How Has India Dealt With Global Economic Recession in the Past?

Whether or not the Indian economy is going into recession remains debatable. But without a correct diagnosis, measures to counteract the problems will be ineffective. 

Fears of recession have been expressed by economists, especially with a slowdown in the global economy. Both the economies of the United States and China, the two largest economies in the world, have slowed down. Ongoing trade wars between the two countries, have contributed to this decelerated growth. How will the slump in the global economy affect the Indian scenario? 

The Indian economy is currently witnessing a downward spiral, with rising unemployment and decreasing demand. Several industries, such as the automobile industry and fast moving consumer goods are in crisis. But can these symptoms be read as signs of recession? 

Some economists have argued that the current slowdown is simply a trough in the business cycle and not a recession as such. But as a recent editorial in the Economic and Political Weekly has pointed out, the current state of the Indian economy needs to be seen as a structural crisis, and not just a slump in the business cycle. Inequitable and jobless growth which have characterised the Indian economy are the effects of this structural crisis. 

If the problem is not correctly diagnosed, then an effective solution will not be formulated. Structural crises in the economy requires fiscal interventions. But dealing with a trough in the business cycle requires a very different approach where the sources that can promote sustainable growth in the economy need to be identified and incentivised. 

In this reading list we explore the ways in which India has tackled similar economic downturns in the past, especially during the financial crisis that began in 2008.  

1) Growth Rates and Recession

In 2009, Sugata Marjit argued that even if India’s GDP growth slowed down to 6%, it will still be on an all time high when compared to periods before 2000. According to him, India would still have the second fastest rate of growth, which he argued did not fit the standard definition of recession. He wrote, “A decline in super rates of profit, fairy tale housing prices, luxurious salaries and amenities and a drop in the abnormal rate of employment in the white goods sector is not a signal of a countrywide recession.” 

If excess capacities are built up with the expectation that we shall have a 9% growth ad infinitum, it is not the social responsibility of the RBI that such capacities remain utilised or unanticipated costs are recovered when expectations are not realised. The RBI surely did not get a cut of the excess profits and salaries in the good times and mother India should not be dragged to serve the cause of faltering markets. At least those who have always preached about the divinity of the invisible hand surely know that bad times are as much a reality as good times in capitalism.

2) State-Level Budgeting  

In 2010, Kausik K Bhadra and Lekha Chakraborty analysed an RBI study on state finances for 2009-10 to see how the economic crisis was affecting state-level fiscal imbalances. They found that the overall imbalance was marginal because some states had announced stimulus packages to incentivise investment, which would revive demand. Tax concessions were also introduced at this time.

What has not happened? The subnational fiscal stance in India has not been significantly affected by the global financial crisis. However, the argument that the rule-based fiscal management through respective FRAs of states and the hard budget constraints operated at the subnational level through imposition of limits on borrowing requirements have created fiscal space to accommodate the unforeseen effects of a global financial crisis is not valid. On the contrary, the economic recession has resulted in a decline in fiscal transfers and stagnant revenue buoyancy, compressing the fiscal space of the states. 

3) Stricter Fiscal Targets

Chakraborty and Bhadra’s article argued for state-specific flexible targets, especially for states which had a fiscal deficit of 5% or more. But Archana R Dholakia on the other hand, wrote that it is precisely these states that require more stringent fiscal rules. She argued in favour of the Fiscal Responsibility Act which sets the same target limit for all states

The case of Punjab suggests that fiscal imbalance is not necessarily correlated with the level of per capita income or growth, implying that sociopolitical factors might be at work. Even if one agrees to the proposal of flexible targeting, what should be the criterion employed to determine the limits for states – efficiency or equity? Use of efficiency would dictate that the states with higher growth performance be allowed higher limits (of revenue deficit, fiscal deficit and debt) compared to the laggard states, as the former can sustain larger deficits. The famous Domar equation used by the Twelfth Finance Commission can even help us derive the sustainable targets for different states. While this may help the high growth performers to grow faster because of liberal borrowing limits, the low growth states would be in a complete shamble. 

4) Housing and the Market

According to Avinash Persaud, housing booms and busts have been responsible for the biggest financial crises since the 1970s. He argued that, “A safer housing market, via planned fiscal intervention to steady supply, would do more to make the financial system safer than all of the other recent initiatives put together.”  

Financial crises are often triggered by assets that were previously considered safe by regulators, rating agencies, and investors, turning bad at the same time. The abrupt overturning of previously strongly held beliefs about market value causes a lurch into risk aversion by banks and others. Bankers in well-capitalised banks, seeing their less well-capitalised competitors suffer, turn risk-aversion into their brand, making it more entrenched, not less so. This is augmented by the use of regulatory-approved risk models that translate past volatility into future risk.

 

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