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UN report and India -- `New', `Old' and a confused economy

G. Srinivasan

THE 4.1 per cent negative growth logged in exports in June and a meagre 1.76 per cent growth in the first quarter (April-June) of this fiscal testify to the troubles of the manufacturer-exporters in penetrating the foreign market.

The Commerce Ministry is averse to predicting the export growth for 2001-02, the final year of the Ninth Plan (1997-2002) since export performance is swayed, among others, by global market conditions, export competitiveness of the domestic industry and t hat of competitors in other countries. In fact, it trumpets with force that India's lower export growth so far this fiscal is ``on account of slowdown of the US and other developed country economies''.

Be that as it may, the fact remains that India's major trading partners are the US and the West European countries which together accounted for 46 per cent of its aggregate exports in 2000-01. It was expected that the US and West Europe would show a dist inct downtrend this year, dashing hopes for any substantive export growth for India in the short term, even as the prospects of diversifying into the Pacific or African markets do not hold much lucrative returns. This is so as the Pacific market is depen dent on the developments in the US, while the African market even in normal times, does not offer high returns.

It is in this context that the recent report of the United Nations' World Economic and Social Survey, 2001 assumes importance for deriving clues to India's foreign trade scenario, in general, and exports, in particular. But the message of this report is not inspiring as the world economy is experiencing another setback in the form of a significant decline in the growth of output and trade, with recovery from the 1997-98 international financial crises still `incomplete'.

Earlier prognosis pointed to a slowdown in global economic growth for the second half of 2000, but the celerity, breadth and depth of the declines had not been foreseen. From over 4 per cent in 2000, the growth of gross world product (GWP) is expected to slow to about 2.5 per cent in 2001 in contrast to the 3.5 per cent forecast in the previous UN assessment. The expansion of global international trade is also expected to decelerate to 5.5 per cent in 2001 from about 12 per cent in 2000.

The current slowdown began in the developed economies, especially the US, in the latter half of 2000. The slowdown, which initially popped only in a few economies, has since broadened and intensified. The current weakness of the world economy stems from a congeries of interrelated developments in the past year which would also be the main determinants of global economic growth in the short term, the UN report avers.

The slowdown was triggered by escalating monetary tightening in major developed economies, particularly the US. In the late 1990s, the US economy was growing at a clip that policy-makers perceived to be unsustainable as demonstrated by an increasingly ti ght labour market, growing external deficits, negative household savings and astronomical levels of private sector debt.

It was widely apprehended that, if left unaddressed, these pressures would result in an acceleration of inflation, followed by a rapid deceleration in growth. In mid-1999, the US Federal Reserve began to tighten monetary policy with the goal of moderatin g demand in order to preempt a resurgence of inflation and engineer a soft-landing.

Central banks in most other developed economies followed the same tack and, globally, interest rates were raised by 150-200 basis points (bps) within a year. Monetary policy in most developed economies maintained this stance until at least the end of 200 0, and in the euro zone until May 2001. As more signs of a sharper-than-desired slowdown emerged in the start of 2001, developed countries began to ease monetary policy by reducing policy interest rates.

As with the earlier tightening, the Federal Reserve led the adjustment, with five cuts in interest rates, totaling 250 bps in the first five months of the year. UN Survey economists hope the monetary easing in more developed economies will moderate the g lobal slowdown even as the lag between a reduction in interest rates and its effects on the economy is normally at least six months, suggesting that ``a recovery is unlikely to occur before the second half of 2001''. So, the authorities can still hope th at India's exports will look up after the second quarter.

Tracing the causes of the slowdown, the UN report says the majority of world equity markets registered substantial losses in 2000 and during the first quarter of 2001, with the rally in equity prices -- both in Old Economy stocks as also the tech ones -- not picking up at the desirable pace. The declining values in global equity markets had an adverse impact on consumer and investment sentiment, leading to reduced consumption and corporate investment.

The UN report contends that the collapse in the value of tech stocks has also whittled down the availability of funding for business investment, in particular, initial public offerings (IPOs) for technology companies. The supply of venture capital funds for start-ups contracted swiftly, in part because the decline in the equity value inhibited the recycling of funds, but also because investors are more risk-averse.

The UN report recalls that for the US and many other advanced economies, investment in the Information and Communication technologies (ICT) sector grew at 30-40 per cent annually in the late 1990s and was the driving force for their robust overall econom ic performance. Particularly, through trade, it was also the major impetus for economic recovery in several developing countries and economies-in-transition.

An interesting point rammed home by the UN report is that the advent of the ICT-based `New Economy' does not imply that the behaviour of investment in ICT differs from the pro-cyclical nature of business investment in general and, therefore, does not imp ly the business cycle is extinct.

Moreover, the factors behind the slowdown, according to the report, in the world economy are the interrelated decline in corporate profits, the tightening of credit conditions and the decrease in investment spending.

As a consequence of the excessive or imbalanced investment in the leading sectors, expected profits failed to materialise. The tightening of monetary policy (as a result of fears of overheating and in a bid to curb asset inflation) and the collapse in eq uity prices caused credit conditions to worsen. This admixture of factors, rather than accelerate core inflation, led business confidence to decline and brought the investment boom to an end, precipitating the slowdown.

A point to note, as the recent experience suggests, is that the shift from `boom' to `bust' may be much faster in the present environment than in the conventional cycle. This interpretation needs to be studied in full because, all said and done, the Old Economy business cycles were slow in the transition phase from boom to bust, unlike the New Economy one which is quick in its vicissitudes and virulent in impact, leaving a whole class of entrepreneurs and investors practically immobilised.

In this regard, the UN report warns that the New Economy firms might take aggressive action to restore profits by reducing labour inputs, trimming inventories and cutting capital spending, causing other firms and economic agents to lower their expectatio ns (or what is euphemistically christened `irrational exuberance') about future earnings.

Fragile stock markets are also likely to decline further in response to the worsening earnings projections, causing a broader deterioration in consumer and business sentiment and tightening conditions in the credit market.

Against this sombre backdrop, the recovery may not be as rapid as the downturn because, once lost, business confidence may not improve as quickly as it deteriorated. This is partly because it is likely to take some time to adjust to the excess capacity c reated by the high rate of investment in the technology sectors.

In essence, the UN report sums up the dilemma confronting the global economy by stating that just as elements of the `Old Economy' continue to coexist with the `New Economy', elements of the old business cycle will complement the features characterising the new cycle: ``It is this intersection of the old and the new that gives rise to the unusual degree of uncertainty about short-term prospects and complicates the task of policy-makers''. So, India is left with little option but to swim in the choppy wa ters of global finance and trade with chances of quick rescue looking none too bright.