Don't get stampeded

Mukherjee's advice right for Europe and India

The caution that Finance Minister Pranab Mukherjee sounded at the recent G20 meeting seems to have been very timely. The world economy and particularly the developed countries face an active danger of a double-dip depression in the aftermath of the Greek crisis and so there is a need to avoid rushing to the fiscal exit all at the same time, Mr Mukherjee advised. Fiscal deterioration is a natural corollary of deep and prolonged downturns as governments try to stimulate economies back to their potential. The slow signs of recovery that the globally coordinated fiscal stimulus generated in the aftermath of 2008 appear threatened in the face of the belt-tightening measures that European economies like Spain, Portugal and Ireland are introducing in order to avoid the fate of Greece. The dilemma faced by policy-makers is real. Investors and markets will give a thumbs down to economies whose fiscal health appears seriously undermined. But the attempt to cut spending too soon will inevitably take economies towards a prolonged period of high unemployment and low or non-existent growth, as has happened in Japan, which, in turn, will severely undermine tax revenue and fiscal consolidation. As the Indian experience prior to 2008 has shown, robust growth is among the best cures for fiscal ill health.

In the circumstances, the need of the hour for developed countries is to calibrate the easing out of the fiscal stimulus so that recovery is not threatened while at the same time introducing structural changes that seek to restore long-term fiscal health and competitiveness. For this, you need time and the crux of the matter is that markets don’t like to wait. In the circumstances, the 16 European countries are doing what exactly is needed, putting together a special purpose vehicle (SPV) which will garner ¤440 billion to lend to countries that face Greece-type problems, threatening their debt and equity markets. This fund will essentially be doing what the International Monetary Fund should have been had it not been emasculated over the years, giving countries a breather so that they can do the right thing and not be stampeded into wrong and counterproductive measures by jittery markets.

India is not directly affected by this in the short run but hobbled recovery in the developed world cannot but affect it adversely, foremost via evaporating demand for exports. The fiscal situation in India has, of course, received a boost through the huge amounts that the government has collected and will continue to collect through spectrum auctions to the telecommunications sector. This will give it the same breathing space as the SPV can give to the Europeans so that the one-time revenue boost is used to bring in long-term structural improvements. India needs to continuously improve its competitiveness by reducing transaction costs that measures like the introduction of the goods and services tax should enable. There is also the urgent need to set right agriculture so as to bring down food inflation. A good monsoon, like a special fund or spectrum bonanza, at best offers a respite which has to be used well to face future battles.