(Written by Sukhveer Singh, an IAS of 1997 batch, Madhya Pradesh Cadre)
These days many countries are facing an economic crisis. Sri Lankan economy is one of them where the prospects of civil war are building up, and the economy is crumbling day by day. The island nation of Sri Lanka is facing a shortage of food and energy items, depleting foreign exchange reserves, sky-rocketing inflation, and a political breakdown of machinery. Many political pundits, economists, and rating agencies attribute its failure to the series of incidents and decisions of GotabayaRajapaksa’s government and his party. The series of significant events could be traced to the civil war followed by the Easter bombing before the pandemic, economic activity disruption during lockdowns, and other covid-related restrictions and the war.
Suppose we retrospect to identify potential pitfalls in decision-making. It becomes vital to know what led the Sri Lankan government to adopt a decision discourse that led to such a crisis when every nation on the globe faces similar challenges. Decision-making is not a simple process. It attracts information inputs, social and cultural influences, cognitive constraints, and attitudes about risk and uncertainty. This article discusses- how the Sri Lankan government undermined its strengths to compel bowing down its economy to the crisis? And how an economy relying on fewer income and production sources are prone to crash? Where does India fit in this story? Are there clouds of calamity hovering over India too?
The covid pandemic has posed severe setbacks for the global economy. The war between Ukraine and Russia unfolded before the globe could recover fully from the pandemic-related supply chain disruptions and lockdowns. The challenges that emerged – the global supply chain disruption and shortages of fuel, food, and other commodities – due to the economic sanctions imposed on Russia by the west have raised the general prices of goods and services. The sky-rocketing inflation concerns with muted economic growth have reinforced the alarm for recession. The vulnerable ones, such as Sri Lanka, may crash promptly.
What went wrong with the economy of Sri Lankan?
The Island mainly imports food items, medicines, machinery and electrical equipment, petroleum products, etc. Its imports constitute 30% of gross domestic product; thus, its consumption heavily depends upon imported goods rather than domestic goods. It funds exports earning mainly from the textile items (41.6% of the import bill) and tea (13.6%), and tourism (33.3%).
The country’s lucrative tourism industry and foreign workers’ remittance, which represents around 1/5 of the country’s GDP, have suffered immensely for the last two years. Other factors such as increased energy bills put pressure on earnings. Agriculture production was reduced due to restrictions on the import of chemical fertilizer. As a result, the government did not have money to pay for imported food and essential items. The tax cuts and excess money creation compounded the problem. The forex reserves dropped to a multi-year low of $0.05 billion against the demand for debt repayment of $ 7 billion this year.
The Sri Lankan economy suffered a classical twin deficit- a current account deficit because of inadequate production of tradable goods and a budget deficit due to reduced taxes. So long as the story goes, one could infer that if an economic structure relies on a single economic sector or a strength, it is more susceptible to collapse than other economic structures with a diversified and integrated economic foundation. Later can sustain the bigger shocks and survive the worst turbulences. Additionally, the crisis worsened due to the wrong decisions taken by the government.
Case in point, Venezuela’seconomic, and humanitarian crisis started in 2016 and took a worse turn in 2017. The Venezuelan economy is an oil economy that depends upon earnings from oil export, thus primarily a single source of earning. Due to American sanctions, oil production went into a freefall. According to IMF, GDP plunged by 12.5 % in 2017, with a higher inflation level of around 25%. Another double-digit fall in GDP followed in 2018. The government has fallen behind in debt payments. Maduro, who was obligated to finance many social welfare programs, could not finance them out of declined earnings. The oil economy fell to ashes in no time.
Another screeching example is Japan. The yen has been weakening in 2022 with the fallout of the war blighting the currency market. The yen has depreciated 20% in the last six months. Researchers reckon it will continue declining in the year 2022. The rating agencies believe the decline in currency is due to the Bank of Japan’s policy to take an unwavering monetary easing stance. That was envisaged to take advantage of the bond yield spread –the difference between the yield on the US treasury bonds and the Japanese treasury bonds- to snatch away profits home out of a ‘carry trade.’ Destabilized currency market could break a two-decade-long Japanese strategy which facilitated Japan to grow with low inflation and a low-interest regime. With changed circumstances, the continued easing will be under fire, and a risk-free currency arbitrage may not be possible. This process could challenge the growth path of this G-10 nation member.
How does India stand out in this time of crisis?
