Jayati Ghosh asks this question and answer really is “This time is different” (though she does not mention the four word deadly phrase).
She points India had this thing coming for a while now and is a surprise why experts missed it:
These are all classic features of the panic phase of a financial market cycle. This doesn’t mean that a crash is inevitable, but clearly it is possible. The real surprise in all this is that investors and Indian policymakers are surprised. For some reason, they apparently did not foresee this turn of events, even though the story of every financial crisis of the past, and many in the very recent past, should have caused some nostrils to twitch at least a year or two ago.
The Indian economy has been in trouble for quite a while already, and only wilful blindness could have led to ignorance on this. Output growth has been decelerating for several years, and private investment has fallen for 10 consecutive quarters. Industrial production has declined over the past year. But consumer price inflation is still in double digits, providing all the essential elements of stagflation (rising prices with slowing income growth).
At the moment the external sector is the weakest link. Exports are limping along but imports have ballooned (including all kinds of non-essential imports like gold), so both trade and current account deficits are at historically high levels. They are largely financed by volatile short-term capital. This has already started leaving the country: since June more than $12bn has been withdrawn by portfolio investors alone.
This situation is the result of internal and external imbalances that have been building up for years. The Indian economic boom was based on a debt-driven consumption and investment spree that mainly relied on short-term capital inflows. This generated asset booms in areas such as construction and real estate, rather than in traded goods. And it created a sense of financial euphoria that led to massive over-extension of credit to both companies and households, to compound the problem.
Sadly, this boom was also “wasted” in that it did not lead to significant improvements in the lives of the majority, as public expenditure on basic infrastructure, as well as nutrition, health, sanitation and education did not rise adequately.
We should know by now that such a debt-driven bubble is an unsustainable process that must end in tears, but those who pointed this out were derided as killjoys with no understanding of India’s potential. Something similar is occurring in a number of other Asian economies that are also feeling the pain at present, such as Indonesia – while the Brazilian economy shows some similar features. The current Indian problems may be extreme, but they reflect what should now be a familiar process in all major regions of the world.
This paper shows how India’s 2003-08 boom was debt driven and not really funda driven..
Further Ghosh says all this has been shown extensively by Charles Kindleberger 50 years ago:
The typical story, which was elaborated half a century ago by Charles Kindleberger, goes something like this: a country is “discovered” by international investors and therefore receives substantial capital inflows. These contribute to a domestic boom, and also push up the real exchange rate. This reduces the incentives for exporters and producers of import substitutes, so investors look for avenues in the non-tradable sectors, such as construction and real estate. So the boom is marked by rising asset values, of real estate and of stocks. The counterpart of all this is a rising current account deficit, which no one pays much attention to as long as the money keeps flowing in and the economy keeps growing.
But all bubbles must eventually burst. All it takes is some change in perception for the entire process to unravel, and then it can unravel very quickly. The trigger can be a change in global conditions, or a sharp slowdown in domestic income growth, or political instability, or even economic problems in a neighbouring country. In India Ben Bernanke of the US Federal Reserve is being blamed for bringing this on, but it could easily have been some other factor. Once the “revulsion” in markets sets in, the very features that were celebrated during the boom are excoriated – by both investors and the public – as examples of crony capitalism, inefficiency and such like. The resulting financial crisis hits those who did not really benefit so much from the boom, by affecting employment and the incomes of workers.
This is what has just started to happen in India, and is also likely to happen in several other emerging markets. But essentially the same process has already unfolded many times before in different parts of the world: Latin America in the 1980s, Mexico in 1994-95, south-east Asia in 1997-98, Russia in 1999-2000, Argentina in 2001-02, the US in 2008, Ireland and Greece in 2009, and so on.
So how come experts missed it..Well it was the four word phrase and plenty of others which have been coined in last 4-5 years..
There is also an interesting piece by Arvind Subramanian and Devesh Kapur pointing to reasons for the crisis, They call it India’s Unique crisis which does not resemble any of the previous crises. Not really..small things have added to make it a big story.
What India is going through was unimaginable even a few months back . And one key reason is complacency shown by both politicos and its expert economic advisers. Some newspapers have highlighted that the same team was present in 1991 crisis as well and this can help today as well. It has been 22 years since the 1991 crisis took place and we still have the same team? Is that a sign of confidence?
Time and time again we have been told things will be fine only for them to become worse. The one thing that comes to mind is inflation. This is one thing in which government has failed successively for many years now. Each reading we are told it would be brought lower. Focusing on WPI inflation, there was some decline in 2012-13 but CPI was twice of WPI. All know it is CPI which matters to public but has been ignored.. Food inflation remains high despite good monsoon, bumper crops etc.
They are all hooked to India’s 8-9% potential growth (which they still are), The belief was India can achieve it without any work at all. It was just magic which was bound to happen.. Only to realise it was just cheap magic tricks which was to be discovered soon….I mean Africa has always had potential all these years but keeps disappointing on its growth outlook..
Though this blog has always questioned the India growth story and firmly believed that it was because of unique global factors that we achieved 9% growth in 2003-08. What was the big deal when most countries achieved higher growth rates during the period? Moreover, it was not macro data which still looked good a couple of years back but the steeply declining quality of life in India. It has become really depressing to live in India’s top cities which have become hells. The story is no better in smaller places as well. People are struggling to get basics at a reasonable price and low transaction costs. Governance has failed to deliver basic public goods and people have created their own parallel informal systems which create/will create further problems..
This blog has written enough on all this and do not want to spoil the rest of the evening on this…
This blog actually proposes to invite all the honorary econ experts to testify in Indian Parliament like they do in other countries. Though for this the Parliament needs to function first! People need to get a perspective on what was going on all this while and why we have managed to reach here despite the potential? Why they have they remained silent on key issues like NFSB and instances of where they highlighted the risks if any.. There should be far more accountability to these key positions and need for a serious debate than simply giving newsbytes on TV channels…