The fiscal stimulus package in the US has reached nearly $3 trillion, and the easy availability of liquidity is leading to developments that need to be watched carefully in India.
First, the new US government announced that it would act as the buyer of last resort with respect to toxic assets in the market, thus protecting the holders of these assets—mostly financial institutions—from the downside risk of lower prices. In this formula, the buyers were protected and guaranteed against losses and could keep all of the gains as markets rose. Second, after the initial anger over executive bonuses and remuneration, the treasury secretary there has announced that he is not in favour of ceilings for pay packets. Third, with considerable liquidity in the economy and interest rates very low, and businesses desperate for credit (the automobile manufacturers, for example), there are a lot of profits to be made by these institutions through lending. Finally, the talk of regulation, control and nationalization has receded—a success story for the fierce and strong Washington lobbying that these institutions have been engaged in over the last six months.
As a result, the very institutions that were responsible for the downturn are now seeing their profits rise quickly, with more opportunities ahead, and want to get away from government controls as quickly as they can. They have offered to repay the funds they received from the government (Troubled Asset Relief Program, or TARP). The downside is for the taxpayer, whose funds were used for the bailout, and who was promised high returns when the funds matured—the settlements that the institutions are now seeking are very close to par values, and thus the taxpayer would have used up his funds for practically nothing. Given the past habits of the bankers and the easy availability of liquidity and credit, we may see those days yet again very soon, perhaps accompanied by high inflationary pressures.
The lesson, perhaps, is that tigers will not change their stripes, and the causes of the financial profligacy that caused the downturn will not go away too soon. Though media and academics in India have been advocating all sorts of fiscal and financial packages to stimulate growth, it is important to consider the above developments and their repercussions. Inflationary pressures in the Indian economy the last time around were caused by high international prices of commodities including oil, as well as the unexpected flow of funds into the financial and real estate markets. Both of these events are likely to recur. There are strong indications that oil prices will be $100 again by this time next year, and China is stockpiling huge quantities of copper in anticipation of the coming price increases. And once there is sufficient liquidity in the international markets, it is possible that foreign institutional investors would turn their attention back to Indian financial markets and real estate, and we would revisit the 2006 and 2007 developments.
There are several in India who would argue that this would be a good development, and we would see the days of high real estate and stock prices once again. There would be a feeling of the Indian economy growing fast once again.
There are two dangers in this argument. First, this would rekindle the inflationary pressures that we saw in 2007 and early 2008. And second, more fundamentally, the mandate for the present government is based on expectations for more for the common man in the nature of social sector programmes and building of infrastructure, for better schools and healthcare and improvements in agriculture—the euphoria of the financial sectors is likely to put the performance of the real economy, in the goods and services sector, in manufacturing and in energy, on the back burner once again, and we would have a repeat of the last five years, with the differences between the rich and the poor increasing faster. I am not sure this is what the young thinkers in the government, those who are strategizing their future, really want.
It is now clear that the National Rural Employment Guarantee Scheme and the agricultural loan waivers have paid off in the election, not the high stock markets. It is also clear that people want specific deliveries—of roads and electricity, for example, and better employment opportunities and improvements in agriculture. Most importantly, they are looking for security—law and order in cities and control of terrorism.
Delivery of these services requires close attention to implementation, monitoring of programmes, and feedback on impact. Attention to these would help to build up individual parties at the grass roots, while simultaneously ensuring voter loyalty in the future. Changes in tariffs and financial sector reforms can wait—even if all taxation is reduced to zero, there would be little impact on infrastructure or health or water or education.
I do see that there would be an ideological conflict within government between the younger members, who see these priorities, and the elders, who would like to carry on as before—and I’d like to see the youngsters succeed.
S. Narayan is a former finance secretary and economic adviser to the prime minister. We welcome your comments at email@example.com