Sunday, June 27, 2010

Exit, Double Dip, Govt. Debt, Recovery!

Nearly all the economic discussion these days revolve around these terms. The endless discussion on cause and affects of recession are now long gone. The centre stage has been taken by spiralling Government debts/GDP ratios, European Debt Crisis, Exit strategy from expansionary policies, avoiding Double Dip recession and sustaining recovery.

The crisis has made everyone Keynesian. The expansionary fiscal and monetary policies implemented by crisis affected countries' governments have increased their deficit and consequently Govt. Debt. In particular, US got drawn into two successive crisis without giving itself space in between to apply contractionary policies and recover from high deficit and debt. Attempts by US government to use contractionary monetary policies after recovering from early 2000s recession accelerated the housing crisis. As a result US Govt. had to go again for expansionary policies which continues till date. No wonder the US Govt. debt to GDP ratio is hovering around 90%.

Europe too is laden with high Debt. Greece which is on brink of bankruptcy has Debt/GDP ratio of about 120%. Italy, Portugal and Spain too have high debts. Unlike US, the mis-management and unbridled Govt. spending is responsible for Greece woes. The discipline in Govt. spending has been missing for a long time as populist policies and high standard of living became more important. Now when its time for austerity, the public is bound to feel the pinch and most affected will be the lower strata and pension beneficiaries. Surprisingly, Japan is comfortably sitting on top of the debt pile with 200% ratio. What makes Japan further unique is its contracting population and deflation which further aggravates the problem by arresting GDP growth. Japan is the second largest economy and its failure will cause havoc to world economy. When is Japan leadership going to wake up?

The way out of the high debt is obvious, lower the government spending and go for contractionary fiscal policy. And there lies the fear. Still the recovery is incomplete. Any premature withdrawal of expansionary fiscal policy is bound to push the economy in another recession, which is widely known and feared as 'Double Dip' recession. As Europe gears up for austerity measures and reduced government spending, US has time to time issues warnings that it might affect the economic recovery. Also unemployment figures in both US and Europe are too high to allow scaling down expansionary policies.

So what could be the Exit Strategy for the governments from expansionary policies. Some quick-fix but unpopular means would be to Print Money or Default on Debt. Former would skyrocket the inflation and common man will suffer. The later will severely dent the credit worthiness and reliability of the country for time to come. The right approach to bring in fiscal discipline would be long drawn and painful. But there is an increasing danger of governments resorting to protectionism in both consumption and jobs to speed up the process. This would invite counter actions from other countries and will further restrict growth at global level. Protectionism on consumption will adversely impact demand at global level and that on Jobs would adversely affect the supply side of the GDP equation. Its significant that countries at G20 summit resolve to refrain form protectionist mindset. Also everyone cannot Exit as same time. Some have to stay longer for sake of the world economy.

Measures taken in India are laudable with government taking unpopular decision to remove subsidies and de-regulate oil market. Also deft handling of 3G and broadband spectrum distribution has given the government much needed funds. However, there is urgent need of reforms on supply side like labour reforms and others to control spiralling inflation.

The financial crisis has proved that world is far more interconnected than we ever thought before. Mis-steps by one country or woes of another affects the whole world. A united, responsible but a painful approach is the only way forward.

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