In Times of Change

The recovery from the chronic global slowdown is only partially complete in both developed and developing countries. However, developing economies are better off depending on local conditions and medium-term productivity growth rather than the large, globally integrated, influential forces that dominated economic activity before the financial crisis, and still play an important role in moulding global regulatory policies. The robust growth registered in emerging economies in the last decade has thwarted suspicions regarding these blocks. Yet, several tensions and external events have the potential to disrupt the process of development.

Output is expected to come in stronger than anticipated in performing economies. The other case could be that very strong speculative capital flows that characterised the third quarter of 2010 may return. Either scenario could potentially accentuate inflationary pressures in the global economy: both those emanating from commodity markets and those coming from increasingly binding capacity constraints in a number of emerging markets. In such a scenario, which pre-supposes that policy tightening efforts underway are not sufficient to rein in demand, authorities would be obliged to tighten more aggressively in 2012, thus leading to a more pronounced slowdown in 2013.

The big dilemma confronting democratic governments is the choice between bailouts and debt waive off. Undoubtedly, capitalist prudence orders for the former. Often bailouts occur more frequently than mass waivers of debt, albeit India presents little difference with its distinct polity and populist commitments. Indeed, complete financial recovery could be a desired endgame, though conquering it would be a pipedream under the present circumstances in which regulators, governments and financial institutions are functioning across powerful economies.

Moreover, high fiscal deficits and rising sovereign debt pose medium-term challenges to a wide-range of OECD countries. So is it time for top rank global policy makers to acknowledge this epoch making economic shift in favour of emerging economies and start sending telepathic connections across the world?

Consumption Conundrum
The global economy has grown over the decades by relying heavily on American consumption and policy dominance (good or bad). This intensified with the disintegration of the USSR in 1991 as it resulted in the demise of an alternative ideological block. The structural force behind large US consumption has been a significant middle class. The middle class is an ambiguous social classification, broadly reflecting the ability to lead a comfortable life. But the current downturn has brought this process to a halt. US households are saving again in an effort to rebuild lost wealth. The consensus forecast is that this will be a lasting effect of the global financial crisis.

How can the world economy fill this void in global demand brought on by the retrenchment of the American consumer class? Naturally, the emerging middle class in China, India and other populous countries are moving to become the next global consumers under the changed set of conditions. But the policy support to achieve such a rebalancing is not easy in these countries facing different lacunas. In short, Asian consumption is tied, according to many analysts, to long-term institutional changes.

Shifting Nexus Of Power
At this decisive phase, as economies in Sub-Saharan Africa and the Middle East develop and open up to trade, links between Asia, the Middle East, and Africa are expected to grow further. Economic integration between these regions and the emergence of south-south trade will certainly result in the formation of influential trade hubs. The trade of the future will be determined by the availability of cheap resources and the destination of final demand; this would be a big accomplishment for these hitherto tail-spinning economies. Big corporations from the developed economies have already begun to question whether the challenges of outsourcing their production processes outweigh the benefits of producing locally. In this respect, Africa and the Middle East offer both low-cost production capabilities as well as a rapidly growing domestic market.
It is becoming rather obvious that China may be losing its status as the "manufacturing leader." Cost economics that have long worked in China's favour have come full circle: domestic wages are on the rise, eroding much of the cost arbitrage offered to foreign companies. Even Chinese companies are affected as improving living conditions in the hinterland discourage potential migrants from seeking work in urban coastal provinces. Furthermore, an aging population in the next decade will likely weigh down labour supply and impact wage competitiveness. As Chinese production moves up the value chain, workers are demanding higher wages, better working conditions, and added welfare benefits. Thus, rising labour costs, along with pressure to loosen control on its exchange rate, could pose a serious threat to China's international competitiveness if productivity does not correspondingly improve.

Intermediate production, rather than locally produced finished goods, as an economic structure presents immense opportunities for emerging markets to develop specific capabilities and capture a bigger share of the supply chain. From a company's perspective, an emerging trade network with a wide portfolio of capabilities allows for diversification in the supply chain rather than extreme reliance on a single country whose competitiveness may be decreasing.

Nonetheless, China will remain an important, if not dominant, player in the future. The country's burgeoning middle class is set to become more affluent and boost consumption levels in the next decade. The head of emerging markets at Morgan Stanley, Ruchir Sharma's newly published book, Breakout Nations: In pursuit of new economic miracles gives some lucid views about the new wave of competency coming from the side of emerging economies.

Challenges On Home Ground
The cheap flow of foreign capital had made Asian economies such as China and Japan exclusively powerful in the region for a long time before opening of other economies, primarily India. But lately both Chinese and Japanese economies are under excessive strain because of their over integration with western nations. The case with India is different because liberalisation took place later and with active regulatory restraints.

Raghuram Rajan in his remarkable work, Fault Lines mentions India's growing income inequality and the dangers that a social underclass poses to the country's economic future. His strong emphasis on the ills of maturing cronyism in India's power centre is worthy enough to be considered as a grave threat to the essence of India's constitutional mandate. Rajan is right in pointing out the growing numbers of Indian billionaires are mostly products of networking rather than enterprise.

For the last several months, the Indian economy has been consistently juggling between controlling inflation and maintaining robust economic growth. In order to control spiralling inflation, the Reserve Bank of India chose to sacrifice growth in order to check the inflation. The 20-month period, until October 2011, of rising interest rates has slowly but surely put the brakes on economic growth.

For keeping alive the basic mandate of India's growth, the wave of policy/regulatory laxes need to be checked at any cost and synergising efforts should be made to retrieve Indian economy's lost confidence. Instead for unwarranted follow-up laws, we require an overhaul in the existing regulatory framework;India can't afford an ill policy regime.

Inflation, that had threatened to derail India's growth for several months, had shown signs of weakening in the recent past weeks. However, inflation is on the rise again, and it is likely to stay in the 7.0-9.0 percent range in the coming months. The central bank cannot afford to conclude that inflation will stabilise in the medium term. So far in 2012, the RBI has already eased the reserve requirements for banks, infusing liquidity into the economy. It is likely that further liquidity could be infused into the economy in the coming months. Measures to ease liquidity may, however, not be enough to provide a much-needed fillip to the economy.

Growth is slowing down, investment is falling, and business sentiment is on the decline. In the absence of any credible government action, the central bank may not be able to stave off calls for reducing interest rates for too long. Questions about whether or not the interest rate will be reduced ahead are giving way to when and how dramatically it will be cut.

Leading social historian, Ramchandra Guha's assertion that the India's economy is a fifty-fifty economy, best reflects the trend, and our economy has been following since 1991. Making Indian economy hundred percent functional should be the prime task of policy makers-the two basic ideas cam materialise this dream-growth with equity and emancipation of the marginalised with ensuring lowest possible economic disparities. Under a mixed or market driven economy, nothing more could be anticipated.
Atul Kumar Thakur
Email: summertickets@gmail.com
(Published in Businessworld, May16th 2012)