The official communication that went out with the interest rate cuts announced by the Reserve Bank of India (RBI) on Friday ended on a dark note: “…a period of painful adjustment is inevitable”.
The warning is not surprising in itself. IDBI Gilts economist Amol Agrawal says in his personal blog that RBI governor D. Subbarao has used this term in at least two earlier speeches he gave in December. These could be grim times. However, I doubt the nation’s top central banker would have been that blunt when he was our top finance ministry mandarin not too long ago. This perhaps shows that RBI has greater institutional clarity about the state of the Indian economy than the finance ministry does.
The question really is how bad the pain will be and how long the adjustment. The likelihood of a full-blown recession seems remote right now. The Indian economy has contracted only twice since 1970, but there have been various episodes when there have been sharp drops in the growth rate, as an economic boom made way for a painful slowdown—what economists call growth recessions.
What will it be this time? Our own recent economic history does not offer too many clues. Through much of the period since 1970, the Indian economy was in a protectionist cocoon. Growth decelerations were often because of domestic policy errors and droughts. The only significant times when global factors kayoed growth was during the two oil shocks of the 1970s and the one in 1990.
But India is now an economy that is tightly integrated with the rest of the world. The current slowdown is similar to the one we experienced in the late 1990s after the Asian financial crisis. But there is little data beyond that one single episode on how a globalized Indian economy could respond to a sharp downturn in the world economy.
One way out of this data drought is to look elsewhere, at how other emerging economies at similar stages of their development have fared during times of global economic trouble. Let’s take a look at one Asian country that was also in the early stages of its long march out of poverty in 1970— South Korea.
South Korea had its own version of economic reforms in 1961, when heavy industries were backed by the state and labour-intensive exports were promoted. That was the beginning of that nation’s economic renaissance.
The South Korean economy grew robustly through the 1970s, averaging a rate of 8.53% a year in a decade that left deep scars on many other economies because of a noxious combination of high inflation and slow growth. Even in the two years when world growth collapsed—1974 and 1975, in the aftermath of the first oil price shock—South Korea expanded its economy at 7.39% and 6.53%, respectively. There was one small hiccup in 1972, when growth fell from 8.57% in the previous year to 4.88%.
The record of the next decade is equally interesting. The second oil shock of 1979 harmed economic growth the world over. South Korea’s economy contracted 2.9% the next year. But even as the overall world economy struggled through tough times in the early 1980s, South Korea was quick to get back on the fast-growth track. It averaged 8.14% between 1981 and 1983 even as world growth was an anaemic 1.69% and most of Latin America was close to insolvency as a result of a debt crisis (global growth of less than 3% is usually considered a world recession).
There are three important points here that offer us some clues on how the Indian economy may behave amid the current global storm. One, no economy is completely immune from what happens elsewhere; a stumble is almost inevitable. Two, a dynamic economy such as South Korea in the 1970s and 1980s, or India right now, usually takes a year or so to bounce back even if global troubles continue. Three, it is possible to sustain high growth in a tough economic environment, and escape the sort of secular slowdown that countries ranging from Japan to Brazil have had to suffer in recent decades.
That is cause for hope. Naturally, none of this will come automatically. National governments will have to ensure that public finances are in order and that policies that promote enterprise and efficiency continue to be pursued. India has not done too well on this score in recent years, something that this column has argued time and again. The recent economic boom offered opportunities to cut the fiscal deficit and pursue further economic reforms, but the opportunity was frittered away.
This year will undoubtedly be a tough one for the Indian economy. But it need not be the end of the sort of high growth that has pulled millions out of poverty and also created world-class companies. A lot depends on how well the government and companies respond to global recession.