The growing economic predicament

At last there is some recognition that the country is facing a serious economic crisis. Rubber growers and tea smallholders are on the streets protesting their loss of livelihoods. Garment factories are closing down or downsizing. Industrialists are saying their industries are no longer viable and competitive in international markets that are themselves depressed. The trade balance is in a huge deficit. Export earnings are showing signs of serious deceleration, while import expenditure is rising. Various controls are being placed to curb imports. Foreign exchange reserves are coming down. There are fears of declining remittances from abroad. The only good news of the reduced oil prices is having no effect owing to a hedging exercise that has lost the country an estimated US $400 million. What worse economic news can one expect in a global context of a recession?

The government is at a loss how to cope with this situation after repeated assurances that the economy is faring well. It is still boasting of an estimated economic growth of 6 to 6.5 percent this year and predicting an improvement next year, when the economy is projected to grow at 6.5 to 7 percent, when everyone is expecting a further economic meltdown. These estimates of economic growth statistics are hiding the impending economic crisis that is upon us.

This column has pointed out for well over a year that the economy is heading towards a crisis. There were so many key indicators that pointed towards the impending crisis. Yet there was hardly any response. They preferred to keep quoting the statistic of the growth rate as if there was nothing wrong with the economy and borrowing to overcome the financial and balance of payments difficulties. Indeed they are continuing to do so even in the face of the growing crisis. Either the government did not comprehend that the economic performance was heading for disaster or was ill advised. The efforts of officials to paint the economy as faring well were supported by reputed international organizations and even certain Ambassadors. The IMF and World Bank seemed to endorse the country’s economic performance, though any discerning reader would have read their warnings of the weakness of the economy by reading in between the lines and in a muted manner. These multilateral agencies have turned politically correct and therefore their public statements must be carefully sifted, read between the lines and sometimes taken with a pinch of salt.

There were several factors that hid the crisis situation. One was the balance of payments surplus despite the huge trade deficit. Everything was fine because there was a balance of payments surplus and the foreign exchange reserves were boosted by continuous borrowing. If there were any problems, the villain of the piece was the sharp increases in oil prices. How rotten the actual situation was is seen in the crisis becoming worse, rather than better when oil prices came tumbling down. If the crisis was brought about by the hike in oil prices, then the problem should be solved by the coming down of oil prices. Not so. The crisis has only worsened. A country that keeps blaming the outside world for its economic ills would never be able to correct itself and take needed countervailing measures.

A word about the paradoxical situation of the massive trade deficit and the simultaneous balance of payments surplus: The trade deficit was more than covered by the continuous foreign borrowing and the large amount of foreign remittance. Foreign borrowing was indeed a postponement of the problem; in fact an aggravation of the problem over time, as these borrowings meant further debt servicing costs and capital repayments that would in due course add to balance of payments difficulties in the future. This was particularly so as foreign borrowing was not being utilized for investment in the production of tradable goods. They were undoubtedly a contingent liability. The foreign remittances had nothing to do with the performance of the economy. Now there are anxieties that these remittances would not grow at the pace they did in the last two years owing to lower incomes, in especially oil producing countries, from which over one half of the remittances are derived.

The great boast of the government was that the economy was growing at a relatively high rate. The 2007 Central Bank Annual Report boasted that for three successive years the economy recorded economic growth rates of over 6 percent. They did not say it had dropped from that of the previous year. We are still told that, despite all the external shocks the economy would grow by at least 6 percent this year.
What do we have to show for this rapid economic growth? A growing economic crisis. Others have shown the statistical artifacts of the blown up growth. It is both this massaging of figures in areas where accurate statistics are not available and the quality of the growth that renders these growth figures insubstantial. A few examples would illustrate this: “Other agriculture” that accounts for over 50 percent of agricultural output, grew at a time when agricultural prices rose sharply. Was this sharp rise in prices consistent with the increased output of official statistics? Then there were large government expenditures on defence, salaries of an expanded public service and extravagant expenditure on the overstuffed cabinet of over a hundred and their staff and travel. All these expenditure add to growth as the statistical convention is that these expenditures result in the production of goods and services. This statistical fiction is indeed misleading. When these expenditures are modest their contribution would not be of much consequence to the final outcome. When they are large and growing, the growth figures are misleading. In fact these expenditures are root causes for inflationary pressures.

Budget 2009 that has just been passed by a large majority has not taken into account the actual economic conditions. Revenue estimates are likely to be seriously eroded by the decline in production, profits and incomes. Expenditure is extravagant and unconscionable. No longer can the government expect to pass on the problems by borrowing from abroad. Foreign loans would be difficult to get, the country’s ratings are low, and the costs of borrowing would be very high. This inability to borrow from abroad may at last make the government and people realize the poor state of the economy.

In this economic crisis there is a vital need to recognize its severity and take countervailing measures to mitigate it. Fundamental to this is the need for fiscal reform to curtail government expenditure. The World Bank and our own think tank appear to suggest a depreciation of the currency by about 25 percent. This may help the export sector but aggravate inflationary pressures. We are in a serious predicament as the government failed to take early less drastic measures. Now it may have to swallow the bitter pill of a substantial depreciation of the rupee.