition riots in Mumbai itself. It is projected as if the only form of violence that claims innocent lives in India is bomb-blasts by terrorists.

The film is however, apparently, conscious about the problem of projecting Muslims as terrorists. In order to project another Muslim identity, the film shows Arif Khan, a honest and brave police officer who is given the responsibility to take the terrorists to the designated place. This character is also highly problematic. It is shown in the movie that the Muslim officer is the most ruthless officer in the force, who beats up people mercilessly. He has no family, unlike the other Hindu police officer, who has a caring wife who calls him almost every hour. This ruthlessness and violence of the Muslim police officer only strengthens the stereotype that Muslims are essentially violent.

The film is problematic on other counts as well. When Naseeruddin Shah calls the Police Commissioner and asks him to fix a negotiator, the Chief Minister relegates the responsibility to the Commissioner giving him unlimited powers to deal with the situation. At the same time the Chief Minister expresses his incompetence to deal with such situations. There have been constant attempts on the part of the media to denigrate the role of the political leadership in the country. It is projected that the political leadership is most worthless and inefficient. While it is true that there are problems with the political leadership in the country, they are the democratically elected representatives of the people. It is the right and the duty of the political leadership, who are accountable to the people, to take important political decisions. However, in the movie we see an immediate snub to the political leadership and a taking over of the police who are given unlimited powers.

Secondly, as far as the terrorists in the movie are concerned, it is never mentioned as to whether any case has been proved against them or not. Are they really responsible for the bomb blasts in Mumbai trains, which are constantly referred to in the movie? Has the judiciary pronounced its verdict on them? If yes, what is the verdict? Nothing is said. Naseeruddin pronounces them as guilty and kills them. In this entire process, the rule of law, the right of the accused to face free trial is completely subverted. No one in the film even utters a word of protest to what was being done in the name of common man. In the end, the Police Commissioner lets Naseeruddin go with pleasant words. Who has given the right to this so called common man to kill people? Moreover, who has given the right to the Police Commissioner to let him go? Today, we are seeing large scale resentments against the police and the media within the Muslim community because of their insensitivity towards the community. Every Muslim youth who is arrested by the police is pronounced guilty immediately. The film also does the same and further argues for mindless killing having scant regard for the rule of law.

The larger question however remains. At the end of the day what can the common man do in the face of such terrorist attacks? This question needs deep thinking on the part of the entire political establishment as well as the people. The answer cannot lie in the policy of eye for an eye. A culture of violence free politics has to be collectively cultivated. Secondly, the anti-Muslim prejudices have to be collectively shunned and the police must be made accountable to the people. This is only possible with democratic parties and voices politically marginalizing the fundamentalists of all varieties. In short, only a democratic political movement is an answer to terrorism. Neither a police state nor the common man turning himself into a terrorist can provide any solution.

The Crisis in the US Financial Markets

The international financial market is currently in a crisis the intensity of which is unprecedented since the Great Depression of 1929-30. Within a week we have witnessed the serial closing down of the biggest investment banks in the USA and the world, some of which, like the Lehman Brothers, survived the aftermath of the Great Depression. In order to put breaks to this slide, the US Government has been forced to intervene in the market in a big way. Even then, nobody is sure whether this crisis will end or not; nobody is even sure whether we have witnessed the worst phase of the crisis or more is yet to come. In this context the following questions are being raised:

How severe is the crisis?

It is argued by certain sections of the media that ultimately, the world has witnessed such crises in the past. In 1997-98 there was the East Asian financial crisis. So the present crisis is no different. This argument is way off the mark because of the following. To be sure, the East Asian financial crisis was very serious and affected a large number of countries, including Brazil and Russia. But it originated and caused problems for countries which were in the periphery of capitalism. Ultimately, the origin of the crisis and its effect were largely limited to developing countries, with limited impact on developed countries. Even India and China, although so close to the East Asian theatre were not affected by it. But the present crisis has taken place in the heart of modern capitalism, the USA. This alone points to the fact that this crisis is of a qualitatively different nature.

In contrast to this, it is also being argued that this is not the first financial crisis that the USA has faced. Even in the recent past, during the late ‘90s and early part of this century, the USA economy witnessed similar problems following a period of relatively better economic performance. Thus, this crisis will not pose serious problems for the US too. What is missed in this type of analysis is the fact that the present crisis engulfs not only the financial sector of the US economy but has serious repercussions for the real sector of the economy also. While this will be taken up later, it suffices here to point out that the biggest investment banks in the USA have collapsed and the government has come out with the biggest bail out plan in the history to save the financial sector in the USA and the world. At least, the US Government knows how serious the crisis is. According to renowned economist Paul Krugman, the broadest measure of unemployment in the USA, has risen from 8.3 percent to 10.3 percent over the past year, roughly matching its high point five years ago.

How did it all go so wrong?

Let us first look into the functioning of banks. If the banks are giving loans to the public they have an expectation and assessment regarding the public’s credibility to pay back the loans. This expectation is backed by the collateral of the loan or the valuation of the project for which the loan is claimed. As long as the banks have correct estimations regarding the valuation of the mortgage or the project, its expectation will be realized. If due to some reason, the value of the mortgage or the project suffers drastic decline, then the possibility of the banker getting back the loan reduces greatly. Now, loans given by banks are assets to them. In case of defaults, this financial asset for the banks becomes essentially valueless. On the other hand, based on these assets, banks take credit from other agents for various purposes. Now, if the asset position of banks weaken then there exists a risk that the Bank will not be able to pay back to its creditors. If this happens in a large enough scale then the bank has to go bankrupt.

