The fallout of the Greek crisis will make India’s macroeconomic management more challenging. Crises in developed markets enhance the attractiveness of fast growing major emerging markets for global capital, and there is a lot of it sloshing around in search of opportunities. With economic growth this fiscal expected to be in excess of 8%, Indian equities present as good an opportunity as any for global capital.
Ironically, this makes macroeconomic policymaking tougher. The Reserve Bank of India (RBI) will have to walk a tightrope to manage the impossible trinity—an open capital account, a fixed exchange rate and an independent monetary policy.
Illustration: Jayachandran / Mint
India’s conservative approach to taking on foreign debt insulates it from the threat of a sudden outflow. However, the finance ministry’s policy of maintaining a stable environment for foreign equity investors is going to make the central bank’s job tougher at a time when it has begun to drain liquidity and nudge up interest rates.
The challenge of grappling with a surge of inflows was expected. The February Union Budget had provided for sterilization bonds of Rs47,263 crore. Since then, the economic environment has got tougher, with food inflation gradually spilling over to manufactured products. RBI’s answer to the challenges will show up in the exchange rate. The central bank’s volatility-centric approach to exchange rate management will be tested by sharp swings in capital flows on the heels of the Greek crisis.
When exchange rate appreciation—it was 12.9% in fiscal 2010—is juxtaposed with inflation in industrial inputs, India’s political economy may begin to have a say in macroeconomic policymaking.
Some key exports such as gems and jewellery and leather show a high degree of employment intensity, and as these sectors lose competitiveness, the government will be under pressure to find a palliative. RBI governor D. Subbarao, who was then the finance secretary, will remember, in a similar situation in 2007, the lobbying by exporters to get the central bank to intervene more decisively in the forex market.
India’s conservative approach to capital account flows and the improvement in the underlying economic structure since 1991 has largely insulated it from a direct fallout of a Greek kind of crisis. But the underlying structural changes have given rise to a different set of macroeconomic challenges, which flow from greater integration with the world. The medium-term fallout of the Greek crisis will test both economic policymaking and the government’s ability to stand firm in the face of demands from small but vocal interest groups.
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