BackUPA II: waiting for a crisis?
UPA II: waiting for a crisis?
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The Prime Minister hosted a dinner earlier this week and released a report lauding the achievements of UPA II to mark its anniversary. The other side is an out-of-control fiscal deficit, slowing growth, stubbornly high and rising inflation, a lack of job creation and growing external imbalance. In fact, as the rupee keeps falling despite some central bank measures, I have started wondering whether we are heading for a balance of payments crisis and what, if anything, can be done to avoid it. It was amusing in this context to read a report (Business Standard, 18 May) to the effect that the finance ministry is “pitching" for higher ratings from Fitch. Clearly, the way policymakers look at the situation and other analysts do is as wide as it can be.
In reality, the problem seems to be structural, not cyclical, and the root cause domestic. Given the floating exchange rate policy we seem to have followed for the last few years, the rupee had appreciated significantly in nominal and, much more so, in real terms between March 2009 and mid-2011 on top of a sharp earlier appreciation in 2007-08. An overvalued currency not only diminishes the competitiveness of the tradables sector of the economy, but also increases consumption thus reducing savings, both leading to higher deficits on the current account. (The external deficit also reduces the gross domestic product, or GDP, compared with its potential at a reasonably competitive exchange rate.) No wonder the current account deficit has widened from less than $10 billion in 2006-07 to perhaps $70 billion-plus in 2011-12 and led to a sharp rise in the net external liabilities of the economy. (We will have to wait for five weeks for the official data). While part of the reason could well be the rise in the price of both crude oil and gold, there has also been a huge growth in manufacturing imports, another manifestation of the uncompetitiveness of the exchange rate.
Is putting restrictions on gold imports a solution? To my mind, the answer is in the negative given our hunger for gold, this would merely drive gold imports and inward remittances into the illegal smuggling/hawala market, leaving the current account unaffected as we experienced for 40 years.
Is larger and more determined Reserve Bank of India intervention a possible solution to the continued slide on the assumption that at the present exchange rate, the tradable sector is now more competitive in the global market and the deficit will correct itself in 2012-13? But exchange rate changes affect trade numbers with a lag. Again, lower gold and oil prices now prevailing may help, but services export growth is falling. Shutting of mines (coal and ore) would reduce exports and increase imports. Flip-flops on agricultural exports (cotton and sugar) only damage our reputation as a reliable trading partner. Overall, it is difficult to be optimistic about an improvement in the current account in 2012-13.
In any case, some stability in the exchange rate would be needed if discretionary capital inflows are to resume. However, if the problem is structural, as I believe it to be, then intervention to hold a level would merely waste reserves which are already less than the external borrowings. It would be meaningful only if it is accompanied by various macroeconomic and regulatory measures, including the following:
• A mid-year budget cutting the various subsidies and deficit sharply, not just cosmetic austerity measures announced by the finance minister, increasing domestic prices of petro products may also help reduce consumption, waste, smuggling and imports;
• Acceptance of a higher inflation for 2012-13;
• Giving up the policy of a floating exchange rate and manage the real external value of the rupee in a manner suited for an economy producing non-differentiated goods and services with the objective of bringing down the deficit to say 1% of GDP in three years. This would also need a more rational index model than the bilateral trade-weighted real effective exchange rate;
Much is also needed to be done on our foreign direct investment policy, goods and services tax, environmental regulation, tax laws and infrastructure. Can we not do these things voluntarily instead of waiting for a crisis? We obviously can, but one is not very hopeful in the absence of a political/governmental leadership capable of “leading", i.e., articulating, arguing, convincing their partners and opponents of the logic of the proposals. Policymaking has been reduced to the lowest common denominator—it is so comfortable to withdraw, to backtrack, to blame things on the coalition dharma, on global economy, etc.
A.V. Rajwade is a risk management consultant, columnist and author.
Comments are welcome at theirview@livemint.com
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