New India's Road Test

Today is being called Black Friday in India as the BSE Sensex, the index of 30 most-traded shared in the Mumbai Stock Exchange, plunged by 1071 points. This fall, one of the biggest in a single day in the history of the index, takes the Sensex to 8700 points. This was clearly unthinkable in January, when the index peaked 21,000 point mark. Even in March, when the Sensex experienced big falls and credit crunch was well under way, the Sensex was hovering around 17,000 mark. Given that the Indian economy was experiencing a 12%+ inflation, the rupee was weakening, the government was facing a crisis and oil prices were firmly around the $120 mark, that was a lot of optimism.

I remember meeting a stock broker around the time in Mumbai, who tried to explain to me why investing in stocks still at that level made sense more than any other asset, saying - "how low can it possibly get? 12,000 mark? But it will still bounce back, because the Indian economy is fundamentally strong. And, you know why this is - because we save." I am sure those words are coming back to haunt him now, but it is not just the stock market, which is in a worrisome state. The oil prices are low [though the news is that OPEC is agreeing on a production cut so that they can go back up], but Indian inflation is still at 9% level. The rupee has plunged, currently trading at over Rs. 50 a dollar. I also remember an Indian banker assuring me that India will not be affected by the current crisis, as they 'have always lent 80p per rupee held as Capital'. In effect, what he was saying that India is in a permanent state of credit crunch anyway, and the situation can't get much worse.

However, it seems it is going to get worse for a number of factors. Indian banks may escape this crisis because of their risk-averse nature, but that is not going to help the economy anyway. Besides, because Indians save, and they are more likely to do so in the middle of a crisis, and as the spending spree of the new 'IT-enabled' middle class comes to a halt, the economy may come to a sudden standstill. Successive Indian governments systematically neglected agriculture, through a combination of protection of vested interests, neglect of land reforms and allowing the infrastructure and institutions to degenerate. An urban downswing will now catch the country unprepared and the demand will sink - this isn't going to be a pretty sight.

This is Indian economy's big test. Today is possibly the day when the financial tsunami of the Western Credit crunch finally reached Indian shores. This is the test for country's economic resilience, in which I doubt, and the ability of our policy-makers to prove that there is substance in the claim of economic growth they have been making in the media for so long. Rupee has depreciated against the dollar by 20% in the last few weeks, so the rest of the world does not think so anyway; if the government can not prove this quickly, and effectively, we may face a meltdown - Rupee going bust with all our savings.

India has made two attempts to build a rich, capitalist economy. The first, under Nehru's stewardship, looked at the state guiding the economy through its formative phase, building the necessary institutions, developing indigenous capacity and allowing the capital formation and infrastructure building. This was a flawed attempt, for two reasons. Experiences worldwide has shown us that the state can not do this institution building. And, second, because we tried to do it for too long - well into 1990s, when the need for such a guiding hand was over. In summary, there was a 'failure of imagination' beyond Nehru, which we suffered from.

The second attempt started on the ashes of the Nehruvian model, more as a knee-jerk reaction to IMF conditions than a commitment to policy. The second attempt, largely stewarded by Manmohan Singh, then Finance Minister and the current Prime Minister, was about letting go of the economy. This was a welcome step, more in line with the fashion of the day, and unlocked the Indian entrepreneurs who were readied by the Nehruvian intervention but were then kept in a leash by lack of imagination. But, while the economic policy leaped to the other extreme, too little was done to reform the society and invest in institution building. Over the years, India built a corrupt and inefficient bureaucracy which encouraged cronyism, and this is a bigger bane of capitalist development than trade tariffs. Years of systematic underfunding of primary education left the country with a two-tier education system - world-class at the top but poor in most other parts. The administrative system, and a prolonged affirmative action programme, discouraged meritocracy. Vested interests blocked agrarian reform. Forced urbanization created crime hot spots. So, while the myth of a new India was created, this was limited to pockets of affluence and was on shaky narrow foundation.

This is what will be put on test next few days. Fittingly, Manmohan Singh, the architect of this incomplete renaissance, is at the helm, which means he has to answer most of the questions about the failure, if there is a failure. It is not just the stock market phenomena, which would have happened as the Foreign Institutional Investors start their customary cut-and-run; if the indicators are correct, the pain will soon reach the main street and savings bank accounts of millions of people. The Indian public must be ready for this test.


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