Despite weak economic data, Indian policy makers continue to assert that the economy is doing just fine. It is time to stop living in denial and accept that the economy has entered an unwanted phase. By Vivek Sharma

It is comforting to appear confident and optimistic, especially when you are facing severe headwinds. Policy makers, whether they are ministers, central bankers or senior bureaucrats, should appear to be demonstrably in control, and an unflustered demeanour always helps. That is part and parcel of their job and their ability to do so has a disproportionately high influence on the effectiveness of the policies they come up with. 

Finance minister P Chidambaram is among the most optimistic of Indian politicians. Even with all the recent weak economic data, our finance minister still exudes confidence that the 2008-09 GDP growth will be near 8 per cent this financial year and is confident that the economy will bounce back next year and clock a 9 per cent growth.

Early this week, Chidambaram even assured us that "the fundamentals of the Indian economy are very strong". Not many have piled on to him for that remark, probably because the rest of us are no less optimistic either. Even the prime minister continues to assert that GDP growth will be close to 8 per cent this year.

Even someone as optimistic as the finance minister may find this tough. How do you describe the decline in industrial growth to just 1.3 per cent this August, from as high as 10.9 per cent for the same month a year ago? Moderately weak?  Somewhat painful? Whichever way one may describe it, there is just no escaping the reality behind those numbers - that the Indian economy is slowing down rapidly and we are not quite sure how long it will last.

Dig deeper and the industrial growth number is even more alarming. Manufacturing output, which accounts for the bulk of the industrial index, increased at 1.1 per cent as compared to 10.7 per cent for August last year. That is more a standstill than an expansion. For the first five months of this financial year, growth in manufacturing output has more than halved to 5.2 per cent from 10.6 per cent for the same period last year.

The infrastructure index, which contributes slightly more than a quarter of the industrial production index, also shows a similar story. From as high as 9.5 per cent a year ago, infrastructure output growth has slipped to just 2.3 per cent in August this year.

Now, there are some who argue that these numbers are way off the mark and the real industrial growth is much better. Economic research firm CMIE, which continues to maintain its GDP forecast for the current financial year at an incredible 9.4 per cent, is at the forefront of those who believe that the official industrial output data bears no resemblance to ground reality.

To support its position, CMIE had cited the average sales growth reported by top manufacturing companies for the April - June quarter. Even after adjusting for inflation, average sales growth came above 20 per cent for the first quarter, which was way above the official industrial growth numbers.

But, why didn't it question the official numbers last year when industrial output was actually expanding in double digits? Average sales growth for manufacturing companies last year, adjusted for inflation, must have been over 35 per cent. Does that mean official industrial growth figures for the last financial year was also wide off the mark?

Again, if the official industrial output data is bad, then there should be some underreporting in farm and services output data as well and everything needs to be revised higher. That would mean the Indian economy was expanding much faster than the Chinese economy all these years. That is a bit difficult to digest.

Credibility at stake
The motives of economic forecasters in downplaying economic fears are as yet unknown, but the incentives to politicians are very clear. But, there are downsides as well, when politicians try to appear optimistic and downplay public fears. More than optimism, politicians and public officials need credibility. Coming up with overtly optimistic statements, when the world is falling apart, can destroy the credibility of even the most trustworthy of politicians, hard as they are to find.

During a crisis, it is more important for policy makers not to lose their credibility than to appear calm and confident. When the governments of the largest economies appear clueless about fighting the crisis, stock markets across the globe are falling like nine pins, large banks going bankrupt or being nationalised, and even the domestic economic data weak, there is no point in pretending that nothing is wrong in our world. Repeated assertions about 'strong fundamentals' can do more harm than good, as such statements will eventually prove to be false in the face of fresh economic data.

Our policy makers, from the prime minister downward, should present a more realistic evaluation of the economic conditions facing us. They can still try to sound confident and optimistic, as long as their assessment is closer to the realm of reality. They should state clearly that our economy will go through a phase of slow growth for a year or two, but assert that the decline in growth will be nowhere as steep as in most other economies and that a domestic recession is completely ruled out at this point. Such forthright admission of reality will lead to a general scaling down of expectations and the economy as a whole will be better prepared to face the downturn, rather that keep getting hit by nasty surprises.

Not communicating sufficiently enough can be equally harmful as being overly confident in your communications, especially for regulators. Just as the economy is slowing down, the RBI is in a dilemma. When central banks across the world cut interest rates in a coordinated move this week, RBI watched from the sidelines. Much as RBI governor Dr. Subbarao would like to cut rates, he is still constrained by high levels of inflation. For the latest reporting week, inflation declined to 11.8 per cent and officials from the finance ministry have been assuring us that it will drop to single digits soon.

But, Dr. Subbarao knows better. While at the finance ministry, he also would have given us the same upbeat sound bites about inflation coming down. As RBI governor, he has little leeway for such loose talk.

Indeed, oil prices have come down and the risk of higher retail fuel prices adding to inflationary pressures is no more, at least in the short term. But, the rupee's steep fall in recent weeks has offset part of the gains from lower international oil prices. So, a fuel price cut will have to wait. At the same time, there are other developments taht may add to inflationary pressures.

Good news turns elusive
Advance estimates of the agriculture ministry released last week says the kharif output of all major crops this year, except rice, will be lower than last year. The sad spectacle of the government desperately trying to import wheat when international food prices were soaring last year is still fresh in our memory.

Yes, global food prices have come down because on expectations of lower demand. But, if output in a major consuming country like India falls short, prices may stabilise at the current levels which are not exactly cheap. This will be one of RBI's major worries in the coming months.

Just like every other central bank these, the RBI will also have to be on constant standby to pump up liquidity in the system. It has already brought down the CRR by 150 basis points, which will relase nearly Rs60,000 crore of additional funds in the system. The move came after overnight rates shot above 20 per cent and the RBI was forced to cancel a scheduled bond sale.

The RBI has been so far relatively silent on the global financial crisis, its impact on the domestic economy and liquidity conditions. Last week, the central bank said domestic banks are adequately capitalised and issued a specific statement about ICICI Bank. Still, rumours continue to flood the markets.

There have been reports that a large domestic bank borrowed short-term funds from another bank at an exorbitant rate of 20 per cent, suggesting that the borrowing banks is facing severe liquidity problems, which traders assumed was ICICI Bank, given the rumours circulating about it, and the stock tanked nearly 20 per cent.

As the bank regulator, shouldn't the RBI ask domestic banks to be more forthcoming in their disclosures about exposures to credit derivatives and other toxic assets?

That brings us to the responsibility of bank managements to be more transparent about their holdings and transactions. It is now months since rumours about ICICI Bank fiest surfaced. The bank's management keeps repeating the same lines that its exposure to international credit derivatives is very low and the bank has sufficient capital. Still, even seasoned industry analysts are not sure about the bank's various exposures. If a bank is indeed borrowing short-term funds at a higher rate, isn't it better to disclose it upfront and explain the reasons for doing so rather than letting the market speculate?

Leadership in difficult times is about getting a firm grasp of the conditions, accepting them as reality and explaining all the aspects lucidly to facilitate effective decision making at all levels. Policy makers in developed countries have been found wanting in this area and the whole world is now paying a heavy price for it.

It is time Indian policy makers stop repeating their mistakes.