Why India Inc should not ask for the moon from govt

By R Jagannathan

For the average businessman, macroeconomics is as far from being a concern as melting ice-caps. For them immediate cuts in interest rates or duty concessions (or protection) or FDI in retail seem more relevant.

Expecting miracles from Manmohan Singh in two weeks is foolish without understanding what is going on everywhere, including in our own backyard.With a bad fiscal deficit to cover, political allies to appease, and global investors to pander to, it is anybody’s guess if Manmohan Singh can hope to keep the domestic business lobby happy.

So, it’s time businessmen paid more attention to macroeconomics and events far away - even if it does not directly affect them. Demanding interest rate cuts when they can’t be given is like living in a state of denial.

[caption id=“attachment_385745” align=“alignleft” width=“380”] Expecting miracles from Manmohan Singh in two weeks is foolish without understanding what is going on everywhere, including in our own backyard.[/caption]

A mosquito is harmless if it’s just buzzing around an elephant. But if it gets into the animal’s ear, the pachyderm goes crazy and may end up trampling everyone in the vicinity. Right now, Greece and Spain have got into the ear of the world’s largest economy - the European Union - and whether they stay in or go out (Greece is still a 50:50 case, while Spain is unlikely to leave), they have rocked everybody’s boat.

How did this happen?

It’s called the butterfly effect. Mathematician and meteorologist Edward Lorenz, who coined the term, found that a very small difference in initial weather conditions may have a very large effect as it gathers steam. Thus, a butterfly snapping its wings in Mexico may set off a chain of events in air and wind conditions that ultimately result in a tornado somewhere else. It is not the butterfly which causes the tornado, but it could well have set forces in motion that result in it.

Greece is not the cause of the world economy’s current problems. But it has exposed the flaws in the world economic system like never before - and threatening its edifice.

This is exactly what happened when the US government decided to let Lehman Brothers go bust in 2008. But instead of just one investment banker going under (RIP), the subsequent loss of confidence in the viability of the banking system sent the entire world economy into a tailspin.

Over the last one year or more, tiny Greece’s bankruptcy has triggered off another Lehman kind of chain reaction that will result in a global slowdown or recession no matter what policymakers do.

This is why regardless of whether Greece stays or exits from the eurozone, we will be impacted even if the Indian economy has nothing to do with Greece. This is why macroeconomy matters - and businessmen need to develop the ability to connect the dots from what seems to be an isolated event to the bombshell that lands in their backyards.

In the short term, here’s what global macroeconomics is telling us.

This is the first time in living memory where all of the world’s growth engines are simultaneously faltering.

After Lehman, the US economy crashed, and so did Britain. The eurozone’s leaders thought it was those stupid Anglo-Saxon economies that are failing, not us. We are safe in Fortress Europe.

Then Greece, which had overborrowed by fudging figures, sent out a distress signal. As the markets started noticing that the country could not possibly pay back its huge debts, they started examining signs of similar stress in other countries: Portugal, Ireland, Italy, and Spain. Add Greece before Spain, and you got Europe’s PIIGS. To their shock, they discovered that all of them were in the same boat - though for different reasons and in different degrees.

Despite a promised bailout of its banks, bond yields in Spain have crossed 7 percent and Italy is faltering. Eurozone’s future is not assured.

Today, it is the Americans who are goading Europe to “do something” to prevent a second global contagion. America’s own economy is on steroids, with near zero interest rates for nearly three-and-a-half years, but its growth is looking anaemic. Europe is headed that way too.

When you connect the dots, this is how the world looks today. The US and Europe are decelerating; this means the world’s biggest exporters - China, Japan and Germany - will also slow down, though Japan has been in a coma for the last 20 years.

As for India, we have managed to shoot ourselves in the foot by mindless government spending and by letting inflation rip for the last four years. Our own economy is careening to a halt.

So what will happen to the rest? When all growth engines slow down, commodity exporters will also see prices crash. We can expect oil and metal prices to fall in the coming months.

To prevent another global recession, the world will unleash a flood of money - either through continuous monetary easing, or by lower taxation, or both. Europe, the UK and China have already done so. At a time when all countries are running huge fiscal and budgetary deficits, prudence demands that belts should be tightened, not loosened. But that will not happen because no politician likes a slowdown and austerity is a strict no-no when the economy is going down the tubes.

The politicians won’t do what is right. Central bankers can’t do anything beyond monetary easing. After all, you can’t push interest rates below zero.

Even as a flood of liquidity is unleashed, the world will probably see a brief spurt in cash flows to equity, gold and various asset markets - but the spurt of optimism will probably not be lasting. Once the markets have digested the easy money, they will go back to their moping and moaning. Reason: budgets ultimately have to be balanced. A flood of money can only lead to inflation in a falling output scenario.

The macroeconomic challenge for the world is this: countries have to balance budgets and trade. The world’s big exporters - China and Germany - have to export less and consume more. The world’s big consumers, the US and the southern eurozone countries, have to cut down on consumption and start saving to balance their books.

This will call for a fundamental realignment of the direction of trade and global incomes. Europe and America have to prepare for a reduction (or at least a sharp slowdown) in prosperity, something like what happened in Japan over the last two decades. Till this adjustment happens, the world economy will continue to teeter from one crisis to another.

The same scenario beckons in India, too. Our current account deficit, currently at 4 percent of GDP (but now coming down due to a slowing economy and the sharp drop in the rupee), is a mirror image of government overspending (an estimated fiscal deficit of 5.1 percent of GDP in 2012-13). The government’s high spending has pre-empted savings, and the private sector is being crowded out of the market through high-cost credit. This has resulted in stagflation: a mix of slowing growth and rising inflation.

Over the next three years, global and domestic macroeconomics is going to bite you in the butt.

Whether you like it or not, credit is going to remain expensive, capital will be difficult to access, and the markets will not reward you well. And taxes will, in all probability, be raised, either through a hike in rates or a reduction in subsidies.

So what do you have to do now?

First, make sure you use surplus cash very wisely. Second, this is the time to squeeze efficiencies out of everything - from supply chain to raw materials. Third, this is also the time to axe losers in your portfolio and invest in winners. Four, you have to keep hiring to a minimum. And five, this is also the time to examine the tradeoff between higher margins and higher volumes. Infosys is in precisely this kind of dilemma now. If it chooses margins, its business will not grow - or even decline.

Don’t forget to watch what’s happening in Greece, or Italy or Spain. Watch the macro economy. Also don’t forget your own backyard - India. Manesar tells us the urban labour is going to be tougher to handle. We are going to live in interesting times.

And think twice before asking for all kinds of concessions from government. Manmohan Singh doesn’t have much money to play around with.

(This article has been adapted from a piece written for The Entrepreneur_)_