Wednesday, December 9, 2015

THIS BOOM WILL END SOON

FROM BUSINESS WORLD OF 22 JANUARY 2006


An interest-driven cycle


Whenever I write about the economy, it upsets some people. Just now, when the economy is doing well, if I say that there will be a downturn, people think I am spoiling the party. If they read analysts’ reports, they will find the theme of caution is now almost a year old. But then, analysts are read only by people who pay, directly or indirectly, for their services; and analysts are congenitally pessimistic. If they warn against catastrophes that do not come to pass, their clients will forgive them; but if they fail to predict a bust, they are not worth their salt.
If I predict a downturn, am I also not being a pessimist? And is not pessimism a form of wishful thinking, just like optimism? It cannot be ascertained whether I am predicting a bust because I am mental or not. But what matters is not what I predict, but why.
What I am saying is the following. The widespread belief that the current boom is driven by Indian companies that became efficient and globally competitive during the downturn of 1997-2002 is mistaken. It was started by the increase in liquidity and decline in interest rates that resulted from the rise in reserves. Reserves rise because people who have foreign exchange – exporters, foreign investors, NRIs abroad – sell it to Reserve Bank. In return they get Rupees. So a rise in reserves inevitably increases money supply. If people get more money in their bank accounts, they will repay old debts and borrow less. That reduces the demand for loans, and leads banks to reduce interest rates. Both lower interest rates and lower debt increase business profits. That cheers them up, and they start investing. And more cash cheers people up and they begin to splurge on consumer goods. That is the kind of boom we are having, not the kind in which the higher profits come through a reduction in real inputs into production. Although the latter also happened, it was not the cause – its timing was wrong for it to have been the cause.
This sequence would go into reverse if reserves begin to fall. Money supply would fall, liquidity would decline, discretionary expenditures such as investment and expenditure on consumer durables – of which houses are the most important – would fall, and that would pull the economy into a downturn. The rise in reserves has virtually come to a halt; we should ask ourselves whether this is accidental and temporary or denotes a change in trend. To me, it is clearly a trend – it is driven by the rapid deterioration of the balance of trade. It is worsening at such a rate that the current account deficit must outrun capital inflows before many months pass, let alone years.
People ask: if Germany, Japan, Korea, Taiwan or China went on booming for decades, why cannot India? That is because their booms were export-driven. Their balances of payments too, like ours, were in surplus; their interest rates too were driven down by liquidity being fed by a payments surplus. But their payments surpluses continued for decades because their exports went on rising at least as fast as imports. Our imports are rising faster than exports; that is why our boom cannot last.
But what about the world’s confidence in India? About India being the hero of the 21st century? The world’s view is shaped by what is happening now, not what will happen tomorrow. India is booming today, so the world is impressed. The day the boom goes bust, the world will see India as a boring country and turn to the countries that are booming then.
And might the downturn, when it comes, be a soft landing? May we just slide from 7 per cent to 5 or 6 per cent? We may; CSO may varnish GDP figures and soften the landing. But our financial system generates too much debt and too little equity. When liquidity dries up, loans become difficult to get and interest rates rise, borrowers get into trouble. Some of them cannot service their loans; the assets they bought with borrowed money are sold to repay their debts. The commonest such assets are land, real estate, shares and equipment; their prices will fall the hardest. Because our economy is debt-ridden, it has sharper downturns. Remember, Japan’s downturn lasted a decade because it too is debt-ridden.

When the downturn comes, not only will prices fall, but there will not be enough buyers; these assets will turn illiquid. Just now people are panicking because flat prices are skyrocketing and they feel that unless they buy now, they will never be able to buy a flat. They are wrong: when the downturn comes, there will be plenty of flats to buy. For those who have money and a job at that time. Just wait; just as a sunny day has dark clouds on the horizon, dark clouds have a silver lining.