Exactly a year ago on Tuesday, Lehman Brothers Holdings Inc., the iconic 158-year-old Wall Street investment bank, filed for bankruptcy, triggering a meltdown of the global financial sector that eventually enveloped even the real economy.
The contagion, initially restricted to the US, spread rapidly to Europe and Japan, setting off the worst economic crisis since the Great Depression of 1929.
Looking back, especially in the light of the so-called “green shoots” theory that a recovery is already under way, it is tempting to write the crisis off as a bad dream.
More so in the Indian context, where the chorus of claims of an economic recovery is becoming louder every day. Tempting while it may be to the political ruling class, it would be a mistake to do so and would be tantamount to falling prey to hubris. There are lessons to be learnt (as Pronab Sen, India’s chief statistician, points out elsewhere in this paper) and preparations to be made for the economy to tackle the emerging new world order. Return to business as usual is the worst advice possible.
Contrary to the opinion voiced in some quarters and also echoed by some politicians, the Indian economy is not decoupled from the rest of the world. The only issue is that it is not fully integrated into the world economy. This is true particularly with respect to the financial sector. Largely because of resistance from the Reserve Bank of India (RBI), the country has not made the rupee fully convertible on the capital account. It is precisely this which shielded the economy from the global financial contagion.
The Indian economy lost as many percentage points in growth as the rest of the countries in the global economy did.
The fact that the country is growing at 6% is impressive no doubt, but has to be seen in the context of its size and level of integration with the world. It is as yet only a new member of the club of trillion dollar economies; compare it with the US, which tops the list at $14 trillion.
What has actually worked in the country’s favour has been the domestic rural economy. The commodity price boom, bountiful crops in recent years and a sustained injection of public money into the rural economy through the National Rural Employment Guarantee Scheme provided a solid base to the country’s demand structure.
So when the global meltdown began to have an impact on India through a contraction in exports of goods and services, domestic rural demand held up for most part. It is only now, under the threat of drought, that the rural economy is beginning to wilt. While the kharif, or summer, crop has been damaged by the below-normal monsoon, the late surge in rains has ensured that the rabi, or winter crop, is not impacted similarly.
To be sure, it will be a while till exports come back up, in terms of actual volumes more than the rate of growth, to last year’s levels.
The bigger worry is the government’s fiscal deficit, or gross borrowings. The gains of the good years, when tax revenues rode the economic boom, were frittered away by the United Progressive Alliance in its first term; worse, it continued with the nefarious practice of keeping several components of the fiscal deficit below the line and thereby concealing the actual deterioration in the fiscal health. So, when the crisis hit the economy, the government had limited room for manoeuvre and hence had to restrict its demand stimulus. Worse, it has severely hamstrung RBI in its monetary management and, hence, left the economy vulnerable to risks of inflation.
The surge in the stock markets, now threatening to touch dizzying heights once again, is not only masking the bad news, but once again stoking a feeling that things are fast heading back to normal. One of the reasons is the good news emerging from various quarters of the economy that the worst is behind us; which is very different from stating that a recovery is under way. That is only part of the story. Several analysts have already flagged the fact that the global system is once again awash with liquidity that is looking for lucrative returns. Any tightening of global liquidity or any fresh signs of reversal in pole economies such as the US, would lead to an abrupt reversal of these flows.
So, a year later lessons are still being learnt. In the context of a developing country like India, as Sen explains in an interview, it is even more critical that these lessons are learnt well. The politics of failing to understand this basic truth can be devastating for the country. Not only could the crisis recur, but this time it would not be so benign to a country already weakened by the first round impact.
Leaving you with a thought from Bloomberg columnist William Pesek, who wrote this on 20 February: “Remember how two years ago most people said the subprime crisis was containable, Asia was immune to global turmoil, and Goldman Sachs Group Inc. alumni could do no wrong? Well, think again.”
Anil Padmanabhan is a deputy managing editor of Mint and writes every week on the intersection of politics and economics. Comments are welcome at email@example.com