Indian Economy, 5th edition (49 page)

An Introduction

India’s involvement with the global economy got a completely new dimension in 1991 when it committed it self to the cause of the economic reforms. The involvement went on increasing with the every passing year. The corporate class who were the most concerned lot regarding economic reforms in 2001 requested the GoI to accelerate the process of reforms, via a memorandum, by that the industry and trade had enough proofs that the ongoing process of reform was better for them. We see the dynamics of world economy taking a shift once the provisions of WTO got implemented. To be precise, once the process of globalisation commenced in the ‘defined terms’ (defined by the WTO), India’s involvement with the global economy again increased to a new level. By 2000, IMF/WB, together with the credit rating agencies had started terming India the ‘next BIG economic happening’ – having the potential of emerging as ‘the biggest economy’ of the world. Once most of the advanced economies crash-landed after ongoing financial crisis, especially in Eurozone, India was declared almost the ‘last hope’ for the global economy (China was also seen in the same light but with a caution due to its non-democratic polity) – this can be seen as the arrival of India on the global scale – emerging as one of the most important member of the present global economy – now experts say that India has every potential to play a very vital role in the ‘global economic order’ which will emerge tomorrow!

Looking at the global importance of the Indian economy the current Economic Survey (2011-12) has added a new chapter to it with the title –
India and the Global Economy
– the very introductory lines
1
of the chapter looks like a celebration of the
India Story
– “The big story of the last decade for India has been its arrival on the global scene. The Indian economy had broken free of the low-growth trap from the early 1980s. By the mid-1990s, following the economic reforms of 1991-3, India began to appear as a player of some significance in the global economy. Then, following the East Asian crisis of the late 1990s, and from the first years of the first decade of the 21 st century, there was no looking back. India’s exports began to climb, its foreign exchange reserves, which for decades had hovered around 5 billion dollars, rose exponentially after the economic reforms and in little more than a decade had risen to 300 billion dollars. Indian corporations that rarely ventured out of India were suddenly investing all over the world and even in some industrialized countries. When, in 2009, the Group of 20 (G-20) was raised to the level of a forum for leaders, India was a significant member of this global policy group.”

As the enhanced process of globalisation came with new opportunities to India, it has also brought with it new challenges and responsibilities. Now, India can no longer view the global economy from a spectator’s standpoint which it means that the happenings in the global economy have large implications for India. Now, every time there is a major financial crisis in the world, it has an impact on India and her growth prospects.

To give the ‘real feel’ of the issue this chapter of the book has been titled as the Survey titles it (it looked futile to go for more jargonised and less comprehensive titles). The chapter systematically examines
2
:

(i)
the state of the global economy and India’s position therein;

(ii)
the current global slowdown and their implications for India and the policy challenges that these issues give rise to the domestic economic environment; and

(iii)
India’s role as a constructive player in the evolving global order in light of the G-20

GLOBAL ECONOMY TODAY

Economic developments throughout 2011were not encouraging in major economies of the world – experts have apprehensions that the process of global economic recovery that began after the financial crisis of the 2008 is beginning to stall and the sovereign debt crisis in the eurozone may persist for a while. There is an effort to build
firewalls
around these danger zones, but the world has
little experience
with this; so we need to be prepared for breaches in the walls (the last experience, in 1929, of the Great Depression was not of the similar kind). We may sum up the economic situation of the world econmy by taking clues from the informations
3
given below:

(a)
Recent data from the US economy show a revival and is projected to maintain its growth rate at 1.8 per cent for 2012 – economic growth in the US remains sluggish despite extensive use of both fiscal and monetary policy tools which has been a matter of concern for the whole world.

(b)
The euro zone is expected to contract by 0.5 per cent in 2012

(c)
The global economy is expected to grow by 3.3 per cent in 2012 compared to 3.8 per cent in 2011 as per the IMF’s
January 2012
update of the
World Economic Outlook (WEO).

