Author: S. Venkitaramanan
Publication: The Telegraph
Date: September 26, 2001
Introduction: Both within the US
and outside, the terrorist attack have prompted radical introspection on
the role of the state in the economy
The events of September 11, 2001
constitute a defining moment in the economic history of the modern world,
especially because of their serious effects on the United States economy,
which has been an engine of growth for the world. The terrorist strike
on the World Trade Center was literally an attack on the heart of the US
financial system. It is remarkable how the leaders of the US finance, both
the US treasury secretary and the chairman, Federal Reserve, took immediate
and focussed action.
Observers of the events have commented
on the single-minded emphasis of US authorities on opening the financial
markets quickly. The Federal Reserve pumped in liquidity to the extent
of $ 100 billion, so that the markets were not affected by the seizures
of the payment system. Above all, its chairman reduced interest rates by
half a per cent. He also organized corresponding measures by other central
banks, including the European Central Bank.
The business of New York is financial
business and the priority given to restoration of the stock markets was
timely. Within a few days the stock markets resumed activity - a tribute
to the quick response of the US authorities. What happened on September
11 has changed the attitude of the US administration to fundamental issues,
such as the role of the state in the economy. It appears self-evident that
when a disaster of this magnitude strikes, it is the state, and not the
market forces, which can intervene effectively. The state is bound to regain
dominance.
Typically, the US administration
has already initiated steps to bail-out the US airlines industry, estimated
to cost up to $ 8 billion - a classic bail-out, which commits the government
to give cash support to the airlines, crippled due to the now depleted
occupancy and danger of increased law suits for damages from affected customers.
The US administration has also been quick to act on other areas of disaster
relief. It has won authorization from the congress for nearly $ 40 billion
for reconstruction, besides the expenses for bailouts and security measures.
No longer does the administration hold its budget balance as sacred. The
congress seems to have agreed even to a proposal to use the social security
funds, considered sacred, to bridge the budgetary gap.
Granted that well before Black Tuesday,
the US economy was stalling. The over-investment in certain sectors and
the sudden reduction of demand had led to a recession-type situation. Hopes
were, however, placed on the tax refund package of the president which
was expected to increase consumer spending. These hopes may be misplaced
now.
One of the inevitable, but paradoxical,
consequences of Black Tuesday's events is a boost to public spending. Observers
recall that it was a similar boost in public expenditure following US entry
into World War II that reversed the recessionary trend of the Thirties.
War is admittedly too cruel an instrument to solve economic problems. But,
considering the state of the global economy, one unintended consequence
of the US administration's changed outlook towards increased public expenditure
may well be the early reversal of a threatened global recession.
Much of the impact of the US administration's
proposed expenditure will, of course, depend on its detailed profile. It
also depends very much on the shape and structure of the retaliatory measures
which the US is expected to take. One thing is clear - the decade of the
Nineties, which saw the peace dividend to the US following the collapse
of communism, is over. Defence spending will predominate in the immediate
future. Inflationary consequences are bound to follow. Particularly, this
is true in respect of strategic commodities, such as metals and petroleum
products.
Crude oil prices were expected to
range around $ 25 per barrel in a year's time. It has already risen to
$ 28 per barrel. Although the organization of the petroleum exporting countries
has promised good behaviour, in the sense it will increase supplies in
oil to meet the demands, a rise in petroleum prices cannot be ruled out.
In the event of outbreak of war, transport constraints might further affect
the availability and price of petroleum products. This has an immediate
consequence on the balance of payments of India, as also the fiscal situation
with its likely impact on the oil pool account. India may have no option
but to raise prices of petroleum products if it is to avoid strain on the
already fragile fiscal system.
It is good news that the US financial
and stock markets have reopened. But, they are still volatile. A number
of US corporates are forecasting lower profit figures. Unemployment is
on the rise. Foreign institutional investors, who are important to India's
BoP, may feel the pressure of this volatility. Whether, in the circumstances,
their appetite for Indian securities market will continue to be as strong
as before is a billion-dollar question.
Black Tuesday will also have an
impact on one important sector of India's BoP - software earnings. Some
believe that Black Tuesday's outcome might actually increase US's outsourcing
of software services. At a minimum, the direct consequence of the decline
of the US gross domestic product is bound to be a competi- tive situation
facing India's software industry.
Leaving aside the software sector,
there is also the overall question of exports to the US and the rest of
the world. In a global recession, export prospects are bound to be affected
adversely. Sensitive areas will be garments, gems, jewellery and chemicals.
The increasing tendency of the US government to look inward may also affect
adversely its current stance in favour of the opening of US markets. The
government of India will have to take pro-active steps to ensure that any
adverse consequences are mitigated at the earliest, if necessary, through
fiscal measures and liberal credit to exporters.
One unfortunate consequence of global
uncertainty is the increase in the attractiveness of gold as an avenue
for saving. Already, we are spending nearly $ 7 billion per year on the
import of gold. Increasing uncertainty in the global financial markets
and reduced attractiveness to alternative avenues of saving may increase
the lure for gold being imported through legal and illegal means. It is
time that the government of India takes steps to evolve concrete measures
to provide gold substitutes in the form of financial products, which will
yield a safe return, and at the same time be linked to the price of gold.
The events of September 11 have
a philosophical significance far beyond what the terrorists intended. They
indicate an end to the complacency which has entered the mindset of Western
policy-makers that the markets are predominant and that the state should
not expand. Black Tuesday has made it clear that the state and its services
do matter in a world threatened by terrorism and war. Already, the UK has
provided a state-sponsored insurance cover against risks of terrorism.
Indeed, the insurance industry of the world is facing an almost unbearable
burden because of the magnitude of the likely claims from airlines and
corporates, besides affected buildings. The state is, after all, the insurer
of the last resort and it is an irony that in these days of private insurance,
the state is being asked to help out the ailing insurance grants in the
mecca of capitalism.
Black Tuesday has, above all, resulted
in a radical introspection of political and economic policies by all countries.
While the geopolitical fallout of the US action is of immediate relevance,
what is of significance to us is the widespread economic consequence of
the event. One of the unintended geopolitical impacts has of course been
the lifting of US sanctions on both Pakistan and India. Its immediate effects
on the Indian economy are not likely to be significant, except in respect
of technological imports from the US for the military and space organizations.
Overall, the Indian economy cannot escape the economic fallout of Black
Tuesday. I hope and trust that the government of India takes steps to prepare
and implement a pro-active plant to deal with the consequences of the terrorists'
attack on the bastion of global financial capital.
(The author is former governor,
Reserve Bank of India)