'We can meet the fiscal deficit target but must be prepared to control spending'

Montek Singh Ahluwalia, Deputy Chairman, Planning Commission

MONTEK SINGH AHLUWALIA , deputy chairman of the Planning Commission, speaks for the government in an interview of the rupee’s fall and the prospects for growth and deficit control, on Karan Thapar’s  Devil’s Advocate programme on the CNN-IBN television channel. Edited excerpts:

 

At its nadir, the rupee had depreciated by 20% since the start of the financial year and a little over 7% in August itself. Would you accept that the steps taken by the government and the Reserve Bank (RBI) to arrest its fall haven’t worked?
 

This (currency fall) is not an India-specific event. What you have seen in the past two or three months is an amazing volatility in global financial markets, in which most emerging market countries have experienced a weakening of currency.

 

But when the government and RBI step in to try and arrest the fall, they believe they can succeed and they haven’t.

That is never the approach. Neither the government or RBI have taken the view that we are drawing a red line on where the rupee should be. But what they are saying and I think I agree, at the moment, is that the rupee is a bit over-depreciated but a lot of the correction that occurred might not have been such a bad idea.

 

It’s not just that their steps haven’t worked. Some of RBI’s steps -- particularly the sharp increase in short-term interest rates, the control on capital transfers which the market  interpreted as capital control -- not only failed to soothe nerves; they actually created a sense of panic.

Those particular steps were certainly misinterpreted. Since then, the finance minister (FM) has categorically stated India is not going back to the world of capital control. 

 

He took a whole week to say so and by then the international papers were writing articles about India possibly closing its door.

People nowadays write articles every 10 minutes. Every serious investor, when something like this happens, when the markets are troubled, want to look at what the authorities are saying. 

 

The rupee is steadily sinking. It breached 65 (to the dollar) and even then the authorities were silent.  

What is so sacred about 65? There are two kinds of people in the markets, in the world. There is one lot who say you shouldn’t bother at all; if it over-shoots, it will come back. I don’t share that view; governments can tolerate some volatility but when things look a bit excessive, this can send wrong signals, so it is quite right to come in and explain your position. That’s what the government has done.

 

They could have done it a week earlier or even two-three-four weeks earlier because the slide has been happening since April. The silence from the government, compounded by the refusal of the FM to actually speak on the subject to the press at all, led to concern. If misinterpretations were happening, that then led to panic. International investors read papers like the Wall Street Journal  and the Financial Times  and when those papers were predicting the next control on capital flows would be investor money not being allowed back, people began to worry.

Raghuram Rajan was quoted in FT , clarifying this was not capital control. The chief economic advisor is usually the FM’s mouthpiece. I don’t believe the minister should start speaking every two seconds. He spoke in Parliament, subsequently had a press conference. Whenever there is a problem, it’s a judgement call. We need to create an atmosphere in which markets take officials seriously and I think both Raghuram Rajan and Mayaram (the economic affairs secrerary) categorically said there was no question of going back on capital flows.

 

But it didn’t work. It needed the FM and he was late. Leaving that, on Friday the rupee did go up by Rs 1.35 against the dollar.

Is it a sign of recovery or are you worried that next week it could start heading south again, particularly when the first-quarter performance results come out, which many believe will be disappointing.

I am not predicting what is going to happen to the rupee and nor should anyone in the government be doing so. For the first time, people are beginning to say the rupee has overshot. We are facing a genuine uncertainty. As far as the government is concerned, it ought to have three-four clear messages. I believe it has them and they are very good.

 

What are they?

Number 1, the current account deficit (CAD) this year is going to be much better than last year. From $88-89 billion, it is going to be much closer to 70 bn.

 

At the moment that is a statement from the FM the public have taken at face value and accepted because they want to trust him but he hasn’t provided any basis for believing it .

