An economy is best judged not in fair weather but foul. India has successfully weathered the great financial crisis of September 2008. Indian GDP has grown around 6% in every quarter of the most difficult 12 months in recent history. Most countries suffered an outright fall in at least one quarter.
The global recession started in December 2007. The initial impact on India was muted: GDP growth slowed from 9% in 2007-08 to 7.8% in April-September 2008, still a very high rate. But after Wall Street collapsed in September, India’s growth plummeted to 5.8%, 5.8% and 6.1% in the next three quarters. This was a comedown. Yet it far exceeded the World Bank’s forecast of 4.0% growth in 2009. It exceeded my expectations too.
Let’s compare India’s performances in the Great Recession and Asian financial crisis. In the latter, India’s GDP growth fell to just 4.5% in 1997-98, of which 1% was a boost from the Pay Commission. Today, the annual rate of growth exceeds 6%, of which 0.5% is a Pay Commission boost. That’s a big improvement.
In 1997 India’s foreign exchange reserves were strained, interest rates went sky-high, companies defaulted on loans and dragged down banks. But in 2008 India’s high foreign exchange reserves prevented any panic, even after foreign institutional investors withdrew $ 12 billion from the stock market and foreign credit suddenly vanished.
Indian corporates were much less over-borrowed in 2008 than in 1997, and Indian banks were far better capitalized, so they withstood the financial crisis. Companies that had borrowed big for new projects in 1997 collapsed, and many begged for debt forgiveness. In 2008, Tata Steel, Tata Motors and Hindustan Aluminium had raised gargantuan dollar loans for foreign acquisitions, yet managed to weather the storm.
So resilient was India’s performance that the very foreign investors that had withdrawn $ 12 billion in 2008 flooded back into Indian stock markets at the rate of $1billion per week in May 2009. This was in stark contrast with the Asian financial crisis, when foreign institutional money remained a trickle for years.
Why did India suffer so little in the Great Recession that laid low the biggest economies of the West? First, Indian banks and financial institutions had almost entirely avoided buying the mortgage-backed securities and credit default swaps that turned toxic and felled western financial institutions. Second, India’s merchandise exports were indeed hit by the Great Recession—they declined by around 30%. But service exports did not fall—computer soft ware and BPO exports held up well. This provided an important cushion to Indian exports.
Third, remittances from overseas Indians continued unabated, hitting a record $ 46.4 billion in 2008-09, up from $ 43.5 billion the previous year. The 2008-09 flow was 4% of GDP. To put this in perspective, remember that India’s entire merchandise exports were barely 5% of GDP in the mid-1980s. So emigration (including the so-called brain drain) plus policies to eliminate the black market premium on the dollar now provide a huge balance of payments cushion. Back in the 1991 crisis, India turned to the IMF as lender of last resort for a structural adjustment loan of $ 4 billion. Remittances now make the IMF (and World Bank) look puny.
Fourth, foreign direct investment remained high at $ 27.3 billion in 2008-09 despite the global financial crisis. Financiers reversed flows into India, but long-term investors in plant and factories completed their ongoing projects. Lesson: foreign direct investment is a stabilizing force.
Fifth, monetary policy, which was savagely restrictive in 1998, was accommodating in 2008. In 1998, to check a run on the rupee and penalize banks trying to hoard dollars, the RBI raised the bank rate and cash reserve ratio of banks hugely. This sucked out liquidity, and interest rates skyrocketed. This checked the run on the rupee, but was terrible for industry. By contrast, the RBI in 2008 did not tighten money to save the rupee, which was allowed to fall from Rs 40 to Rs 52 to the dollar. Instead the RBI lowered interest rates and expanded credit. The government cut excise duties to stoke demand. This combination of easy fiscal and monetary policy cushioned the shock to the economy in ways that were missing in 1997-98.
Some things look much worse in 2009 than in 1997. Politicians look more venal, bureaucrats more callous and corrupt, the police more incompetent (and in Gujarat’s case more communal). Maoists are a problem in 160 districts. But even as political management seems to be eroding, economic management has greatly improved. Whether this paradox is sustainable remains to be seen.