S. S. Bhandare*

In quantitative terms, the aggregation of the negative impact can be placed at about Rs 6,500 crore to 7,500 crore in nominal terms, or approximately 0.2 to 0.3 per cent of the real GDP.

Besides, the Indian industry would be forced to absorb the cost escalation (inflationary) impact of:

• a likely hike in POL prices to cut back the mounting oil-pool deficit;
  
• substantial increase in the insurance premia burden
  
• additional bunker’s freight surcharge for shipping
  
• some hardening of interest rates, and so on.

The total burden of these factors would be about Rs 3,500 crore to 4,500 crore, or about 0.2 per cent of the nominal GDP. India would also witness a reduced supply of capital flows of at least $1-1.5 billion due to the freezing of FII investments, cutback in remittances and postponing of FDI and capital-raising through GDRs, ADRs and ECBs by Indian companies.

Admittedly, India’s external vulnerability is relatively low; it remains predominantly a domestic economy, and its export dependency is just about 9 per cent of the GDP. But, significantly, the country's exposure to the US is as much as 20 per cent in terms of goods exports and 60 per cent in terms of software exports. Likewise, our exposure to the European Union countries, most of which are NATO members and more susceptible to terrorist activity, is fairly high at 25 per cent and 20 per cent respectively in terms of goods and software exports. (See Powerpoint presentation).

A slightly long-term perspective
Looking at the quantitative dimensions, the situation per se may not appear to be one of doom or gloom. Yet, it needs to be stressed that the proverbial resilience of the Indian economy cannot be taken for granted. For the past few years, some crisis or other has hit India, be it the US sanctions after the Pokhran nuclear test or the devastating Gujarat earthquake, Orissa floods, or the steep oil price hike. Every such external shock or natural calamity progressively weakens the economic fundamentals.

There are obviously two sides to the macro-economic fundamentals. Apparently, there is no cause for anxiety on the supply side, except perhaps due to the poor progress of the infrastructure sector. In fact, the critical problem at this stage is how to deploy effectively surpluses of food, forex reserves, industrial capacities and liquidity in the banking system for the revival of the economy.

In contrast, the demand side, both consumption and investment, has been so severely battered in the last few years that its adverse impact would be more long-lasting. The constant systemic or structural failures are ripping open demand weaknesses of the economy in practically every sphere. Thus, there is no depth either in equity or debt-markets. As a consequence, financial markets go through turmoil with the outbreak of every shocking event or news. Once again, the aftermath of the terror attacks in the US is going to hurt severely the demand drivers rather than the supply side of our economy.

The way out
Having said this, what is the way out for the economy to obviate the prospect of further deceleration of the real GDP growth in the current year? Do we need more reforms? Better implementation? Vigorous pump-priming? More liberal credit at softer interest rates? It's true that we were clueless earlier, but even more so now.

There is no shortage of discussions and documentations on what needs to be done. Many brilliant suggestions were made in the series of recent meetings with the prime minister, including the presentation of the McKinsey study. Therefore, there is hardly anything new that can be prescribed. Can policymakers seize the opportunity out of the present adversity? Surely, economic fundamentals are operating at the sub-optimal level. Surpluses of supply essentially reflect the deficiencies of demand. Therefore, how to reverse the declining demand in the midst of an emerging crisis is the formidable challenge in front of us.

That the country’s fiscal health will be under acute stresses and strains is now a foregone conclusion. Yet, in the short-term, there is no other option but to reflate the economy through fiscal expansion.

This would certainly entail, among other things:

• fulfilment of all the budgetary commitments of Plan and capital spending
  
• across-the-board or selective substantial reduction in excise (and/or any other form of excise rebate scheme for increased production)
  
• expeditious completion of the disinvestment programme and earmarking its proceeds exclusively for the new infrastructure development initiatives.

As a consequence, we recognise that incremental fiscal deficit (including now foreclosed deficit financing route) will become not only inevitable, but also desirable.

These are extraordinary times and the most difficult phase of transition in the post-reforms period. In this context, the revival of business confidence and stock market sentiments cannot be secured through mere liberalisation of credit and softening of interest rates. In fact, this is no solution to break the bind of deepening demand deflation.

The supply-side equation of the macro situation warrants a Keynesian mode of fiscal expansion, including the printing of currency, howsoever unpalatable this may be to the fiscal purist. This short-term strategic response of course needs to be supported by the long-pending medium-term structural adjustment reforms that everybody is clamouring for.

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* The author is a consultant with the department of economics and statistics, Tata Services