Is Central government ignoring Global Headwinds

Anyone keenly following global news would be aware of the dire states of the global economy. The eurozone is most likely be falling into double deep recession, the economic recovery of US post 2009 crisis has been tepid and fiscal cliff looms large on it, coupled to this are the worrying signs emanating from China, with falling GDP growth rates, stagnating industrial production and piling inventories the fear is of hard landing of Chinese economy. To add to all these economic woes is the ongoing crisis over Iran's nuclear program and a middle eastern war over the same.

Is India prepared to handle the worst, Are there contingency plans in place to protect ourselves from such global headwinds, Does the central government even care about whats happening around the globe. The answer to all of this seems to be a big NO

We have all heard the Prime Minister, Finance Minister and other government and ruling party spokesperson repeatedly blaming the ongoing euro crisis for all the ills that the Indian economy is suffering from double digit inflation to falling GDP growth rates. But do they really care about the ongoing global crisis?

Now of course the real reason for the economic mess the country is facing can be clearly be blamed for the mismanagement and in aptitude of the central government. Without going into detail of the various farcical decisions taken by the government it is clear that central government has led the Indian economy to this moribund state. But what is not clear is what will happen when the global headwinds start affecting us. Are we prepared?

In 2009, when the financial crisis hit upon us, our economic state was on a sound footing. The Current Account balance was at an modest -0.7% in 2007 (Source: World Bank), the GDP growth rate was at a formidable 9.8% (Source: World Bank) nearing double digit growth and Total reserves as percentage of Total external debt was at a comfortable 136% (Source: World Bank). But what is the position of economy now, GDP growth rates is tethering at 5-5.5% (Analyst Forecasts), Current Account deficit is at relatively high -5.21% (Source: World Bank) and our reserves can barely cover our total external debt with reserves to debt ration of 104% (Source: World Bank).

Now we might say the recent measures taken by the government are meant to address these issues, but are they. The so called cap on LPG subsidy has already been relaxed in several of the congress ruled states. FDI in Retailing bringing in significant investment that could tide our finances is ridiculous at the least. To top it, there are rumours that the centre is mooting to bring in food security bill with cost to exchequer of INR 1.19 Crores (India Today). The government on the whole is not at all serious about the tackling Fiscal deficit looming at large especially w.r.t rationalization of subsidy. We can clearly see that subsidy give aways to the voters is the main culprit for the present financial mess, the subsidy expense as share of total expense stands 59.75% today compared to 44.98% in 2004 during the NDA regime(Source: World Bank). And the ruling government is no mood to reverse or stop this short sighted quixotic schemes, on the other it is coming up with ingenious way to give away even more of the hard earned tax revenues to buy up votes with schemes to give free mobile phones and the likes of it.

 All this boils down to what will happen if the present global crisis worsens and there is a lehman like moment. The probability of such an event is likely and with Citibank citing possibility of Grexit at 20%. Rising tensions in austerity hit Spain, Greece, Portugal and Italy coupled with creditor fatigue in Northern countries can create a eurozone breakup. Add to this the stagnation of American economy and Chinese hard landing and the once in a decade leadership change. The world today is filled with uncertainty. IMF and World bank have all cut their global output forecasts. The majoritarian view is that worse is yet to come. But Our central government is oblivious to all of these and is happily pondering on how to crown the crown prince.

This is truly sad state of affairs and one can only hope that people of this Nation  whenever the next elections happen elect the kind of person who can take tough decisions, who has the organizational and managerial capabilities to lead the Nation and offer a clear vision of How India has to leap ahead.

Here I present two part analysis how Global crisis will affect us, First let me start with the global economic outlook in detail.

Global head winds

Eurocrisis

Beginning of this month it seemed that the Euro crisis had taken a turn for the better with ECB introducing OMT (Outright Monetary Transactions) to help embattled peripheral Nations. This coupled with Fed Quantitative Easing buoyed the markets. But within a span of a fortnight, the optimism has evaporated. Street protests in Spain, Greece and Portugal against austerity measures undertaken have rattled the markets. Add to this, the growing demand for separatist state by Catalans and Mr.Rajoy's reluctance to accept bail out, the focus has shifted to Spain. To make matters worse Germany, Finland and Netherlands recently gave a huge blow to chances of recapitalization of banks in embattled countries like Spain and Ireland when the finance ministers of these countries announced that ESM will not be responsible for legacy assets, in effect saying that the new Banking supervisory mechanism will not be responsible for fixing the broken banks and will still be the responsibility of the countries. This seems highly counter productive given that this new mechanism was introduced to break the vicious cycle between National banks and sovereigns.

