The world economy is facing an unprecedented crisis, reminiscent of the Great Depression of the 1930s. It is but natural that the economies of all countries that constitute a part of the global economy are affected adversely.
However, unlike the 1930s when everything was left to the market, all countries are actively pursuing the remedy of increasing liquidity, and salvaging banks and other financial institutions through expensive bail-outs.
Still, at the end of the day, economies remain unstable and stocks, after stabilising briefly, are once again plunging.
India has not been able to escape these trends. The Sensex collapsed from above 20,000 in January, 2008 to less than 10,000 by October.
The FIIs are offloading their shares and taking money out, causing the sharp decline in share prices.
As a consequence, the country's foreign exchange reserves declined from $274 billion in March, 2008 to $238 billion by mid-October, 2008.
India liberalised its economy during the early 1990s, when the world economy was growing at a rapid rate, exceeding 3 per cent per annum.
The liberalisation of the economy and freeing of the trade sector, combined with a sharp devaluation of the rupee, helped it to increase exports.
Simultaneously, the removal of import controls and the abolition of permits and licences enabled manufacturers to modernise their plant and machinery through capital and technology imports, making them more competitive.
More important, there was an upsurge in electronics and outsourcing. Trained and well-educated graduates from the IITs, IIMs etc exploited the situation and contributed to the high growth of the service sector in the economy.
The result was that the trend growth rate of the Indian economy increased from 5.5 per cent annually between 1980-81 and 1990-91, to 6.1 per cent between 1991-92 and 1996-97 (at 1993-94 prices).
But this period of high growth was disrupted because of the 1997 East Asian crisis, which turned the East Asian miracle to an East Asian nightmare.
This crisis resulted in slowing the growth of the world economy. India did not go unscathed, although the decline in the growth rate of the Indian economy was marginal.
Then, as now, the fact that India had not liberalised its capital account helped it to shield the economy from a serious financial crisis.
By 2002-03, most of the East Asian counties were able to rebound from the crisis. Moreover, the Japanese economy which had been in crisis during the 1990s, recovered by the end of the century mainly because of strong demand from China and, to some extent, India.
One consequence of the crisis was that the East Asian countries started managing their capital accounts more prudently.
With the world economy growing at about 4 per cent, the Indian economy had its golden period of growth between 2003-04 and 2007-08, when it grew at an unprecedented rate nearing 9 per cent.
It is indeed unfortunate that India's rapid growth is now being disrupted due to the financial crisis in the US, Europe and Japan.
Policymakers in India have been busy assuring the country that the fundamentals of the Indian economy are strong. Their assurance does not go far, as growth rates in various sectors of the economy are declining.
The Planning Commission, the RBI and now even the Prime Minister have predicted a slowdown in India's growth.
The Reserve Bank has taken important steps, with the twin objectives of increasing liquidity in the system and reversing the outflow of funds on account of selling by the FIIs.
For the former, the RBI cut the cash reserve ratio from 9 per cent to 7.5 per cent on October 10 and further to 6.5 per cent on October 15. It has now cut the repo rate by 100 basis points, to 8 per cent.
To achieve the latter objective, the Bank has given more freedom to FIIs, raised their limits for investment in bonds and has increased interest rates on foreign deposits.
Increased liquidity in the system coupled with interest rate cuts may save financial institutions and banks, but they are bound to lead to increased inflationary pressures.
Thus policymakers are in a dilemma. They want to stabilise the price of the rupee, they want FIIs to come back and invest in stocks, they want banks and financial institutions to start lending to increase investment, and simultaneously they want to control inflation.
They should realise that the number of objectives cannot exceed the number of instruments, and it is next to impossible to defy the 'impossible trinity'. It would be very difficult to achieve all the goals at the same time.
What is the policy mix needed now? In addition to well thought-out monetary, fiscal and foreign exchange policies, the most important initiative that needs to be taken is to increase public investment in rural and urban infrastructure.
A substantial increase in investment in rural infrastructure, particularly in agricultural research and biotechnology, will go a long way in not only increasing demand but also reviving growth in agriculture, which has languished during the last decade.
Accelerated agricultural growth will promote growth in other sectors of the economy, through input-output and consumption linkages.
Simultaneously, public investment in urban physical and social infrastructure has to be increased substantially.
Urban habitats, in general, and the small and medium towns that are closely linked with agriculture, in particular, have abysmal infrastructural facilities like roads, water supply, power, sewerage, housing, educational and health services.
Huge public investments are needed to fill these gaps. Large cities also need substantial investments in water supply, transport and particularly housing. The Indian middle class is prepared to pay a reasonable price for decent houses.
But due to the withdrawal of the public sector from the construction of houses, and land speculation, house prices have skyrocketed.
Housing supply needs to be increased substantially through public and private initiatives to bring down prices to reasonable levels.
What is suggested above is not a panacea, but in times of crisis, it is only Keynesian remedies that are likely to work.
The author is Professor Emeritus, Jawaharlal Nehru University, New Delhi
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