Since mid-September when the government allowed foreign investment in retail and aviation, raised the price of diesel and capped the subsidized supply of cooking gas, the stock market has risen at least 5% and the local currency has appreciated close to 7%. Most brokerages have started revising their outlook on equities and quite a few foreign exchange dealers expect the rupee to end the year at around 50 to a dollar. If that happens, the currency’s rise will be a phenomenal 14.3% from its lifetime low of 57.15 a dollar in June. On Friday, the rupee closed at 51.85 to a dollar.

Should we feel happy about the rupee’s rise? We shouldn’t if we look at the larger picture. Currency appreciation is something which shouldn’t be encouraged in a country with high current account deficit. India’s current account deficit for first quarter ended June 2012 declined to $16.4 billion from $17.4 billion in April-June 2011 on moderation in trade deficit and rise in remittances from overseas Indians but as a proportion of gross domestic product (GDP), it marginally rose 3.9% in the June quarter of fiscal 2013 from 3.8% in the year-ago quarter. Last year, the current account deficit was 4.2%. This year, the deficit is estimated to be around 3.5% but it could be closer to 4%. For the March quarter, it was 4.5% of GDP.

India’s merchandise exports continued to fall in August, the fourth month in a row, widening the trade deficit. As global demand shrank, exports contracted 9.7% and imports, 5.08%, leaving a trade deficit of $15.7 billion. Exports had shrunk 14.8% in July. In the first five months of fiscal year 2013, exports shrank 5.96% to $120 billion while imports contracted 6.2% to $191.1 billion. As a result, the trade deficit declined to $71.1 billion from $76.2 billion a year ago. Analysts estimate the trade deficit close to 10% of GDP for the current fiscal year.

A strong currency will widen the trade and current account deficits. In a recent speech, Y.V. Reddy, former Reserve Bank of India governor, has said zero current account deficit in the external sector over the medium term should be the cornerstone of macro-management. A 2% current account deficit has been treated as an average since the reform process began, though the actual deficit in high-growth years was close to 1%, Reddy has pointed out. In recent past, RBI governor D. Subbarao and Planning Commission’s deputy chairman Montek Singh Ahluwalia have said a 3% current account deficit is manageable. According to Reddy, the deficit should be close to zero on average.

Interestingly, in 1991 when India embraced economic liberalization after the worst-ever balance of payment crisis in its history, the first thing that the government did was devaluing rupee against the dollar. The focus of most government measures in past three weeks has been on propping up the rupee. They are more an exercise in crisis management than reforms, as most of them do not address the structural issues that enhance productivity and efficiency. For instance, foreign money in retail segment alone cannot bring down the cost of goods by better supply change management unless the Agriculture Produce Marketing Committee Act that rules the agriculture market is amended. Laws related to labour, land and mining need to be changed to supplement the spate of measures that the government has been announcing to have a lasting impact. It is also interesting to note that the desperate measures are being taken to attract foreign money through external commercial borrowing and short-term debt when the global system is flooded with money by the easing measures of both the European Central Bank as well as the US Federal Reserve.

There seems to be little choice before the government that desperately wants to manage its balance sheet. An appreciating rupee is fine for the time being to change sentiment and attract foreign money in the equity market but to sustain the flow the government would need to curb its fiscal profligacy. Does this mean these fire-fighting measures are not called for at this juncture? No, that’s not the case. Indeed, they are necessary but not enough. Unless they are supplemented by real sector reforms, they can turn out to be counter-productive as an overvalued rupee is the last thing that the country needs when its current account deficit is high.

Anti-reform steps

Till some time back the finance ministry was taking pride in overhauling the appointment procedures of chairman and executive directors of public sector banks. It institutionalized a system of handholding the new chairman of a bank by the outgoing chairman. A fortnight was given to the new incumbent to understand the bank. That was a progressive step but the ministry has suddenly stopped that practice. Instead of sending the new chief executive officer a fortnight ahead of formal appointment, it has appointed the chairperson of Kolkata-based Allahabad Bank a month after J.P. Dua retired. Shubhalakshmi Panse, an executive director of Bangalore-based Vijaya Bank, replaced him.

The top jobs in Bank of India and Canara Bank, India’s fifth and sixth largest bank by assets, have fallen vacant this month but the government has not yet identified the candidates. Apparently, the list of candidates for top jobs in half a dozen banks cleared by former finance minister Pranab Mukherjee may undergo a few changes with the change of guard at the ministry. Whatever the reason behind this development, a government that is on overdrive on its reform push cannot afford to keep the top positions in nation’s large banks vacant.

A hands-off policy by the government for appointment of top jobs in the state-run banks is the solution to such problems. It should be left to an independent board of experts.

Tamal Bandyopadhyay keeps a close eye on every thing banking from his perch as Mint’s deputy managing editor in Mumbai. Email your comments to bankerstrust@livemint.com

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