The world financial crisis has turned into a global economic slump. Fear about future job and income security has spread more rapidly in all countries than anyone thought possible.
In a few days, people have reined in spending, more swiftly than central banks had contemplated. So have companies. Volvo reported that its total global orders for new trucks in Q3-08 were 115, vs. 42,000 for Q3-07, when things were turning bad. Auto firms are gearing for a 25-40 per cent fall in global demand. So, steel mills are shutting down furnaces across Europe (not least Mr Mittal).
Those two examples are cascading in every manufacturing and service industry (except government services) into an implosive tsunami.
The UK economy shrank by 0.5 per cent in Q3-08. The US economy has shrunk likewise. It would be surprising if numbers for continental EU and Japan did not look similar or worse. Contrary to expectations, China will be lucky to register a growth of 8 per cent in 2008-09. India will be fortunate to hit 7 per cent.
But the issue is not whether growth in OECD in the next few quarters is minus 0.5 per cent or minus 2.0 per cent, or whether Indian growth turns out to be 7 per cent or 8 per cent.
The Reserve Bank of India's latest credit review suggests that the authorities are in denial about how rapidly unwinding could occur with a change in public sentiment, despite our robust domestic market.
The issue right now is whether governments and central banks realise the magnitude of the economic implosion they risk (through complacency or fright, even in relatively robust economies like India) without decisive action; even if it seems to traditionalists to be over the top.
The facts have changed dramatically. Governments and central banks must respond accordingly. Right now, perception and signalling are even more important than reality in ensuring that the public's fearful sentiments are allayed.
But governments and central banks seem in denial about the ineffectual impact of their Herculean exertions last month, which saw unprecedented financial rescue and liquidity pump-priming packages being put in place.
Yet, despite these efforts, which were necessary (if too little too late), the second shoe has dropped. The effects of that are likely to be large and contagious, as sudden concern about the vulnerability of ALL emerging markets suggests.
The financial crisis of 2007-08 required bank balance sheets to be propped up through measures unimaginable two months ago. But those rescues were based on harm done by sub-prime debt, toxic securitisation, and uncertainty about coverage in the credit-default swap market, which unzipped after the demise of Lehman Brothers and (virtually) of AIG.
With a full-blown global recession now under way for 2008-10, even prime loan portfolios will turn sour until economies turn around. That will result in increasing non-performing assets in portfolios that were until two months ago regarded as secure.
So banks will go into a second round of provisioning, write-downs and reserve accretion, requiring more capital. But government rescues have exhausted the ammunition available to fight this new scourge. The Brown Plan will make it more, not less, difficult to raise more bank capital.
National governments, having mutilated their budgets with financial rescues, are now talking up plans to launch counter-recessionary public capex programmes; even as demands on social security safety net financing increases with rising unemployment.
But, as Japan showed in 1990-2005, large public capex can be ineffectual, even counter-productive. What may be better is inducing private consumption through direct and indirect tax cuts, along with expenditure incentives, to ensure that private consumption does not fall through the floor.
But, with governments having stretched their fiscal deficits beyond tolerable limits, those measures seem counter-intuitive and dangerous. If a first-order problem has been created by spending and borrowing too much (whether by individuals, families, banks, companies or governments), can it be solved by spending and borrowing even more?
The answer intuitively is NO. But the consensus among global policymakers seems to be YES - at least until panic subsides and normalcy returns. Even if one agrees, it cannot be without deep concern about mortgaging the future.
In this scenario, what must Indian policymakers do to make sure that growth does not drop below a 5-6 per cent floor over the next two years? Odd as it may seem, and contrary to the complacency of the RBI's opaque and obfuscating credit policy review, my suggestions include:
(1) an immediate cut of 2 per cent in the RBI repo rate, with a corresponding cut in the reverse repo rate;
(2) a further cut of 1.5 per cent in the cash reserve ratio and 5 per cent in the statutory liquidity ratio;
(3) full, unimpeded access to all investors (foreign and domestic) in government securities and treasury bills;
(4) cessation of the RBI managing the exchange rate and focusing instead on financial stability and ensuring sufficient liquidity throughout the system;
(5) crash introduction of exchange traded currency options and interest-rate futures and options;
(6) pooling of government equity holdings in state-owned banks (SOBs) in a Public Bank Equity Fund (PBEF) which the IMF, International Finance Corporation and Asian Development Bank should be invited to augment by $15 billion, through equity ($5 billion), convertibles ($5 billion) and long-term loans ($5 billion); this would increase and anchor the capital base of SOBs without widening the fiscal deficit;
(7) moving in a series of steps toward full market pricing of oil, diesel and kerosene;
(8) dispensing with RBI approval for branch expansion by local or foreign banks;
(9) removal of other petty restrictions on foreign banks expanding in India;
(10) attracting IFC, Asian Development Bank and sovereign wealth fund (SWF) investment in UTI to the equivalent of 40 per cent of its extant capital base so that it can buy grossly under-valued equities in the market;
(11) auctioning to all domestic banks, and Indian transnational corporations with ECB (external commercial borrowing) exposure, $15 billion of RBI reserves with daily tranche auctions of $3 billion;
(12) entering into rupee-dollar swap arrangements with the IMF, US Fed, Bank of Japan, the Saudi Monetary Authority and the People's Bank of China for up to $100 billion; not that the RBI would need to use these but it would settle the market to know the artillery is there if needed.
These measures should be taken before they are needed, for us to be ahead of the curve rather than after an unanticipated unwinding occurs - as it has in the US, EU and Japan with extraordinary suddenness - and threatens to engulf the developing world through no fault of its own.
The government should also boldly accelerate the reform process along the lines suggested by the Rajan and Mistry Reports rather than be timid because it may be the wrong time in the global economic and domestic political cycles.
That would demonstrate to the world that the government is in control of its own destiny and that India means business at a time when the rest of the world is going to hell in a hand-basket.
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