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Monetary, fiscal recipe for overheating India

Monetary, fiscal recipe for overheating India
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First Published: Sat, Oct 20 2007. 12 32 AM IST
Updated: Sat, Oct 20 2007. 12 32 AM IST
India’s move against foreign speculators who exploit a loophole to buy domestic assets was clumsy, but not unexpected. Authorities cracked down on participatory notes (PNs), which have allowed foreigners to skirt investment curbs. PNs account for two-thirds of the country’s annual $75 billion (Rs2.99 trillion) capital inflows, which have caused the rupee to rise sharply. But India’s overheating problem is best solved by fiscal and monetary measures. Rather than tightening exchange controls, India should loosen them and allow its residents to invest freely abroad.
The problem of excessive capital inflows into an emerging market economy is serious. India’s response was measured. It removed a loophole that allowed anonymous foreign purchase of PNs, without the normal investor registration requirements. Foreign portfolio capital has driven the Indian stock markets to record levels and pushed the rupee up 12% against the dollar since January. With the country experiencing more than 7% inflation and significant real wage growth, competitiveness has suffered. Imports are up 31% from last year, against an 18% increase in exports.
The government controls foreign investment and traps domestic money within the local economy. Blocking Indians from investing abroad demonstrates that the local government still wants socialist-type controls over the lives and resources of its people. With reserves plentiful and the rupee strong, there is neither a moral nor an economic case for maintaining such restrictions.
India’s economy is clearly overheating. A rising rupee appears insufficient to lower inflation, yet it makes life difficult for India’s exporters. Inflation and excessive rupee rise are best fought through domestic policy measures. One is fiscal restraint; public spending in the current year is running 36% ahead of last year, a 29% real increase. The other is monetary tightening, forcing short-term interest rates above 10%—3% in real terms—from the current Reserve Bank repo rate of 7.75%.
That would deflate the Indian stock market, reduce the flow of hot money and alleviate the upward pressure on the rupee. That would solve India’s problems more effectively than putting more restrictions on foreign speculators.
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First Published: Sat, Oct 20 2007. 12 32 AM IST