Rising prices and job losses are the two most direct ways an economy inflicts pain on the average citizen. In the 1960s, the economist Arthur Okun added the inflation and unemployment rates in the US to create what is now known as a misery index. This rough and ready measure of economic despair has often been used to assess how well people have done under a particular government, though its popularity diminished after the 1980s as inflation and unemployment in the rich nations declined.
There have been variants of the Okun misery index since then. Robert Barro expanded the index by including growth in gross domestic product (GDP) and the bank rate to the two original variables. Forbes magazine has a tax misery index that adds the marginal rate of various taxes imposed on individuals and companies. According to the magazine’s website, this index is “our best proxy for evaluating whether policy attracts or repels capital and talent.”
A similar proxy can be built to evaluate the macroeconomic stability of a country. Two of the biggest threats to the stability of any economy are the twin deficits — fiscal and current account. Adding the two could give us a useful proxy of how well an economy can maintain its balance when there is global financial turmoil. The news for India is not too good.
The past five years have been a remarkably crisis-free period for the global economy. There have been no painful calamities of the type that hit Asia in 1997 and Russia in 1998. But there is no guarantee that the next few years will be equally tranquil, especially given the credit crisis in the West, the overheated economy in China, rising global inflation and the mess in the US. So, it makes sense to evaluate how the Indian economy can handle global stress in the months ahead.
I have used the economic data for 42 individual countries that The Economist publishes every week. The latest data there shows that India has a current account deficit of 2.4% of GDP and a fiscal deficit of 3.1% of GDP. Add the two. You get a macroeconomic misery index of minus 5.5. That’s outsized. And this number will grow in the months ahead as oil prices rise, the import bill balloons and the government continues to issue off-budget oil bonds to subsidize consumers.
How does India compare with the rest of the world? The US does far worse, with an index value of minus 7. Most other countries in the euro area, too, have worse combinations of fiscal and current account balances.
So, India does not do too badly compared with the rich nations. But it’s a completely different story when we turn our attention to our peers in the global arena. China and Russia both have fiscal and current account surpluses. Their index values are well into positive territory. Brazil has modest deficits that add up to minus 2.6. Malaysia and Thailand have fiscal deficits that are close to Indian levels, but these are balanced by strong current account surpluses. Actually, as far as emerging market economies are concerned, only Pakistan and Egypt are worse off than we are.
Is India slouching to a repeat of the 1991 crisis? The possibility cannot be dismissed. But though we once again have the same noxious combination of widening fiscal and current account deficits, India has several economic strengths as well. India today has a more dynamic economy, less volatile and short-term external debt, a huge pile of foreign exchange reserves and more sophisticated economic management than it did in 1991. A new report on India’s rising twin deficits by Citigroup economists Rohini Malkani and Anushka Shah points out that there are factors that “put the odds in favour of India’s resilience rather than its vulnerability”. That’s true.
But there is little doubt that the economic fundamentals are deteriorating. The hole in the government’s finances is getting bigger. It could now be close to 1991 levels, if measured correctly. The current account deficit, too, is growing and could conceivably touch 1991 levels by the end of this year. The foreign exchange market has already picked up these worrying signs. The rupee has been slipping against most major currencies over the past few weeks. Somewhere in some tax haven, a few hedge funds must be seeing these trends and sharpening their claws.
It is unfortunate and inexcusable that India is now at a point when it seems far more vulnerable than most other emerging market economies. The government should have used the splendid five-year economic boom and soaring tax collections to slash its deficit and prepare the economy for an economic downturn. It did not.
History will not judge the United Progressive Alliance government too kindly on this score. It is distressing that some of the same people who helped pull India out of trouble in 1991 have done so little to prepare for the next round of economic turmoil. One expected more from a team led by Manmohan Singh.
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