Who sabotaged the De-Coupling?

Who sabotaged the De-Coupling?

Now the world economy is facing economic slowdown and is in doubt that, world  is moving to a recession. US economy and Europe have ready shown the signs of recession.  As part of the global village, we are not immune to the world happenings and as a result we are also facing the slowdown. It can’t be claimed by anyone that India  will  be entirely unaffected. But in the beginning when people were suspicious of a world economic slowdown, it was assumed that India can resist such slowdown and people called it as de-coupling theory. It was some what true that India had and has the ability to resist the slowdown; because 70 percent of our growth is  domestic and only 30 percent is from exports and we were growing at a pace of 9 percent.  A country with such a potential can really check the slowdown successfully. But now we are also facing the threat of slowdown; then what happened to the much discussed de-coupling theory, who or what sabotaged the de-coupling process?

As a sign of slowdown profits of our corporate world has come down which resulted in  the cost cutting  and spending of the companies and public has reduced. It will affect the business, the growth and the entire economic activity; ultimate result is slowdown. .  Looking back, the profits of our corporate have come down due to an increase in the input cost and not due to decrease in business. A typical slowdown cycle starts when there is low economic activity followed by the decrease in the business or sales. But here in India, business or sales has increased but profit has come down and cost reduction measures led to lower economic activities.

Then what is the root cause for the slowdown which we are facing; it is the increased input costs. Now let’s check the factors behind the increased input costs. First culprit is the global inflation, especially the price rise in the crude oil. Second, by the wrong measures taken by our monetary authority to check the inflation. In other words needlessly tightened monetary policy has played a major role on today’s growth crunch.

The rise in inflation was a concern everywhere, and was truly a global phenomenon. It was agreed that this inflation was a cost-push phenomenon with higher oil and food prices driving it up.

There are two different types of inflation Demand-pull inflation and Cost-push inflation. In Demand-pull inflation, the aggregate demand in an economy exceeds the aggregate supply. In simple words `too much money chasing too few goods’. Cost-push inflation occur when there is an unexpected and a huge fall in the supply side.  To contain the Demand-pull inflation monetary policy can be used.

Monetary policy brings about a change in the economy by changing the money supply and interest rate. The Monetary Policy regulates the supply of money, the cost and the availability of credit in the economy. By increasing or decreasing the reserves and interest rates such as CRR, Repo rates etc for lending and borrowing done by commercial banks, it is not possible to contain Cost-Push Inflation by tightening the monetary tools. And it is also clear that there is little that can be done by our authorities in the case of oil price rise.

However, to contain Cost-Push Inflation a demand-pull solution was used by the RBI, which had the potential to slow down growth. When the interest rates were raised, consumption and investment was reduced, and that lead to a decrease in production and economic activities. Resultant, there was a slowdown in employment growth and also loosing of current employment.

The RBI had little choice as inflation was a major concern for the government and was more a   political issue. In such a circumstance, RBI gave more importance to inflation by sacrificing the growth. But that lead to the threat of economic slowdown as the growth projections has slipped to 6.5-7 per cent from 8.5-9 per cent. As an indicator industrial production data for December 2008 came out with one of the worst performances on record at negative 2 percent.

If policy makers were not ready to see the difficulties of the corporate world, growth crunch and fall in the stock market; I have no comment on that but they have to remember that a fall in growth rate, particularly in a developing country like India, would badly affect the living style of those at the bottom of the social order.

now too much have to be done to repair the damages that have happened due to wrong decisions. It’s like if a person wants to go one km to right side and instead he goes one km to left side wrongly and then again travel two km to reach his destination.  

Better late than never, it’s not too late to act. There is an opportunity in every crisis. In fact this is an opportunity for India to become an economic power provided if our authorities act accordingly. Our authorities should make timely monetary and fiscal moves. Government can do a lot. It is the time to spend money for improving the country’s infrastructure. By doing so, the economic activities of the country will improve. Thus increased employment and overall growth of the economy; like the US government did in the time of great depression in 1930’s.There is indeed much to do in the infrastructure sector to come up to international  standards. The present infrastructure of India is not enough to support the future growth of the country.  And now as prices of the commodities are coming down globally, we can save the cost also. Under these circumstances, every thing depends on how our government utilizes this opportunity or is restrained by constraints and threats of risk. 

-         Krishnan Thampi K

Head - Research

Capstocks & Securities (India) Pvt Ltd.

(The view is personal)