The Hindu Business Line : Implications of US Fed rate cut

ONE of the fallouts of globalisation and liberalisation is that economists seem more concerned about the world economy rather than restricting their worries to national boundaries.

The contagion effect — a term coined during the Mexican crisis and which troubled economists during the South-East Asian crisis — has assumed larger dimensions.

The world economy is so well-integrated that the chain reaction following the actions of the Big Player — the US — and its implications have become increasingly difficult to predict.

Not long ago, the IT boom in the US led to a surge in business sentiment, worldwide.

Every individual in the business arena was talking about the exponential growth rate, but consumer confidence has been let down and investor sentiments have crashed.

The slump in the world economy has made consumers and investors overcautious.

There is a tendency among the bulls and bears to follow the market in terms of overestimating the growth potential during a boom, and overemphasising the downturn during slumps.

As a result, consumers are holding back money to make purchases later.

There has been a significant decrease in the propensity to consume.

Therefore, the multiplier effect and, hence, a fall in the quantum of investments and in business confidence.

The recent rate cut by the Federal Reserve Chairman, Mr Alan Greenspan, makes one wonder: Are we getting caught in a world liquidity trap — a situation where investors the world over will expect the interest rate to fall further, thereby holding on to their savings in liquid form and using the cash for speculative activity, affecting bond prices? Perhaps, not.

At least the European market is not in tandem with the US and other world markets.

However, the real interest rate in the US has gone negative, which implies that a consumer who postpones his purchases today has to spend more money tomorrow.

If A saves $100 in a bank he is going to get $102.9 after one year, but the goods worth $100 now will cost $103.4. Who is the gainer?

Though ridiculous, this is the logic that prompted Mr Greenspan to go with the rate cut, expecting the increase in consumer spending, to push demand and provide a fillip to the economy.

How will India be affected by the rate cut? With capital getting negative returns in the US, the consumer whose spending is expected to have a multiplier effect, will play an important role.

This will bring forth the real sunrise sectors for the decade. Capital from the US will flow to greener pastures, China and India.

To take complete advantage of this situation, the Government has to play its cards right this time.

The politicians, economists and the mass have, hopefully, learnt their lessons from the Chinese. We cannot sustain the growth rate by attracting one-tenth the FDI and FII that China does.

The proposed Government investment in infrastructure will attract capital inflow; disinvestments will be the bonus.

Government spending will provide purchasing power to the masses which, in turn, will boost production and revive market sentiments.

The better returns from the Indian market, coupled with a laissez-faire policy will definitely boost the FDI and FII inflows.

The Government's plan to start a one-to-one marketing programme aimed at Fortune-500 companies will also, it is hoped, generate capital inflows.

What are we waiting for Mr Sinha?

(The author is consultant, Major Management Consultants, Chennai.)

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