Now anyone with a decent knowledge of economics knows that the underlying problems faced by Europe are not about solvency but of different levels of competitiveness and consequences of single currency without a single treasury and unified fiscal policy. Unless these are tackled a solution the crisis is not in sight. Eurocrisis has two options, go down with a bang with either a grexit or a spexit or the more probable one of long prolonged situation involving more pain, more austerity for peripheral countries, as European leaders foot drag the necessary steps to be taken for European integration. Thus in all probability Europe will be hurling from one crisis to another for the next couple of years or maybe a decade like in the case of Japan post 1990 crisis.

Chinese hard landing

What do we mean Chinese hard landing? For years economists have predicted that Chinese economy cannot sustain double digit GDP growth forever and that as gains of acquiring technological competencies from the developed world become more and more marginal, Chinese economy would stabilise around a moderate growth rate of 3-4%. Now Economists disagree whether this transition will be a smooth affair or a difficult one.

The gist of the problem is that for years China has channeled its savings into infrastructure and capacity development. This in the past has payed handsome dividends in terms of double digit growth, but as the marginal payoff fall, China needs to re balance this flow. Chinese need to save less and consume more as domestic demand needs to pick up to compensate of lack of export demand. This re balancing is critical for Chinese economy for smooth transition.

The worry is whether China will be to re balance the economy fast enough. If China fails to channelize savings towards consumption, then the falling export demand cannot be compensated by domestic consumption. This will result in fall in output and hence sudden drop in growth of the economy. The crucial aspect for this is for Chinese government to move away from Government sponsored economy to an entrepreneurial economy. This is toughest aspect as the Chinese government has to tackle the established and entrenched players who in all probability are part of the communist party.

Currently the thought of hard landing has received for two reasons, one the once in a decade change in leadership which is generally a period marked with uncertainty and confusion and the second one is the impact of Euro crisis on Chinese economy, export have fallen at a rapid pace as Europe accounts for a large size of Chines economy. The key concern can Chinese consumption make up for the lost demand from rest of the World.

A slowdown in Chinese economy has an adverse impact across the world. Major commodity producing Nations will be adversely affected as they are increasingly dependent on Chinese appetite for raw materials. Further countries like Germany which produce the necessary capital goods for Chinese factories are also impacted. Hence the ripple effects are felt throughout the world.

US Fiscal Cliff and Israel-Iran confrontation

The other set of global headwinds are one from the uncertainty of Fiscal cliff in the US. The spending cuts and tax increases that are set to be implemented if congress cannot come up with an alternative. Though the chances of this happening are remote, it adds to general sense of uncertainty in the environment. The other is the possible conflict between Iran and Israel over the Iran's Nuclear program starting a middle east conflict and creating huge pressures over the global oil supply and oil prices.

Impact on India

How will this impact India? The main impact will be in the form of risk aversness of the global investor. A full blown crisis in Europe will affects us as Europe accounts for a sizable chunk of India exports. A Middle eastern crisis on the other hand will send oil prices soaring and will put fiscal consolidation for a toss. But overall the main impact will be in the form of investor sentiment, the growing uncertainty will; force investors to move away from risky markets and into safe havens like US and UK. This will adversely impact us, and may precipitate a Balance of payments crisis just as in 1990. During the lehman crisis, Indian Current account and Balance of Payments situation was in considerably strong position and were able to handle the consequences of shutdown in global credit and liquidity. But the main question is are we in a position to tackle a similar crisis. Are our financials on a sound footing that will enable us to tide over the crisis.

The compounding of the crisis is hard to measure, but the global uncertainty will also certainly dissuade domestic investors. this will result in firms putting off expansion plans and capital outlays. These are the long term growth drivers of any economy and thus a situation will arise that of stagnation. We can clearly see the policy paralysis in the current environment virtually caused the near stagnation of capital expansion of the economy, one can only imagine the likely impact of a global colossal crisis.

Thus all the more reason that the Central government takes head of the world around us and takes hold of the finances of this Nation and move towards fiscal consolidation. It should understand there is no room for indulgence in vote winning giveaways and subsidies and that nation as a whole will suffer due to their in aptitude and foolishness.