Let us now see what happened in the US markets. Firstly, it should be noted that the economic growth in the USA is largely consumption driven, with housing forming a very important part of consumption demand. Owning a house in the USA is a matter of social prestige and security. But every individual who is investing in housing does not necessarily build it in order to stay but sell it at a future date to gain profit. There was huge housing price inflation in the USA, which was largely based on speculations and higher demand for houses. As a result of this high price of houses, many more individuals started to invest in housing.

Now, in order to invest, the investors needed loans from the banks, which were provided against a mortgage. Since there was a housing price inflation, many borrowers managed to pay back the loans between 2000 and 2003. This increased the expectation of the banks that giving loans for the housing sector is actually profitable, since in the past loans were recovered based on the housing price inflation. Moreover, with the housing price inflation continuing, the banks estimated that by selling the houses, in case of default, the loan could be reclaimed. This reduced the bank’s scrutiny of the mortgages and resulted in giving more loans to borrowers whose creditworthiness was low, which are essentially the sub-prime loans. In 2006, 20.1% of all mortgage backed loans were sub-prime.

This did not cause any alarm, as long as the housing price inflation continued. But this could not continue for long due to a simple economic factor. With the housing price inflation a large number of investors invested in the housing market which resulted in a steep increase in the supply of houses. At the same time the demand for houses could not increase more since there was a slow down in the growth rate of GDP and increase in unemployment between 2001 and 2005. Both these factors had to bring the price of houses down which started to decline sharply from December 2005. This resulted in problems for the banks through two routes. Firstly, the valuation of the project (houses) for which the loans were taken declined. Secondly, loans were issued against mortgages of lower valuations to begin with. This resulted in a situation where the banks could not recover their loans and suffered losses.

The above discussion raises two issues. Firstly, why were such sub-prime loans given in the first place? Secondly, how did the problem in the housing market and the sub-prime mortgage market become such an all encompassing problem for the financial sector?

The answer to the first question lies in two facts. One is that there have been substantial de-regulations in the USA following the decline in the earnings of commercial banks in the United States in the 1980s. Secondly, the unbridled quest for profits is also responsible. Every bank is thinking that if I do not give the loans somebody else will give and earn profits. Hence, in the end, every bank starts to provide these sub-prime loans.

On top of this, the banks engaged in myriad forms of financial innovations which resulted in contagion of the problem in the housing and the sub-prime mortgage markets to other financial segments. What was essentially been done is the following. Suppose person A takes a sub-prime loan from a bank. Now for the bank this is an asset, since this will generate a future stream of income. Subsequently, the Bank floats another subsidiary or the Special Purpose Vehicle (SPV) to which it sells this asset. With the selling off of this asset the risk associated with it is also transferred by the bank. The SPV issues papers called securities to sell in the market and mobilize funds to buy the asset. The return to these papers is linked with the performance of the original asset. Moreover, these papers are itself assets to its holders against which loans can be taken. (This process is called securitization. It is estimated that 80.5% of the sub-prime loans were securitized in 2006.)

Now, if the person A defaults in his payment commitment to the bank, then there is no income flow that is coming from the loan as an asset. If the mortgage is not securitized then the initial bank from which the loan is taken suffers loss. On the other hand, if it is securitized, all those who are holding securities on this asset do not get any return. As a result with the initial asset becoming valueless, a chain of assets become valueless. This results in problems for large section of the players in meeting their payment commitments. More financial instruments such as these were produced in the US market which resulted in the contagion of the problem of the housing and sub-prime mortgage markets to the entire financial architecture resulting in bankruptcies as has been mentioned above.

In short the financial de-regulation of the financial sector along with the banks’ profligacy in providing sub-prime loans, based on wrong assessment, along with the innovations of various financial instruments led to the massive crisis in the financial sector in USA.

This crisis essentially has resulted in a loss of confidence in the financial sector, resulting from massive defaults, where people are not sure whether they will get back the money that they are lending. As a result people who are willing to borrow money from the market are not being able to get it. This is harming investment prospects in the economy. Moreover, massive job cut in the financial sector is also causing a decline in the aggregate demand in the economy. Both of these are slowing down the US economy.

What does the crisis signify?

There is a theory in economics which says that the Government is inefficient and can never be a solution to economic problems. In fact it was believed that the Government is a problem and not a solution as far as working of markets is concerned. The first casualty of this crisis, apart from the US economy and the banks, is this orthodox belief in the ultimate efficacy of the market mechanism. This economic myth was proved wrong during the Great Depression and again has been proved wrong today. The crisis proves that unbridled free market orthodoxy results in massive crises. Now, it is the US Government which has to step in with a massive bailout plan of $700 billion to save the private banks and other players in the financial market.

Secondly, the invincibility of American capitalism has been questioned like never before, at least not since the Second World War. For all those, who are talking about how good the US economic system is, please hold your breath and look at the mess that the US is in right now. The present crisis should also be a wake up call for all those who want to mould the Indian economy like that of the USA.

Thirdly, for Indian Government this is a wake up call against the policies of financial liberalization that it wants to pursue. Clearly, the model of unbridled financial liberalization has failed in the USA. It is high time that our Government drops the idea of putting us voluntarily into the possibility of a crisis that the USA is currently faced with.