Sanjaya Baru | The world economy and us: Are we decoupled?

Referring to persistent uncertainty on the economic front, following the Covid-19 pandemic, the Ukraine war and other developments, and commenting on the continued risk aversion of domestic business, the banker Uday Kotak told a gathering of business persons last week: “You keep on getting a barrage of bad news from around the world. It’s got to affect your psychology and your mind and we are not immune to this.”

Recalling the global pessimism following the trans-Atlantic financial crisis of 2008-09, Mr Kotak added that he had stopped reading leading financial newspapers at that time “for they only had ‘negative news’.” Mr Kotak is a successful and a highly regarded banker and newspaper owner. So, it is unlikely that he in fact chose to adopt an ostrich-like posture during the 2008-09 financial and global economic crisis. It is more likely that his remarks sought to convey a sense of frustration within the investing class in India.

Mr Kotak’s remarks, however, draw attention to an important dilemma facing the Union government’s economic policy managers. Even as official spokespersons boost investor and consumer morale at home, they are unable to wish away the fact that the global economy is becoming increasingly challenging. Not only has global commodity inflation impacted the Indian economy but, more importantly, the economic slowdown in major economies — the United States, China, the European Union and Japan — has had a negative impact on Indian export growth, exerted pressure on the trade and current account deficits, forced the central bank to draw down foreign exchange reserves defending the rupee, and so on.

Government economists have tried to boost domestic sentiment at home by repeatedly claiming that despite all the external economic pressures, the Indian economy would do well and that India would come out on top as the world’s fastest growing major economy. The Union finance ministry’s Monthly Economic Report (MER) has repeatedly made such claims over the past few months, conceding the global challenges but asserting that they would not have debilitating consequences for domestic economic growth.

“The global economy continues to navigate an increasingly turbulent and uncertain environment,” says the latest MER. “These unfavourable developments have led the International Monetary Fund to downgrade its outlook on the global economy, revising downward its projections of 2023 growth rates for most economies. Amid this deteriorating outlook, the US Federal Reserve and the European Central Bank telegraphed a hawkish stance in their fight against inflation. Higher interest rates may tip economies into recessions if central banks stay their course. Additionally, higher borrowing costs may expose fault lines in corporate and sovereign debt structures, further accentuating global macroeconomic stress. A rapid deterioration in global growth prospects, high inflation, and worsening financial conditions have increased fears of an impending global recession.”

Having made this assessment of the global outlook, the Union finance ministry’s MER concedes that “the spillovers of the global slowdown may dampen India’s export businesses’ outlook”, but bravely asserts: “However, resilient domestic demand, a re-invigorated investment cycle along with strengthened financial system and structural reforms will provide impetus to (domestic) economic growth going forward.”

This sounds very much like the old “decoupling theory” that was purveyed by some in 2009 when the trans-Atlantic financial crisis had led to a global economic slowdown. It was claimed at that time that India had succeeded in insulating itself from the global fallout of the trans-Atlantic crisis by pursuing cautious external liberalisation, especially in the banking and financial sectors.

Intervening in this debate, the then governor of the Reserve Bank of India, Duvvuri Subba Rao, delivered an important speech at a symposium on “The Global Economic Crisis and Challenges for the Asian Economy in a Changing World” in Tokyo in February 2009, questioning the “decoupling theory”. “The decoupling theory”, said Dr Subba Rao, “held that even if advanced economies went into a downturn, emerging economies will remain unscathed because of their substantial foreign exchange reserves, improved policy framework, robust corporate balance sheets and relatively healthy banking sector”.

In a rapidly globalising world, argued Dr Subba Rao, the “decoupling theory” was never totally persuasive. Given the evidence of the last few months — capital flow reversals, sharp widening of spreads on sovereign and corporate debt and abrupt currency depreciations – the “decoupling theory” stands totally invalidated.

Reinforcing the notion that in a globalised world no country can be an island, growth prospects of emerging economies have been undermined by the cascading financial crisis with, of course, considerable variation across countries. India too has been impacted by the crisis — and by much more than it was suspected earlier.

It was a different era. 2009. The governor of the central bank had the courage to speak his mind. Even when influential policy makers in New Delhi purveyed the decoupling theory, the RBI governor spoke his mind out, like a true professional. We now live in a new India of hype and bluster and self-censorship by officials and key policymakers. Most policymakers, officials and diplomats are scared to speak their mind out.

Even senior business leaders will only say what is politically palatable. It must have taken some courage on the part of Mr Kotak to have at least made that convoluted speech in which he tangentially referred to the sense of unease and uncertainty within the investor class saying, “There is concern in many areas, therefore people are uncertain. Let’s unwind that and move forward.” The first step towards “unwinding”, to use Mr Kotak’s term, is for professionals in the government to speak truth to power and call a spade a spade.

So, what’s the bottom line? During his first term in office, Prime Minister Manmohan Singh would repeatedly claim in his speeches that “the world wants India to do well, our problems are at home”. Even today, most of our problems are at home. However, it is not clear how hospitable the global environment is likely to be even if the “world still wants India to do well”.

It is time the Union government offered an honest, realistic and objective assessment of where the economy is headed and how policy intends to shape this future so that investors can begin to “unwind” and move forward.