Beware! Recession coming
Four factors indicate the possibility of a recession. The United States central bank, known a Federal Reserve Board or the ‘Fed’ has increased
Four factors indicate the possibility of a recession. The United States central bank, known a Federal Reserve Board or the ‘Fed’ has increased interest rates by 0.25 percent. This is small but it has made clear its intention to increase the rates three times in 2017. The United States is considered to be a safe haven. An increase in interest rates will encourage foreign investors to pull money out of the emerging markets like India that are considered more risk prone and invest in bonds issued by the US government. Foreign Institutional Investors have already pulled out about $ 2 billion recently. The share markets are down and value of the rupee has declined because of this repatriation. This flight on foreign investment from India is likely to continue due to the expected increase in interest rates in the United States in the coming year.
The second reason is the increase in oil prices. About a third of the global oil supply is produced by members of the OPEC, which includes oil majors like Saudi Arabia. These countries have recently decided to reduce the production so that the prices may rise. Consequently, the prices have inched up from about $ 45 per barrel to about $ 55 per barrel. India is a major importer of oil. An increase in the price of oil means that more money will go out of the country for these imports. People will have less money left in their pockets to buy other goods from the Indian markets.
The third reason is the increasing lack of confidence in the financial system. Large numbers believe that the government will again demonetise the new notes of Rs 2000. Some fear that notes of Rs 100 too may be demonetised. There is talk of the government seizing bank lockers and asking the owners to explain the source of gold and jewellery stored therein. Prime Minister Modi has declared that the government will start scrutiny of benami property held in the names of employees or non-existing persons. There is a sense of fear all around. Attention of the people has turned to protecting the income earned by them till now rather than earning more in the future. Businesses make decisions to invest in new factories based on their expectations of future demand.
These expectations are like oil on water today. The fourth reason is the lack of demand in the economy. The Finance Minister has made it known that the money deposited in the banks in the present drive of demonetisation will be used to reduce the debt of the government. That is a laudable objective. However, this means that there will be no increase in demand from the government. On the other side, there will be less money in the hands of the people. Thus, there will be contraction of demand from the people and stagnation of demand from the government. The total demand in the market will fall. These four factors have come simultaneously and are likely to pull the economy into a recession.
The government must act fast to prevent such an eventuality. The first cause of a possible recession was increase in interest rates in the United States. It will not be possible to attract large amounts of foreign investments in this situation. However, we can take steps to keep our capital within the country. The Prime Minister has expressed concern that Indian businessmen were investing overseas rather than in India. Reason is that they are welcomed with respect in foreign countries while they are being hounded as scoundrels in India. My assessment is that Indian businessmen do not want to indulge in tax evasion.
They are forced to do so. A few unscrupulous businessmen start evading taxes in collusion with tax officials. They sell their goods at cheaper rates in the market because they do not pay taxes. The honest businessman who pays taxes cannot compete with them. As a result everyone starts evading taxes. The problem starts with the tax officials colluding with businessmen. It the job of tax officials to collect taxes, not help evade them. There is no alibi for the collusion of tax officials. The government must take steps to check corruption among these officials instead of hounding businessmen. A more positive attitude towards businessmen will encourage them to invest their monies in India rather than overseas. That will help counteract the negative impact of outflow of foreign capital due to the increases in interest rates in the United States.
The second cause of a possible recession was increase in the international price of oil. The way out is to reduce the consumption of energy in the country. The government is focussed on increasing manufacturing in the country. Manufacturing requires large amounts of energy in the form of electricity, coal or oil. We need to step back from this and promote the services sector instead. One rupee of GDP created in manufacturing consumes ten times the energy in comparison with the same one rupee of GDP created in services. Secondly, we must introduce steep progressive pricing of energy.
Those consuming, say, more than 100 units of electricity per person per month should be charged at Rs 15 per unit. Those running cars giving an average of less than, say, 15 km per litre of diesel or petrol should be charged at double the rate in comparison with fuel-efficient consumers. Every car owner must be required to produce an “Aadhar card” of the car specifying his fuel consumption. Reduced oil consumption will prevent hiher outflows due to the imports of oil.
The third cause of a possible recession was lack of confidence in the financial system in the wake of demonetisation. The government must assure the business community that it will not hound them. The talk of seizing bank lockers and benami property must cease. The government has enough powers under the existing laws to take action against those indulging in these activities. It must act quietly against them instead of making loud noises.
The fourth cause of a possible recession was a reduction in demand due to the government using the tax receipts for repaying debt. This measure is necessary but should be deferred until the economy is firmly established on the growth path. For the present, the tax receipts should be used for increasing investment. One does not ask a sick man to engage in exercises. Similarly, repaying of debt must wait.