Tuesday, February 4, 2014

Back after a long hiatus...

The last series that I intended to post was supposed to be a commentary on the fiscal mess India was getting into and how markets have been deceptively benign to India. I wanted to show that markets can be very cruel and what happened to Spain in 2012 could happen to India any time. As it happened, I lost my notes for all 21 chapters, and just lost the will to recreate the train of thought.

But the issue is as relevant today as it was then. We are nowhere out of the precarious situation, though people are more cautious post the shock we got in July and August, 2013. At the same time, the macro trends that were set in motion over past five years are still in full play and the consequences will be there for all to see. Make no mistake about it, we are still headed for a lot of pain unless there is some serious intervention.

There are a few positives that have happened in past one year. We have a central bank governor whose policy action is based on some understanding of macro economics; who is willing to base decision on sound economics rather than banking traditions (question: what created the global bubble and financial crisis to begin with?). This means the RBI will be better prepared to deal with the mess as things unfold. There is also a belated realization that gross economic mismanagement is a sure fire way to lose elections, populist gimmickry notwithstanding. Still, the populists have a lot going for them, a shrill voice, faux concern for the poor / middle class / name what you like here, and some spineless resistance by people who are supposed to know better but choose to step out of line of fire.

The big question of how markets will behave still remains. I cannot predict where they will go. I can only point to what can happen. What can happen is that markets can be incredibly cruel and unforgiving, that they can stay negative far longer than fundamentals warrant (the flip side is true and is already happening, the markets have been quite positive despite fundamentals being in complete mess), that once the markets get in a punishing mood, they can bring any economy to its knees. I wanted to show that comparison in relation to Spain; an economy that was roughly the same size as India in 2012, is an EU member, is a developed economy and so on. But the country stayed literally under siege till ECB came to its rescue.

We carry the same risk and I think part of that risk will materialize in 2014. The developed world is growing again, though markets are running ahead of themselves there too. QE is unwinding, though it seems likely that ECB will now need to start doing some QE of its own too. Still, the rest of the world is becoming more attractive, and that takes the wind from under the sails of the argument 'India is still growing at X%, which is much better than the rest of the world'. Fact is that there is a complete neglect of economic history in this country. And if you look back, the fact will emerge that India has recorded negative GDP growth, both on quarterly and annual basis. Also, the fact will emerge that India has never bottomed out quarterly growth rates like 4.5%.

The above statistics are based on old paradigm. Guess what? The new paradigm is scarier than old paradigm. Prior to 2005, India maintained a decent manufacturing infrastructure. Industry was shielded by non-tariff barriers and also a perennially depreciating currency. Since 2005, we have seen both openness and an appreciating currency happening simultaneously. The result has been decimation of the industrial sector, which does not bode well for a recovery. For the very first time, we are also seeing declines in the services sector too. That leaves agriculture, which provides a feeble defense to a prolonged slowdown or a relatively high rate of growth in a 'bottoming out' quarter.

The prognosis is nowhere close to clear. The real risk lies in our policy responses. None of the warning signs have been used for setting our house in order. Pressure comes, and knee jerk reaction happens (reduce gold imports, jack up interest rates to bolster the currency, and so on). Then something else happens (Abenomics, ECB action, delayed tapering) and we go back to the 'good old days' of merrymaking.

To come up with any conclusions, a lot of things need to be watched. Like the rise of AAP, there is too much that is unprecedented, throwing away all old calculations out of the window. We are in for some interesting times, to use a cliche.

1 comment:

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