India is a diverse economy that includes heavy and high-tech industries, modern agriculture, traditional village farming, handicraft, and various services. Its labour market also has a wide variety varying from highly skilled to manual labour classes. Its economic system is a hybrid system where capital and socialist aspects combine to produce goods and services. Thus, it upholds private ownership of production activities and federal decision-making to achieve social objectives.
A mixed economic system with organized and unorganized components works in tandem in an environment of democratic setup with cultural, geographic, linguistic, production, and consumption diversity. Diversity is a fascinating subject to apply in economics, which indeed provides resilience to the factors of production, namely location, labour, capital, and entrepreneurship. For example, cultural diversity could increase tension between migrated and native people. Still, it can result in economic benefit through increased openness and inclusiveness among the people of different states, creeds, or castes. Openness is crucial because it removes entry barriers and inclusiveness manages various diversities. Researchers found that they play a role in attracting and maintaining natural resources and human capital intact.
India has different terrains, climates, and natural resources in the different parts of the country in terms of geographic diversity. Different attributes such as location, availability and skill set of labour, the local governance, climate conditions, and availability of raw materials affect the kind and size of industry set up in the area. For example, Punjab, Haryana, and western Uttar Pradesh developed as a green belt for grain production – it attracted investment in irrigation infrastructure. However, hilly terrain in the east is suitable for tea and coffee plantations. Similarly, Gujrat, Maharashtra, and some southern states attract high-tech industry investment.
Consumption habits are different in different parts of the country. India is so diversified that every small region boasts its culinary cuisine and traditions. Traditionally clothing and ethnic wear change as you go north to south and west to east. It is also quite simple in rural areas where they wear very simple and untailored clothes. The demand for white goods varies on the economic strength of the household.
Therefore, a country that does not depend upon a specific product or service exclusively possesses unique advantages- it fabricates a diversified set of needs and diversifies production factors. For example, when northern states were under lockdown during the second wave, southern states produced and consumed goods and services. One part of India can manufacture goods for itself and supply them to the other part hurdle free. One food item can be substituted for another food item. Overall, the diversity helps adjust to make choices more resilient and accommodating.
Macro-economic Parameters of India
India’s underlying macroeconomic parameters are strong enough despite minor weaknesses. The policies such as production-linked incentives, increased infrastructure spending, and a self-reliance program impart an edge to move forward to create a multiplier effect on economic growth, job creation, and efficiency. India’s foreign debt is less than 25 % of its total debt obligations. The foreign debt component is less than its forex reserves in size – though it needs to be served in 5-10 years. India being a buzzing economy, attracts more foreign direct investment portfolios. However, India’s current account faces higher oil and gas price challenges.
India declined by 7.3 % annually in FY 2021, and now it is expected to grow at 8.6 % annually in subsequent FY 2022.IMF projects 9% economic growth for the Indian economy in FY2023. Therefore, it has excellent prospects for economic growth in the coming years.
India consumes around 15% of goods and services through imports. But what is distinguishing for India is that one-fourth of India’s imports are to meet its energy need. Two, the export composition is diversified – except for engineering goods, other items contribute less than 10% each from the sectors, including gems and jewelry, petroleum products, or drugs and pharmaceuticals. There are dim chances that engineering goods export could decline. Three, the current account deficit is filled by capital account surpluses. And finally, India can substitute import items except for mineral fuel and oils. These strengths in trade account place India in a relatively commanding position.
According to data released, India’s retail inflation surged to 7.79% in April 2022 due to rising fuel prices and food prices.RBI may raise inflation expectations to a higher single digit in the coming months. But, India is in a sweet position to restrain it to a single-digit number and tame it down to the lower levels subsequently. Since the monsoon forecast is good, and also it appears that the energy prices have already peaked.
Crisis, an opportunity for India
India is looking at this crisis as an opportunity to shift global manufacturing units to India. The impact of the pandemic and the war has been to destabilize the globalization process—the world’s multinational companies are eyeing India as an alternative investment destination that intends to substitute their China-dependent. In turn, India is looking to invest in future technologies and requirements. For example, the government of India has announced to impart support to the industries investing in hydrogen, green energy, and its storage. This initiative could take India to become self-reliant and contribute positively to climate change initiatives.
In conclusion, India seems unbeatable in facing any challenging economic environment of higher inflation and subdued growth. It is a too diversified economy to fail, standing on a grid of many economic pillars. Moreover, it is an exceptional opportunity for her to adopt a reform ecosystem -which India has already started embracing – to attract more manufacturing units and focus on research and investment for future technologies.
