The big fat greek tragedy

India Today, 9 July 2015.

The difficulties in Greece will weigh on the future of Europe. They will indirectly induce greater fear in the global financial system, and hamper global growth. This makes India's growth environment more daunting. It will be more difficult to export and it will be more difficult to attract capital flows. We will have to push harder on our economic reforms in order to fare well. It is essential to avoid mistakes in the form of trying to manage the outcomes of financial markets -- as is being done in China today on the stock market and as was done with the rupee in 2013.

The crisis in Greece has just got significantly worse. Now Greece may face the extreme crisis of an economy that tries to function without a currency. If Greece is ejected from the Euro, people in Greece may be reduced to doing transactions by exchanging foreign exchange or makeshift arrangements like barter.

These events have generated turbulence in the world economy. To some extent, they increase the danger of difficulties in other parts of the Euro zone. They hamper the outlook for an economic recovery in Europe.

India's international trade with Greece or with continental Europe is relatively small. Hence, the direct fallout of the events in Greece for us is limited. But the woes in Greece add to a difficult picture on the world economy, and this makes it more difficult for Indian exports.

A more important channel of influence runs through the global financial system. When there is more uncertainty in the world economy, people tend to put more money into the four safest countries of the world: US, Japan, UK and Germany. This makes capital more expensive for emerging markets like India.

The events in Greece thus make life more difficult for India on both international trade and international capital flows. These difficulties come at a bad time for India. While the GDP data is showing rosy results, other indicators suggest that the recession which began in the first quarter of 2012 has not yet ended.

What is to be done? There are two main things that we have to be careful about. The first is the problem of economic reforms. When the external environment becomes more difficult, we have no easy methods to obtain growth. Now we have to emphasise the only lever for economic growth that we do control: domestic economic reforms.

Deeper economic reforms are required, in order to get the economy moving again. The need of the day is deeper re-engineering of the machinery of government. This requires setting up capable technical teams who can diagnose complex problems, redraft laws, support the administration in carrying new laws through Parliament, and setting up the institutional capacity to enforce laws better. In the modern media age, there is an accent on superficiality. What we require in public policy is the opposite.

The second major issue that requires care is to allow financial markets to do their job. When news breaks, markets respond. Nifty and the rupee will move in respond to events. Negative news will make markets go down. It is important to allow markets to do their work : of absorbing news and discovering the price.

Sometimes, policy makers have the temptation of using levers of power to manage financial markets, to manipulate the market and forcibly determine what the price on the market should be. This can be particularly damaging.

As an example, in China today, the government is going all out to prevent a decline in stock prices. This is damaging at two levels. First, stock market investors should go in with open eyes, and be used to the idea that stock prices fluctuate. Second, the tools that the government is using are quite distortionary, and damage the economy.

In similar fashion, in India in 2013, the rupee depreciated owing to global developments. The government went all out to prevent a rupee depreciation. This was damaging at two levels. First, the exchange rate is a market, and everyone should be used to the idea that the exchange rate fluctuates. There are no certainties about whether the rupee will go up or down. Second, the tools that the government used to fight the rupee depreciation were distortionary, and damaged the economy. The short term interest rate was raised by 4 percentage points in order to fight rupee depreciation. This dealt a body blow to the domestic economy. Such mistakes must be avoided.

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