Decoding World Bank report: India not prepared for the next financial crisis

In the wake of the Lehman crisis in 2008 that took down one global financial biggie after another, Indian policy makers were patting themselves on the back. Then finance minister (who is currently the President of India) Pranab Mukherjee, finance ministry mandarins as well as many leading economists argued that India's conservatism in opening up the financial sector had insulated its economy from the global headwinds.

Congress president Sonia Gandhi famously said it was her late mother-in-law's bank nationalisation that saved the Indian financial sector.

But does that mean that India is well prepared to face any crisis or risk? Far from it, if one goes by the World Bank's World Development Report, 2014. The report, titled Risk and Opportunity: Managing risk for development, has drawn up a risk preparation index (RPI) that estimates preparation for risk across countries. On a scale of 0 to 100, India scores a mere 31.

The components of the index are: average years of schooling; immunization rate for measles; proportion of households with less than $1,000 in net assets; access to finance index; percentage of the labour force contributing to a pension scheme; proportion of respondents stating that "in general, people can be trusted"; percentage of population with access to improved sanitation facilities; and gross public debt as a percentage of revenues. The risks that the report deals with occur at the level of the household, enterprises, financial sector and the macro economy. So, the entire gamut of risks - from illnesses and job losses to natural disasters to global financial meltdowns - is covered.

Forget the world average of 55, India's score is even lower than that of the lower middle income countries average of 43. Needless to say, India trails other countries that it considers itself as being in the same league with. Russia scores 71, China 69, Brazil 58 and South Africa 45.

 Decoding World Bank report: India not prepared for the next financial crisis

Index of risk preparation across countries. Source: World Bank

India's casual attitude to risk management is typified by the example of Mumbai, which is the lead in for a chapter on obstacles to risk management. The report notes that a Brimstowad (Brihanmumbai Stormwater Disposal System) report had, in the early 1990s, listed several steps to help Mumbai cope with the annual monsoon fury. Till 2005, when the city was ravaged by unprecedented rainfall, very few of those recommendations had been implemented. The Madhav Chitale fact-finding committee, appointed after the 2005 flood, made suggestions very similar to those made in the Brimstowad report. "These measures were supposed to be implemented by 2015. But as of 2012, only about one-fourth of the 58 projects in the 1993 Brimstowad Report had been completed, while the tendering process for four major projects had not even begun," the report points out.

In contrast, Bangladesh gets a pat on the back. The report points out that India's tiny neighbour was hit by three cyclones of similar magnitude in 40 years. The first, in 1970, claimed 300,000 lives; the toll in the second, in 1991, was 140,000 while in the third it was 4,000. The steady decline in casualties has been attributed to a nationwide program to build shelters (from 12 in 1970 to over 2,500 in 2007), investments in improved forecasting capacity and a relatively simple but effective system for warning the population.

This year's WDR is focussed on risk management - the process of confronting risks, preparing for them, and coping with their effects - because the world has seen huge positive and negative changes. While globalisation and technological modernisation have ushered in immense benefits, economic crises, natural disasters and medical epidemics have brought a lot of turbulence in their wake.

While the reflexive response is to insulate oneself from change in order to avoid risk, the report argues that managing these risks can be a powerful instrument for development. It makes a few simple points.

• Taking on risks is necessary to pursue opportunities for development. Inaction should not be an option.

• It will be easier to cope with risk if one shifts from unplanned and ad hoc responses when crises occur to proactive, systematic, and integrated risk management.

• Governments have a critical role in managing systemic risks, providing an enabling environment for shared action and responsibility, and channeling direct support to vulnerable people.

Whenever the UPA government is put on the mat for mismanaging the economy, the standard defence that is trotted out is that the current slowdown is the result of global factors, which could not have been anticipated. That defence becomes a tad weak in the light of this report, which lays a lot of emphasis on sound and stable macroeconomic policy to manage risks. `A stable macroeconomic environment and ample revenues and resources -fiscal space - to finance government programmes and policies reduce uncertainty and enable economic agents to concentrate on productive activities rather than on trying to mitigate high risks,' the report says.

Though the report does not specifically talk about India in this context, it soon becomes clear that if India had managed its economy better in the pre-crisis years, it would not have been in the mess it is in now. The government, despite being headed by a top-notch economist, can hardly take credit for setting up `credible, transparent, more flexible, and sustainable macroeconomic policy frameworks' which, the report says, increase a country's resilience.

Nor can the country claim to have 'credible, predictable, transparent, and sustainable' monetary and fiscal policies that will help people manage risks. 'That requires building reputation and policy space in good times by keeping inflation low and stable, having exchange rate arrangements that absorb shocks from the international economy, and following fiscal practices that generate adequate surpluses and reduce the public debt burden.' Can the UPA government honestly say it has done these? Instead of behaving 'prudently during upswings' in order to accumulate resources for bad times - one of the suggestions of the report - the government went about squandering resources on patently wasteful welfare programmes and unsustainable subsidies which have the potential of weakening the economy in the long run.

The report cites the examples of the Czech Republic, Kenya and Peru where lower fiscal deficits, disciplined monetary policy and lower current account deficits helped the countries cope better with the 2008 international crisis than they did with the 1997 East Asian crisis.

The report laments that `policy makers seem to have short memories regarding the origins of crises'. Systemic financial crises, it points out, are almost always preceded by unusually high credit concentration and growth. Even though this process is well understood, `policy makers often do little to control credit booms'. If it were not for the fact that such a voluminous report could not have been printed overnight, it would look as if this was directed specifically at finance minister P. Chidambaram asking banks to give cheaper loans for consumption as a fillip to certain industries, despite its dangers (See more here and here ).

The report suggests that countries set up an independent fiscal council to provide the right incentives for the government to build up resources to cope with cyclical downturns and long-run contingencies. The councils, it says, should be designed in a way that avoids political capture, the rise of government incentives to ignore council advice, or the possibility of being dismantled when conflicts within government occur.

By 2012, 22 countries had such an institution in place. If an independent council is not feasible, the reports suggests 'adopting transparent and comprehensive fiscal frameworks, including top-down approaches to budgeting'.

India had something similar, in the form of the Fiscal Responsibility and Budget Management Act, which had clear targets for reducing the revenue and fiscal deficits. But first Chidambaram postponed the revenue deficit elimination by a year when the Act (passed in 2003) was being notified. And then less than a year after that, pressed the 'pause''button on the FRBM target. His successor, Mukherjee, went a step further and brought in the concept of an `effective revenue deficit' ostensibly because a lot of capital expenditure was being shown as revenue expenditure. All it did was dress up the deficit numbers, obviating the need to reduce either the revenue or the fiscal deficits.

When economic policy makers resort to such numerical calisthenics, there is no scope for any transparent frameworks or independent institutions. Or for managing whatever risks buffet the country.

Seetha is a senior journalist and author

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Updated Date: Dec 21, 2014 00:36:43 IST