by : Swaminathan S. Anklesaria Aiyar
Pains of a slowing miracle economy
Dated: October 5, 2008
I am not usually a pessimist. But I predict that India will suffer a
lot of pain in the next 18 months, as the economy slows down along
with the current global slowdown.
The US, Europe and Japan are sinking into recession together. Forget
claims that India has decoupled from the US and can keep growing fast
regardless. India and most developing countries are indeed much less
dependent on the US economy than in the past. So, Indian growth will
be dented rather than smashed. GDP growth will slide from 9 % last
year to 7% this financial year, and to maybe 6% next year.
Now, 7% is a miracle growth rate by historical standards. You might
think that declining from super-miraculous to merely miraculous growth
cannot be particularly painful. You would be dead wrong. The direction
of change matters more than the absolute level. Rising from 5% to 7%
is blissful, but falling from 9% to 7% is painful. And a subsequent
tumble to 6% will be more painful still.
To appreciate why the direction of change matters so much, recall the
1990s. India went bust in 1991, reformed by globalising, and reaped
the reward of fast growth. GDP growth averaged 7.5% in the three-year
period 1994-97. India's growing integration with the world economy
enabled it to share in the global economic boom of those years.
Foreign institutional investors flooded into all emerging markets,
including India, sending stock market prices spiraling.
Indian optimists thought that miraculous growth was here to stay. But
along came the Asian financial crisis in 1997, and the Indian economy
slumped along with the global economy. Indian GDP growth averaged just
5.5% in the next five years.
Now, 5.5 % may not sound too bad, just a modest deceleration from the
7.5% of the preceding boom. Indeed, India's 5.5% at the time was one
of the fastest growth rates in the world. Yet the change in direction,
from acceleration to deceleration, caused enormous pain.
Industrial growth crashed in 1997-98, and barely limped forward for
years. Many industries had borrowed massively during the mid-1990s
boom to invest in world-class new plants, for which there was suddenly
no demand. Huge projects were abandoned unfinished, with companies
defaulting on mega-loans. These financial defaults brought the lending
institutions also to the verge of bankruptcy, from which they were
saved mainly by creative accounting and a friendly RBI. Medium and
small companies crashed along with their larger brethren. Employment
went into a tailspin. Stock markets crashed and companies stopped
repaying fixed deposits, so household investors suffered trauma.
The budgets of the central and state governments assumed steady growth
of revenue year after year. But the 1997 slowdown hit tax collections.
Meanwhile, a bumper Pay Commission award hugely inflated the wage
bills of central and state governments. So, governments, corporations,
employees and households investors were all sucked downward into a
whirlpool of distress. The only saving grace was the IT boom, sparked
by the global YK2 scare. But that turned out to be a bubble, and it
burst in 2001.
Difficult though these years were, they did not witness economic
collapse. India did not revert to the old Hindu rate of growth of 3.5%
witnessed in the three decades after independence. GDP growth in
1997-02 averaged a solid 5.5%. But the direction of change was
downward, not upward, and that was enough to cause widespread
I fear we are about to see a repetition of that process. As in the
1990s, a booming world economy first lifted Indian growth (and stock
markets) to new heights for several years, giving rise to the illusion
of permanency. As in the 1990s, the subsequent global slump is going
to cause an Indian slump too. As in the 1990s, the fiscal problems of
the government are going to be exacerbated by a Pay Commission award.
However, we are much better prepared for this downturn than in the
1990s. Our foreign exchange reserves are almost $ 300 billion,
cushioning our balance of payments. Corporations have not gone on a
borrowing spree paying 20% interest, as they did in the 1990s—they
have large cash reserves, modest debt-equity ratios, and interest
rates are much lower today. The banking system is in relatively good
shape today. The latest Pay Commission award this time is less onerous
than the 1997 one. Our savings rate has crossed 30%, and can keep
financing a healthy rate of investment. Infrastructural sectors like
telecom, power, roads, and ports will be only minimally affected by a
Nevertheless, pain will be widespread and sometimes deep. Income and
job opportunities will slacken, sometimes dramatically. Many companies
will suffer shrinkage or bankruptcy, especially small ones. Boom
sectors like transport, restaurants, trade, real estate and exports
will go into reverse gear. Credit will tighten, for consumers as well
as companies. Corporate profits will slump. The revenues of central
and state governments will fall, curbing their ability to alleviate
distress. The stock markets will fall further, and the Sensex may fall
below 10,000. Tighten your seat belts: we are running into rough