RIS-DP # 158
While the global economy has pulled back from the financial abyss, it is by no means out of the woods. The developing countries (including India) should be prepared for: (a) medium term stagnation in their exports to the developed countries, (b) severe reduction in inflow of longer term capital from the developed countries, (c) a high degree of instability in short term capital flows and (d) instability in exchange rates with a serious risk of a dollar crisis. The impact on the Indian economy of these external factors may be more serious than is currently recognized in official documents. The conventional approach of assessing the impact of exports on growth and of external capital inflows on investment may be flawed. A large part of the recent (2003-07) increase in saving and investment rate and in growth rate in the Indian economy may have been due to external factors. And as the external stimulus provided by rapidly growing exports and cheap external credit during these years fizzles out, so could the recent acceleration in Indias GDP. In order to prevent such reversal in growth rates, increased efforts are necessary to: (a) generate domestic demand, in particular in unorganized sector where there is considerable underemployment and where additional demand can create its own additional supply, (b) mobilize domestic savings for longterm investment, (c) explore opportunities for greater South-South co-operation for trade and finance, (d) provide for protection from volatile capital flows and unstable exchange rates including a possible dollar crisis and (e) make an intensive study of financial risks of the corporate sector. If India is to achieve a steady growth of 8-9 per cent per year over the medium and long-term, it must look for a new balance between market and state and between North and South. In business as usual scenario, India may return to pre-bubble trend growth rates of about 6 per cent per year. On the other hand with appropriate reforms (quite different from those popular under the now defunct Washington Consensus) we can turn the crisis into an opportunity for maintaining rapid growth of 8-9 per cent per year and make it more sustainable and more inclusive.