(d)
GDP growth in advanced economies declined to 1.6 per cent in 2011 compared to 3.2 per cent in 2010 and is expected to be even lower at 1.2 per cent in 2012 (IMF).

(e)
Growth in emerging economies slowed to 6.2 per cent in 2011 compared to 7.3 per cent in 2010 and is projected to be 5.4 per cent in 2012 (IMF).

Reason of the Crisis

Predominant reason for the subdued growth in advanced economies at this juncture remains the sovereign debt crisis that started in the peripheral economies of the euro zone, but from the latter half of 2011, started to adversely affect the major economies there, as well. The exposure of European banks to public and private debt, issues relating to medium-term fiscal consolidation, and lack of consensus as how to resolve the crisis have continued to weigh on the global economic outlook as the eurozone accounts for close to
20 per cent
of global GDP.

Capital flows volatility resulting from the spillover effects of monetary policies followed by the advanced economies further affected the exchange rates and made the task of macroeconomic management difficult in many emerging economies; which is giving rise to a
new dimension of globalisation
in the post financial crisis world, where easy monetary policy in one set of countries may result in inflation elsewhere due to cross-border capital flows
4
.

Unemployment Scenario

Situation of unemployment in advanced economies in general, and the peripheral economies of the eurozone in particular has not improved (which deteriorated in the wake of the global crisis). The OECD Employment Outlook 2011 observed that
5
:

(a)
with the recovery stalling, OECD unemployment remained high, with close to 44.5 million persons unemployed.

(b)
the extent of unemployment has been varied across OECD countries, with Spain exhibiting the highest unemployment rate (21.7 per cent).

(c)
the main losers have been youth and temporary workers, some of whom have been getting out of the job market.

(d)
the US has shown some improvement (8.7 per cent in 4th Quarter, 2011 compared to 9.1 per cent in 3rd Quarter, 2011), but nevertheless remains high.

The persistently high rates of unemployment in advanced countries, especially in the crisis-affected countries of the eurozone, the
inherent contradiction
of fiscal consolidation is having a social fallout in the peripheral economies and has sharply polarized public debate fon the appropriate economic policies to be adopted.

EUROZONE CRISIS

The eurozone, a currency union of 17 European countries, has been going through a major crisis
6
which started with Greece but spread rapidly to Ireland, Portugal, and Spain and subsequently Italy. Sparked off by fear over the sovereign debt crisis in Greece, it went on to impact the peripheral economies as well, especially those with over-leveraged financial institutions. These economies, especially Greece, have witnessed downgrades in the ratings of their sovereign debt due to fears of default and a rise in borrowing costs. The sovereign debt crisis has made it very difficult for some of these countries to re-finance government debt. The banking sector in these countries also stands adversely affected.

Good Experiment:
After the euro was launched, the eurozone witnessed not only a decline in long-term interest rates (especially from 2002 to 2006), but an increasing degree of convergence in the interest rates of member countries. A common currency, similar interest rates, and relatively strong growth provided a basis for a rise in public and private borrowing with cross- border holdings of sovereign and private debt by banks. Those were the good times for the eurozone

Crisis Triggered:
In the aftermath of the global financial crisis in 2008, sovereign debt levels started to mount. The revelation that the fiscal deficit in Greece was much higher than stated earlier set off serious concerns in early 2010 about the sustainability of the debt. The downgrade of ratings led to a spiral of rising bond yields and further downgrade of government debt of other peripheral eurozone economies as well, that had high public debt or a build-up of bank lending or both.

Spread:
Concerns intensified in early 2010 as cross-border holdings of sovereign debt and exposure of banks came to light. The financial markets quickly transmitted the shocks which not only led to a sharp rise in credit default swap (CDS) spreads but later impacted capital flows elsewhere.

The underlying weaknesses of the zone have made it difficult to resolve the crisis:

i.
The eurozone lacks a single fiscal authority capable of strict enforcement;

ii.
Economies with different levels of competitiveness (and fiscal positions) have a single currency;

iii.
These economies cannot adjust through a depreciation of the currency;

iv.
There is no lender of last resort, i.e. a full-fledged central bank (as is RBI in India and other economies).

