Before stepping into the plane for Beijing, Prime Minister Manmohan Singh said India would not be part of any alliance that aimed at containing China, while his hosts, with their characteristic vagueness on the border dispute, confirmed they have a containment strategy for India. Fortunately, unlike their political masters, India’s economic policymakers recognize the challenges posed by China.
The Economic Advisory Council (EAC) released its review of the fiscal year 2007-08 last week. It observes that “actions of some large central banks in the region set constraints that limit the ability of any one currency to get ahead in the appreciation game, without incurring an avoidably large economic cost.” Clearly, this is a reference to China. The report adds that it doesn’t see any scope for the appreciation of the rupee in the remaining months of the current fiscal year.
Nonetheless, it was good to note that the EAC was under no illusion about the exchange rate challenges that India’s exporters and others faced. The capital account surplus is many multiples of the current account deficit (some glaring errors in Table 8 could have been avoided) and hence appreciation pressure on the currency would persist in the next fiscal year. Therefore, the EAC wanted clear signals to be given to the industry to improve productivity rather than hope for?any?relief? on?the? exchange?rate front.
Unfortunately, government policies, instead of helping enhance national productivity, have been effective in “containing” it. The EAC notes that power generation has fallen short of the targets set for the Plan period 2002-07 even as economic growth has spurted. With the overall GDP crossing $1 trillion and the per capita income crossing $1,000, the demand for power would only rise. It is very important for the nation to stay ahead of electricity demand if the economy were to perform close to its potential.
Another area where the government has been derelict is fiscal management —the EAC attributes the headline improvement in fiscal deficits entirely to higher tax revenues. Further, the tactic of “hiding” (rising) subsidies below the line through the issuance of securities understates the true deficit. The hidden deficit is estimated at 2% of GDP. The persisting high global prices for crude oil in the last few months will show up in a wider merchandise trade deficit and this also means a higher fiscal burden. Pricing of energy products that reflects international realities has multiple benefits. For instance, this would increase the household savings rate and help finance capital spending if realistic energy prices made fewer households purchase automobiles. Further, despite lessons from decades of wasteful public spending, the government has wasted precious resources without even a trace of benefit through the National Rural Employment Guarantee Programme. Better sanitation and water availability in rural India would have had a greater impact on employability and productivity.
Although the EAC report was released mid-January and a speech Reserve Bank of India governor Y.V. Reddy gave in Hyderabad was on 3 January, it’s possible to interpret his speech as the sort of advance warning that the EAC wants to see. In his speech at the annual conference of the Indian Econometric Society on capital account management, Reddy mentioned that it was important to encourage market participants to expect greater exchange rate flexibility so that they were “prepared, equipped and enabled to adjust to greater flexibility.” His comment that what was volatile yesterday would become flexible tomorrow and that this was the process by which India was moving towards greater exchange rate flexibility should leave no one in doubt about the risks of rupee appreciation in the next fiscal year.
After years of procrastination, China is forced to contemplate faster appreciation of its currency precisely at a time when a higher inflation rate is beginning to cause a real appreciation in the economy. Greater and steadier appreciation of the yuan over the years would not only have been more orderly but could also have moderated the recent spike in consumer price inflation. That has not been the case, and the result is a likely large spike in the real effective exchange rate of the yuan in 2008. In that event, the Indian corporate sector ought to be prepared to accept a stronger rupee.
Thus, monetary policy stewardship continues to be a strong point for India’s economic prospects in the coming year. How far it would be able to drive the economy forward at high speed without any support from the executive is an open question. Unfortunately, the answers might be found too late to fix accountability on the present government, since policy errors of omission and commission tend to affect the economy with a lag.
(V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at email@example.com)