Rate Cuts, Trusts, Banks and the Summer of 2001

Finding Cheer in the Din of Gloom= and Doom

A competitive effort is on-going to paint the econ= omic outlook bleak. There are some who have predicted doom for as along as one c= an remember. Then they are those who had differences with the Bush administrat= ion and do not even try to cover their delight at the bad turn in economic even= ts. Then there are those who were predicting just six months ago that crude oil would hit $200 per barrel and now have to see it at $25 trapped in the deep abyss= of a worldwide recession. Finally there are those who, having the advantage of= the best observation posts, unmatched access to global data and analytical skil= ls, but yet missed the storm headed this way and hence are not taking any chances. = And then there are those who simply wish to be in fashion.

Making gloomy predictions are always safer than the reverse; it protects the soothsayer against wrath. If things turn out for t= he better, people are content, and happy people are not as wrathful, as unhappy ones can be. So, government agencies, multilateral organisations, internati= onal financial institutions are all retailing versions of the deepest gloom. 2009 will be a wash, most say; don’t expect a recovery till some time in 2= 010. Decoupling? Sorry, that word has been expunged from the records. Ergo, it y= ou are India, expect the growth of the 1980s (5%), if not the Hindu rate (3%).=

It seems to this columnist that the close similari= ty in views of diverse protagonists is a catharsis: The chosen path of mental = recovery from a terrible year (2008) when everybody got most things wrong, besides having earlier missed the brewing mess. A sort of collective guilt is being purged in the putative deepest recession, which will complete the morality = tale by punishing all of us.

There is no doubt that economic conditions are dire and a lot of it has flowed directly from regulatory weakness and later from plain incompetence in dealing with the resultant problem, in the headquarte= rs of the global economy. But that is another long and grievous tale. However,= in understanding the extent to which institutions are painting the outlook excessively bleak, one must also remember that for public institutions and = governments there is a great exit available. If things turn out better than the terrible prognosis being made presently, then it will be because of the unprecedented and coordinated stimulus, fiscal and monetary, which the world’s governments and central bankers courageously forked out. It is heads I win, tails I still win!

Let us look at the US downturn in the 1970s and ea= rly 1980s, the worst in the post-War period till now. Recessionary conditions b= egan in July 1973 and lasted till March 1975, with 5 of the intervening 7 quarte= rs having negative GDP growth. If we look at private domestic demand (which excludes export demand and government expenditure) we find that negative growth also= occurred in 5 quarters. Recessionary conditions in the early 1980s lasted longer: fr= om April 1980 through Sep 1982, with 6 of the intervening 10 quarters showing negative GDP growth. If we tu= rn to private domestic demand, the downturn started earlier in Oct 1979 and ended= in March 1982 – a period of 30 months, during which there were a total o= f 7 negative quarters of a total of 10. The maximum number of consecutive negative quart= ers was four – Oct 1979 to Sep 1980.

In the current period, GDP growth in the US was negative in Q4 of 2007, but recorded positive growth in Q1 and Q2 of 2008, returning again to negative in Q3 and likely in Q4. Private domestic demand= has however been continuously negative ever since Q4 of 2007. That is, there has already been four negative quarters, to which one can add Q4 of 2008 and Q1= 2009, making for a total of six consecutive negative quarters, a longer period of contraction than that either in the 1970s or the 1980s. <= /p>

It must be emphasized that monetary and fiscal conditions were diametrically different in the US in the 1980s as compared = to what it is now. In the eighties, both inflation and interest rates were both wel= l into double digits. The only fiscal stimulus – the Reagan tax cuts was sig= ned into law in August 1981 and could make little difference till 1982, when the recession ended. Contrast that to interest rates at less than 2 per cent fo= r most of 2008 and 0.5 per cent now and the enormous fiscal largesse, more of whic= h is expected to be rolled out in 2009. Then there is the coordinated big easing= in monetary and fiscal stances in other parts of the world – advanced and developing. It is hard to imagine how all of this high-powered intervention running into trillions of dollars cannot but have an effect.

It is plausible to make the argument that even as = the US economy begins its recovery in the second quarter of 2009, it may not be= very strong as a part of the financial sector problems will still have to be wor= ked out. That may constrain the recovery of net import demand in the US, for export-oriented economies, including Japan. The EU has independent structur= al problems which may cause its recovery to be relatively drawn out. Therefore, while conditions for economic growth in 2009 are likely to be weak, there w= ill be positive growth in the second half of 2009 in the advanced economies.

India today does not suffer the problems of previo= us crisis years. Her farm and hence rural sector is robust, having benefitted from go= od monsoons, improved seed, adequate fertiliser and remunerative prices over t= he past several years, plus farm loan relief. The banking sector does not have= the burden of non-performing loans that it did in the late 1990s. Indian corpor= ates today stand on a foundation of sound business models and lower financial ri= sk which is incomparably stronger relative to previous periods. Our capital markets = are well-regulated and operate without the shadow of scandal. Our external paym= ents situation is reasonably strong and with subdued crude oil prices, it should strengthen further. The inflation outlook now looks fairly benign.

India has suffered on account of: (a) drying up of external loans and equity finance for corporates that negatively impact investment; (b) weak export demand; (c) severe disruption in credit markets after the collapse of Lehman that hit all leveraged demand very hard; (d) e= rosion of business confidence in line with global developments. While the first two will take some time to improve, the latter is in our control, so to speak. = We will poorly serve our own interests, if we get influenced by the doom and g= loom that are being retailed today and fail to take a reality check based on com= mon sense and our actual experiences on the ground.

[Total number of words excluding title: 1,130]

The Economic Times: Friday, December 26, 2008 <= o:p>

The Economic Times: Friday, December 26, 2008
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