This is Part 4 of our series, 2018 in Review, and focuses on Economics. Specifically, three areas of concern that should worry us in 2019.
When asked what he thought about the French revolution, Chinese premier Zhou Enlai is supposed to have replied that it was too early to comment. Analysts doing the round up of the economic events/themes of the year, sadly, can not resort to such profound wisecracks. The first draft of economic history must be written, no matter how unpolished, tentative and even presumptuous it may seem to the future readers.
So I write about three economic (meta) events which were ‘important in 2018’. These events not only made headlines in the 2018, but also set the stage for the next year. Their economic effects will linger on in 2019, and possibly even beyond.
Normally, trade and war don’t go together. Trade is a positive-sum game; it creates value. War is a negative-sum game; it destroys value. Trade enlarges the size of the economic pie; war diminishes the size of the economic pie. Despite the obvious contrasts, in 2018 the rhetoric of the trade war became increasingly popular. President Trump’s withdrawal from from the Trans Pacific Partnership was followed by the threat to impose tariffs on a long list of tradables.
How will this pan out in the future? Will the US be able to secure bilateral deals that would prevent the full-fledged trade war? If a trade war indeed breaks out, what shape will it take? Will individual countries focus their retaliation against US only or will there be a generic all-out war? There is much that is in the realm of speculation. But one thing is certain: the genie is out of the bottle and it will be very difficult to put it back. Foundational principles of the multilateral trade organizations such as non-discrimination among trading partners are inherently incompatible with the reciprocal ‘deal-making’ which is the talk of the town today.
Needless to say, this will have a long-term and most likely an adverse impact on our living standards. Sherlock Holmes should have the last word on this trade policy. In The Hound of the Baskervilles, Sherlock Holmes comes across this paragraph:
You may be cajoled into imagining that your own special trade or your own industry will be encouraged by a protective tariff, but it stands to reason that such legislation must in the long run keep away wealth from the country, diminish the value of our imports, and lower the general conditions of life in this island.
After reading this passage, Holmes rubs his hands in glee and asks Watson: “Don’t you think that is an admirable sentiment?” Most certainly, it is.
Writing for Pragati in 2017, I had made the following observation:
Economy and polity do not exist in silos; they interact. When the median voter is in pain, she will demand palliatives and ultimately get it. It may be a debt waiver, price ceiling or a cheaper home loan.
The context of the observation was the sharp contraction in the currency supply following Demonetization. In a normal economy, to lubricate the increasing transactions, cash should expand at the rate of nominal gdp growth.
However, in India, the chronic shortage of currency lingered on in 2018. Monetary contraction of this magnitude is bound to have painful consequences, especially in the cash-intensive informal sector, though such consequences may appear with a lag. Now this shortage has come to haunt the policy makers. Agricultural prices have virtually collapsed, especially in the perishable segment. There are reasons for believing that this collapse is an iceberg, merely a visible part of the much deeper agony in the informal sector
The political consequences of this agony are palpable. The ruling party has lost important mid-term assembly elections and by-elections. Worse, there is a strong clamour for sops to address some of these challenges as national elections are around the corner. While the exact contours of these ‘sops’ would be known only in the first half of 2019, it is a plausible assumption that competitive politics will test the limits and resilience of the Indian financial system.
The Banking Sector and the RBI
There are few things that are as consequential for the political economy of the country as the complex triangle between the Finance Ministry, Public Sector Banks and the apex banking sector regulator, the Reserve Bank of India. The year 2018 began with the disclosure of some of the most egregious cases of operational risks and frauds. By some accounts, the loss to public sector banks on this count alone exceeded around forty thousand crore. Add to this the NPAs and the potential risks caused by the impending credit push for the small scale industries and agricultural loan waivers in the election year, and one can predict that the banking sector is unlikely to fade out of the news cycle in 2019.
2018 ended with the news of the growing tussle between the government and the central bank, and consequently the departure of the RBI governor. Irrespective of what the underlying reasons were, this departure has probably reset the relationship between the treasury and the central bank, the consequences of which will be felt far beyond the immediate year.
If you think this roundup is somewhat negative, you’re correct. Public policy by its very nature is risk averse, and a public policy wonk’s view should be hawk-eyed about tail risks. But it would be unfair to overlook positive trends. In the first half of the twentieth century, millions of people were killed in two world wars; the invention of antibiotics like penicillin saved a similar number of lives. On the whole, the world is getting better, and surely India too is making her contribution in the betterment of the world.
On this note of cautious optimism, let us welcome the new year.