Iceberg Ahead : Why Stability Is More Important Than Growth



The Titanic, accelerated to 35 knots, full speed ahead, just before it hit the iceberg. Besides all the other factors, the speed at which it was going, gave it little chance of avoiding disaster, and of surviving the damage after it was hit.

Declaimer: This article written was originally in December 2014, and some of the data points may be outdated.

This is a very appropriate metaphor for the dilemmas facing India just now. We have a “Titanic” mentality, a flawed belief in our invincibility. One part of this Modi Mania says, “We have Modi”, implying he will get us out of any hole, even change the Laws of Physics/ Economics.

To change the metaphor I have used above to describe macro-economic management just now, “steering the economy” is very similar to driving a car. You don’t accelerate a car as you go through a crowded village, you slow down till you reach an empty stretch again. Or better still, you don’t accelerate on a flat tire, you wait for ‘stability’ before you try accelerating again.

The world economy is seeing great uncertainty and increased volatility in many markets. Some of the areas are as follows:
  • Deflation/ depression possibilities in Europe, as the region nears its third recession in 6 years.
  • Falling oil prices will seriously affect major oil producers, including major Emerging Markets. These economies will see sharp spending cuts, or huge Budget Deficits and hence, falling currencies.
  • A general commodity bust, consequent to a slowdown in China, could tip into a serious crisis.
  • A rickety Japan, which has several problems, and has still to see the after-effects of an unprecedented last-ditch attempt at speeding up a sputtering economy. This could end in a Greek-style blowout.
  • A potential currency war could be triggered by any of Japan, China, or Germany devaluing suddenly and trying to garner export competitiveness. This triggers an upward Dollar spiral, with disastrous consequences for everyone.

Hardly a time for a still-stable Indian economy to try and wring out additional decimal points in growth, by shifting Monetary Policy from its focus on stability. This makes me want to wade into this ‘debate’ between Mr. Jetley and the RBI on Interest Rates.

This chorus for an Interest Rate drop is rather like a bunch of kids sitting in the backseat of a car, screaming “faster!!! Faster!!!”, with no idea of what the driver is dealing with. I don’t understand this obsession with growth, in an economy that is one of the fastest growing in the world anyway… certainly has the highest growth momentum in the world. It’s not like we are teetering on the verge of recession, like Europe, or trying to fight chronic deflation like Japan. I can understand an obsession with growth in those economies.

India is the only major economy still battling inflation. And we are just coming back from a near Currency Crisis…..shouldn’t we be focussed on stability, especially given the rocky seas visible ahead? How have we quickly created a consensus that all is well and we are ready to jump off a cliff with an umbrella?

Most of the underlying factors are still in the red zone.

Most of the underlying factors are still in the red zone. The Fiscal Deficit, for one: we are going to overshoot yet again, a modest target that still brackets us with France, that basket case of a no-hope economy that sits at the heart of the Eurozone crisis. The CAD is back above the 2% red line, in an era when the falling Euro and JPY are going to increase your Trade Deficit. If you look at the trade-weighted REER in nominal terms, you will find the Rupee has been overvalued, which is not going to be good news for your CAD.

If the CAD also represents your Savings Deficit, then any further uptick in the Investment Cycle will only bring more bad news on that front. So why not keep high real interest rates to push up domestic savings?  A drop in the credit offtake could mean a cyclical deleveraging effect. This can be made up with other reforms that improve corporate profitability, like labor and land (acquisition) reforms, which bring down the cost of other inputs. Tinkering with Monetary Policy to bring down the cost of capital, is just lazy Govt, taking the easy way out.

The steep drop in oil prices has been a good stimulus for the economy, but this decline could have been used to bring down the Fiscal Deficit with some temporary taxes. Such initiatives could also cross-subsidize Energy Efficiency programs and VGF funding for Solar.

With all this talk about the Modi Wave, the real change of macro-fundamentals has been zero, and we are already talking about going to “lose money” again, even as liquidity is already flooding in. This will only feed inflationary pressures, leading to a 2-steps-forward-and-one-step- back policy that will only promote volatility in Monetary Policy.

I mean, why do we always look to Monetary Policy to bail us out of a slowdown? Is it because everything else is more complex, or is it because Markets are most sensitive to money flows, and they have a disproportionate voice in the mainstream media? Are the profit priorities of just a few rich and influential individuals, going to be allowed to destabilize the country’s most important economic objective… provide stability first, and then create the right environment for growth to find its natural level?

Shouldn’t the government’s targets be FIRST an inflation target, a Fiscal Deficit target, a Public Debt target, a Primary Surplus target…..and then a growth target, which follows as a RESULT of the enabling environment that is so created? A driver is first meant to ensure that a car is stable, there are no accidents and the wheels are not flying off before he listens to the kids screaming in the backseat. In India, you find very little debate on the rest of the variables that drive stable growth, and all the conversation is just about growth at all costs. This only promotes cyclicality and volatility, with its economic costs…..most importantly, these costs (i.e. inflation, debt defaults, spikes in unemployment, etc) are borne by the poor and the middle class, while the short-term benefits of incremental growth are eaten away by the elite.

A Modi Govt that is looking at the long-term is better served by a sharper focus on stability, and creating the right environment for sustainable growth, rather than a blind rush for growth. I sincerely hope that Raghuram Rajan who has set himself the target for a “bullet-proof” Balance Sheet, will not be swayed by this cacophony of voices that are looking for growth on steroids.

If at all Interest Costs need to be lowered, the Govt can give an Interest Subvention of, say, 4% for Solar investments. This will have the effect of reducing the Cost of Capital for solar investments, helping promote investments. Except that the cost would show up in the Govt’s Fiscal Deficit, even if it is as a Capital Subsidy. But at least it will discipline the Govt, which will have to find other spending cuts. The net effect of a further solar subsidy (over and above the VGF of Rs.1 cr per MW), will be to reduce imports (of coking coal and oil) and the cost of energy. Energy independence will give a fillip to agriculture and water management, which is just where growth momentum should be promoted.

To summarise, the Govt should focus on promoting asset profitability, rather than reducing the cost of liabilities. With the rose-tinted profit outlook being posted by every analyst worth his salt, why should we resort to rate cuts: instead, keep real interest rates high, even as you reduce the cost of other inputs, especially land, raw materials, and management value-add. This will bring in foreign investment, which will help kick off your Investment Cycle with equity rather than debt. That will kick off a virtuous cycle, bringing in FDI, besides promoting domestic savings. It will also silence industry lobbies behind this cacophony for lowering interest rates.

Lowering the cost of capital often results in misallocation of investments, even as we are suffering the after-effects of the rate-lowering spree and spraying of cash, after 2008. The chorus for a rate cut could hardly be wanting to go into another cycle of misallocation (of investments), even as we have still to write off the NPAs of the last cycle.



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