The appreciation of the Indian rupee in the last month remains a subject of animated public discussion. Two independent research houses, GaveKal and DSG Asia, have commended the Reserve Bank of India (RBI) for setting an example and for finding its claws, respectively. William Pesek in Bloomberg says that other Asian countries must take note. In the Business Standard on Saturday, Surjit Bhalla argued that allowing the Indian rupee to appreciate while our neighbour to the North continues to keep its currency artificially low does not make economic sense.
The appreciation pressure on the currency from inflows could not have been met with a China-style response of allowing interest rates to remain low—so that sterilization is not costly—and of allowing the currency to remain undervalued. That would have been possible only if the inflows were directed towards India’s (infrastructure) investment spending.
They are not. Investment is happening in areas where it has the effect of stoking demand rather than in areas where it boosts the long-term productive capacity of the country. Hence the central bank needs to restrain it, and altering exchange rate expectations by reintroducing volatility is one of the many ways. But, if exchange rate appreciation and higher interest rates are to be avoided, the short-term solution is to deter inflows.
The issue defies a neat solution. At core are the questions of export competitiveness and the issue of dealing with capital flows, their application to relatively unproductive investments, speculation, credit growth and overheating. Hence, RBI is battling multiple problems even as it continues to face blatant political interference from the present government. The real reason why India is forced to deal with short-term demand management is that, over the last three years, the country has seen no improvement and, worse, is backsliding on the enhancement of the country’s productive capacity. IT companies are forced to run with multiple power generators in Bangalore. Maharashtra is facing extended power cuts every day. National highway projects are making slow progress, if at all. Airport infrastructure improvement remains some time away and much productive time is lost waiting in lounges as aircraft circle overhead.
Despite the often-touted number of science and engineering graduates running into thousands, three years of good economic growth has led to a shortage of talent. But the minister for human resource development is busy implementing a poisonous and divisive educational policy.
The Indian economy is fast losing competitiveness, not because RBI chose to inject some exchange rate volatility for various reasons but because the economy’s readiness to handle a permanently higher level of aggregate demand has been stopped in its tracks.
That is the crux. The UPA government is part of the problem not only because it is an “unproductive asset” (acknowledge Bibek Debroy) but also since it is pursuing CPA—a counterproductive agenda. One should not deny India’s communists their credit in this state of affairs.
While China’s reported economic growth rate has been in excess of 10% over the last four years, its inflation has remained below 3%. India’s wholesale price inflation is between 5% and 6% and consumer price inflation is around 8%. China’s inflation remains low for various reasons—some economic and some not. But, one of the chief reasons is that its unit labour costs are still declining. Stephen Golub and Janet Ceglowski in their paper (‘Just how low are China’s labour costs?’, November 2005) use data for the period 1980 to 2002 to determine China’s unit labour costs (per unit of output in manufacturing) and also relative unit labour costs (compared with other countries). They produce two estimates based on different data sets. China’s relative unit labour cost advantage over India—depending on which data set one prefers—is between 40% and 60% in manufacturing, as of 2002. It is unlikely to have narrowed significantly since then.
India and a few other countries are bearing the full brunt of China’s policy, which allows it to capture growth and employment from other countries. China is doing at the sovereign level what big businesses do to their smaller rivals—price them out of competition—with consequent impacts on income and employment.
The extent of impact is mitigated by the growth in productivity. India’s infrastructure (hard and soft) woes—a direct consequence of policy incompetence—compound it. Two more years of the UPA government, two more years of China’s exchange rate management and the prospect of a multi-party, local interest-driven coalition at the Centre in 2009. Tranquillizers, please!