First published: Monday, 16 June 2008

Oil and food shortages combined with rising inflation have created a sense of economic crisis in India and the mood is beginning to turn grim. 

While the nation's growth rate even till last year has been a handsome 9% there is some indication that this will decline. 

Current inflation is not only the highest in the nation in the last eight years, but the rate at which the inflation itself is rising (the inflation of inflation) is extremely high. 

It is likely that within the next few months the inflation rate curve will cross the growth rate curve. This has not happened in a long time and adds to the concern. 

Is this just a passing cloud or a foretaste of the end of what has over the last four or five years been widely touted as India's economic take-off? 

Persistent flaws

Predicting economic trends is always hazardous, but if one went beyond the headlines to the data, there would be reason to conclude that the long-run prognosis for India continues to be good. 

This will entail some skilful policy crafting and so, in making this forecast, I am keeping my fingers crossed that the government, no matter which one it is 2009, will be astute enough to do it right. 

The analysis is predicated on two broad "facts".

First, while there are important and persistent flaws in India's policy regime, this particular crisis is not its own doing. It is a global phenomenon that has washed up on the nation's shores. 

This therefore compares with the downturns of 1997-1999 and 1972-1974, when there were major global crises and India was hit by them. 

The 1972-4 crisis is of particular relevance, since that was also caused by a steep rise in global oil prices. 

It was a classic case of stagflation. Prices rose rapidly and growth slowed down. India's inflation rate at that time had inched towards (but never reached) 20%, and that remains the record for independent India. 

The 1997-9 crisis, which started in East Asia, also caused a slow down in India's growth rate, which had reached 7% per annum for three years before that and dropped down to 4.5% in 1997. 

But these happened when India was a much more closed economy. 

There is reason to expect that we will be rocked much harder this time, since the nation is much more open now. 

I should hasten to add that this must not be construed to be a case for keeping the economy closed. 

The vastly higher growth that India has enjoyed since 1994 is largely because of the more open policies. 

To close the economy would amount to opting for perpetual poverty in order to avoid the crisis of occasional poverty. 

The second reason for optimism is that India is today one of the highest investment economies in the world. 

It saves and invests around 35% of its national income. This is a recent feature of the Indian economy and is comparable to the best-performing East Asian countries. 

Judicious mix

Arguably no other macroeconomic variable correlates with a nation's growth rate as well as the investment rate - this augurs extremely well for India's long run growth. 

The catch however is in the qualifier "long run". The next year is likely to be very tough on the nation since inflation in a poor country is a curse. 

So many Indians live so precariously close to subsistence that inflation can easily tip them over the edge. In the immediate run, the government has to use a judicious mix of market interventions to protect those who are the poorest. 

In the longer run much will depend on how well we can create jobs to absorb the surplus labour.

This cannot be done by government alone through subsidies and public-sector jobs. 

We need to craft policies to encourage the private sector to expand and use more labour. 

This requires three critical changes: better infrastructure, less bureaucracy and more flexible labour laws, which allow for different kinds of contracts and permits firms to lay off workers when demand is slack. 

Research shows that policies that making it easier to lay off workers, somewhat surprisingly, create more net employment. 

What can destabilise growth is political instability and nothing fuels this more than when large segments of the population feeling left out of the mainstream. 

Hence, poverty and unemployment need combating urgently. 

A crisis can be an opportunity. 

It was the crisis of 1991 that set India on the path of reform. The present global crisis will mean that firms and corporations in industrial nations will look for ways to cut costs. 

If a poor country like India can put its house in order and be pro-active in the global market, it can be a critical player in helping corporations cut costs. At the same time it would improve its own economic prospects. 

So expect some belt tightening, but don't expect the trousers to fall down.
Dr. Kaushik Basu, Professor of Economics and Carl Marks Professor of International Studies at Cornell University

This article first appeared on the BBC News Column on Monday, 16 June 2008.