Prime Minister Manmohan Singh is due to meet business leaders at the end of the month. His meeting may seem to have little to do with the ongoing battle to defend the rupee. However, there is a deeper link between the sorry state of Indian manufacturing and the persistently high trade gap; and that link deserves attention right now.
The authorities have been busy fighting fires on the external front in recent weeks. India needs strong capital flows to fund a current account deficit of around $100 billion this year. Worries that the US Federal Reserve will begin to reduce its programme of bond purchases, perhaps as early as September, have sent global financial markets into a tizzy. Money is being pulled out of emerging markets in a hurry, and the currencies of countries with large current account deficits—India, Turkey, Brazil and South Africa—have been battered.
The finance minister has tried to calm the markets. He has been assiduously trying to get more foreign portfolio flows into the country, even the sort of short-term debt that the Indian policy establishment has shunned after 1991. The tax on gold imports has been increased. Speculative positions in the foreign exchange markets are being reduced through administrative measures. The Reserve Bank of India has been selling dollars. Some of these responses have attracted criticism, but we shall leave those for another day.
Even as the fire-fighting continues, it is time the national debate begins to shift focus to the structural factors that have led to such a large current account deficit in the first place, as economist Ajit Ranade persuasively argued in these pages on Tuesday. This newspaper has maintained earlier that the large current account deficit seen in recent years is a sign that India—more specifically its tradables sector—has lost competitiveness. Recent data on the growth in total factor productivity and the incremental capital output ratio, two standard measures of efficiency, throws ample light on this.
The revival of Indian manufacturing exports has thus to be a central part of any plan to fix the current account problem. It is well known that Indian industry is hobbled with problems such as high costs, regulatory whims and poor infrastructure. The profligate spending by the current government has further raised costs for companies. The great productivity push on factory floors around the turn of the century is now only a distant memory.
These problems are well known. The way India lost out a massive opportunity in textiles to China, Vietnam, Bangladesh and Sri Lanka after the end of the restrictive multi-fibre agreement some 10 years ago is a case in point. The ambitious National Manufacturing Policy released in 2012 aims to raise the contribution of manufacturing to the Indian economy from the current 16% to 25%, by 2022. This essentially means that manufacturing output has to grow at around three percentage points faster than the overall economy for the next decade, a tough proposition given the current business climate. The policy also has a very clear exposition of what needs to be done to achieve this stretch target.
India needs a competitive manufacturing sector if it is to earn enough dollars to fund its imports, especially its thirst for oil. Interestingly, this was also the thinking in the 1980s. The two oil shocks of the previous decade exposed the underlying weaknesses of the Indian economy. Policymakers came round to the view that India needed to be a competitive exporter if it had to pay for imports. That was the thinking behind the initial changes in the policy framework: a weaker rupee, lower import tariffs and fewer restrictions of expansion of industrial capacity.
It is hard to fault such thinking even now. India needs to let the currency gradually move down, reduce restrictions on industrial capacity creation and fix infrastructure. The high current account deficit and the weakening rupee are merely symptoms of a deeper malaise—uncompetitive manufacturing.
Going after gold buyers or currency speculators is nothing more than shooting the messenger.
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