The global impact of policy calls may affect our rupee ambitions
- Limited fiscal headroom and ideological signals of trade policy could get in the way of efforts to globalize India’s currency
One of the most significant yet economically speaking irrelevant recent developments was a downgrade of the US sovereign debt rating to AA + from AAA by Fitch Ratings. It is significant because this elicited umbrage from the US Treasury, as downgrading the creditworthiness of Uncle Sam is considered a highly disrespectful thing to do. The fact that the US government embarrassingly hits its debt ceiling (which has now been disbanded) every now and then is reason enough to consider a downgrade. Add to this the tricky issue of impounding Russian money stacked in US Treasury bills. If a government for any reason decides to not pay a creditor, it is a technical default. Hence, the irony of today’s scenario is hard to miss.
The Fitch downgrade is irrelevant because at the end of the day, it means nothing. AA + is as good as AAA, and the difference is only one of reputation. The UK and EU have a rating of AA, while Japan has A +. Germany along with smaller European countries like the Netherlands, Switzerland, etc, have AAA. Markets reacted for just about a couple of sessions and then reverted to normal. Back in 2011, S&P had downgraded US sovereign debt to AA+ and has left it at this level for over a decade. The usual disdain for the agency’s decision was expressed, but it was soon business as usual.
Rating agencies have clearly been biased while rating India. Our rating remains at BBB-, notwithstanding a rather outstanding performance on the economic front on almost all parameters, with the only sore point—which is brought up routinely— being the state of fiscal balances. This has come in the way of a rating upgrade, which seems to be necessary for us to move towards internationalizing the rupee. But such a focus on fiscal balances also raises some anomalies.
India is looking to maintain deficits at 3% of gross domestic product (GDP) ideally, and has a current glide path to 4.5% of GDP by 2025-26. But once other nations accept the rupee and want to hold it, there would be a case for running higher deficits as rupees are made available to other nations. It would also mean having other countries hold our domestic debt. One of the motivations for having Indian bonds included in global indices is to get fund houses investing in government debt. It will help to get dollar inflows and hence shore up the country’s forex reserves.
Today, the US has a debt-to-GDP ratio of around 130%, Japan 260%, UK nearly 100% and the eurozone 90%. The ratio for India is around 90%. This figure does not seem high in comparison with these nations. But consider the fiscal implications. The other four, which account for 90% of the world’s forex transactions and reserve holdings, usually run high deficits that keep their debt paper in sufficient supply for their currencies to play a global role as means of exchange and stores of value. The US and Japan have fiscal deficits of around 5.6-5.8%. For the UK, it is 4.5%, while for the eurozone, it is 3.3% (the 3% norm emanated from its process of monetary union). Hence any currency that claims ‘reserve’ status must run deficits so that other countries can invest in their debt and access that currency. Can India afford to run higher deficits to supply rupees to the world? Can we escape its impact in terms of higher inflation?
With talk of the rupee’s internationalization now gathering momentum, some policy decisions have been taken which are right in terms of rationale, but may come in the way of its global prospects. These ideological inflections need to be addressed as we work on globalizing the rupee.
The Centre’s announcement of import licensing for laptops, computers, tablets, components and other items has raised antennas. Its argument is that licence issuance only means permission must be taken for imports and need not act as a restriction. It makes sense because it will keep a check on Chinese imports, which have swelled in recent years. Further, as the government has included computers, laptops and mobile phones under its production linked incentive scheme, it wants to prod domestic manufacturing beyond imported kit assembly operations. An import check placed by licensing can offer clarity on the quantum of domestic production taking place. Licensing that serves security interests does not contravene World Trade Organization norms and should not raise a red flag. Yet, widening this net can do so.
Another issue that comes in the way of being a global player is India’s ban on export of non-basmati rice. Here too, there is a domestic compulsion of output fluctuation amid uncertainty that can justify such a move. The result, though, is that global rice prices have gone up. Last year, New Delhi banned wheat exports when domestic output dropped. Similar actions have been taken not just on foodgrains but also sugar, when output came down as part of the sugar cycle (production tends to fall every 4-5 years). But banning exports of any product presents a picture of a closed economy, where domestic considerations are more important than global ones.
At a different level, the withdrawal of India’s ₹2,000 note has created some problems. Reports indicate that high-denomination Indian currency is not being accepted in Nepal. The reason is that holders in non-Indian territories don’t have an exit route when such decisions are taken. As the withdrawal was on grounds of a ‘clean notes’ policy, a pertinent apprehension is that the same could happen to the ₹500 note that was issued at the same time after demonetization in 2016. When such measures are taken, we must ensure that holders of rupees in foreign territories have access to outlets where the currency can be changed. This would need to be worked out through either Indian bank branches or designated foreign banks.
As we embark on internationalizing the rupee, specific attention must be paid to the ideological signals of trade bans as well as our approach to the fiscal deficit. We must also take into account the global impact of any domestic policy decision.
Madan Sabnavis is chief economist at Bank of Baroda and author of: ‘Corporate Quirks: The Darker Side of the Sun’