Remedy:
European finance ministers, in May 2010, agreed on a rescue package worth Euro 750 billion to ensure financial stability by creating the
European Financial Stability Facility (EFSF).
In October 2011, the eurozone leaders agreed to a package of measures that included an agreement whereby banks would accept a 50 per cent write-off of Greek debt owed to private creditors an increase in the EFSF to about Euro1 trillion and requiring European banks to achieve 9 per cent capitalization. The date for this package was brought forward to July 2012. To restore confidence in Europe, EU leaders also agreed to a fiscal compact with a commitment that participating countries would introduce a balanced budget amendment. In December 2011, the European Central Bank (ECB) took the step of offering a three-year long-term refinancing operation (LTRO) at highly favourable rates to alleviate funding stress which helped bring down the yields somewhat during January and February 2012. But overall uncertainty about the effectiveness of all these measures and how further resources would be raised, their adequacy, and doubts about sovereign debt levels coming down remain there. Due to low-growth scenario, the ability of Greece and other economies to undertake further fiscal austerity remains a big matter of concern for the world.

Eurozone and India:
Though distinct from the European Union (EU), the Eurozone is its major subset. The eurozone and EU account for about
19
and
25
percent of global GDP, respectively. The EU is a major trade partner for India accounting for about
20
per cent of India’s exports and is an important source of foreign direct investment (FDI). The IMF has forecast that the eurozone is likely to go through a
mild recession in 2012.
A slowdown in the eurozone is likely to impact the EU and the world economy as well as India.

The sluggish revival of global growth in 2011 came on top of disruptions in supply-chain networks resulting from the devastating earthquake and
tsunami in Japan
(in March 2011). Later in the year (October and November), severe
flooding in Thailand
also disrupted some supply chains. Political uncertainties in some Middle East and North African countries have been another source of uncertainty apart from their obvious
implications for oil prices.
The severe uncertainty in the eurozone impacted the global financial markets leading to capital reversals to safe havens in December 2011. Global economy, at this juncture, in the short run, is being threatened by multiple shocks emanating from various sources, economic, social, and geopolitical. The lower global growth forecast by the IMF for most countries in 2012
perhaps
reflects the repeated cycles of uncertainty arising from these diverse sets of factors.

India is, nevertheless, projected to be the
second-fastest-growing
major economy (7 per cent) after China (8.2 per cent) as per the IMF. In the medium term, challenges for the global economy continue to emanate from the way the eurozone crisis is addressed. The high deficits and debts in Japan and the United States and slow growth in high income countries in general, have not been resolved. The looming risk to the global outlook is also on account of the geopolitical tensions centred on Iran that could disrupt oil supply and result in a sharp increase in oil prices and even disrupt supply routes.

While the current conjuncture is important for anticipating outcomes in the short to medium term, the current global situation is also a manifestation of certain long-term developments and changes in the relative positions of the major economies that have now perhaps reached certain critical proportions.

CHANGING DYNAMICS

The global economy has gone for a big change in its dynamics over the last two decades and this process has every potential to further the change in coming years and may be for decades to come. The shares of major economies in global GDP, manufacturing, and trade —a few traditional tools of assessing global economy—suggest that there has been a marked change in the configuration of the world economy (especially over the last decade). Over the last 20 years, sustained growth of a number of emerging economies, especially the BRICS economies, has resulted in an increase in their share in the global GDP. As a consequence, the value addition in the world economy has been moving away from advanced countries towards what have been termed emerging economies. The decline in share is particularly marked in the case of the EU. The shift towards Asia has been significant and, within Asia, away from Japan to China and India. The
fivefold
increase in share of China in the global GDP has placed it as the second largest economy in the world. The increase in share of India, though less dramatic, is nevertheless of an order that places her as the
fourth
largest economy in PPP terms
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.