There are two reasons why I believe the CAD this year will be a lot better than last year. First, last year saw a big burst of additional gold imports. That has already come down and we do not expect it to be repeated. Second, prices of petroleum products have gone up; we think there is going to be a moderation in the demand for oil products. That will happen to some extent anyway because growth is less than originally projected and I think commodity prices are going to be relatively modest.

 

If you can bring the CAD to $70 bn, will you get the finance needed to finance the inflows?

Last year, 2012-13, we dragged in about $92 bn from different sources.

 

That was before the threat of tapering (of the US Federal Reserve’s quantitative expansion) and that could start next month.

The markets have already factored that in.

 

Are you saying when the tapering starts, the flow of funds out of India won’t come as a flood? Duetsche Bank says at that time, the rupee could sink to 70 and below.

People are predicting both 60 and 70; don’t take any of these seriously. The reaction of the markets to the anticipated tapering has already begun. We, in any case, are expecting to draw in $20 bn less. It’s possible you get a short-term scarcity of funds because of uncertainty, for a month, for two months, for four months.

 

That will sink the rupee further?

Unless the safety net you have, your foreign exchange reserves, are not deployed. Now, I have no idea what the new (RBI) governor wants to do or the FM wants to do. There is no point whatsoever of having forex reserves if you are not going to use these when necessary.

 

How  much would you be prepared to spend ?

That’s a judgment which, first of all, the government should keep you guessing. So, it will be foolish of me if I give any number. I will answer this by an analogy. What does a country do when it suddenly experiences a short-term shortage of liquidity? The first question that the markets have to ask is, is this government or country basically, fundamentally, sound?.

Are they going to bring growth back? Are they going to keep the fiscal deficit under control?

 

Both of them are big question marks in this case.
 

We’ll come back to that. The government has clearly given the signal that we are very concerned about growth. We are going to do what is necessary to remove the impediments to growth.

 

First, come back to the reserves. You are saying that in certain circumstances these should be used.

Yes. Further, if you are a normal country and you needed liquidity protection, you would use a swap arrangement or go to the International Monetary Fund (IMF). We don’t need to do any of that.

 

You’re ruling out those two possibilities?

I would personally rule these out. We only have a swap arrangement with Japan. Of $10 bn; we have $280 bn of our own money.

 

So, the reserve should be used first and the fal back is the swap arrangement?

I’m not even saying that; those are the judgement calls the people managing the currency have to make. My limited point is this. Even if you believe we can get $70 bn in a year, you can’t rule out that for two ot three months, you might have a shortage. You have to keep in mind the reason we built up these reserves.

 

That’s the period we use the reserve, for the shortage period of two-three months?

It’s why we have got these; else, we should have got rid of these long ago.

 

The Business Standard,  in a lead earlier this week, said the government in fact should set up a standby facility to give it a safety net with the IMF.

Absolutely ridiculous suggestion. The scale of facility you’d get from the IMF is very small compared to the reserves you have. And, if you were to announce half the policies that the IMF would want you to announce, to get a standby facility, you would need to use your own reserves.

 

An alternative suggestion by Surjit Bhalla is that in addition to this swap arrangement, why not set up a similar one with the Bank of England and with the European Central Bank. You use these to reassure investors.

As a general rule, I am in favour of exploring the possibility of regional swap arrangements. The international financial architecture now formally acknowledges that you have to have three levels of safety net. The first is your own reserves, the second is swap arrangements and the third level is the IMF. I don’t believe the ECB would be interested in a swap arrangement with a non-reserve currency.       

 

The Bank of England?

I doubt if they would be interested, either. Their whole approach would be, look, because of the European crisis, we have hugely increased the ability to borrow from the IMF.

 

Which means the only swap arrangement possible is the one you have with the Bank of Japan?

Well, there is a Chiang Mai arrangement where we are not members but I think, long term, this is an issue both the finance ministry and the external affairs ministry have to think about, whether we need to join a regional arrangement.

 

What worries people is if you find (annual) growth falls below five%, inflation rises substantially above 6%, your current account deficit is above the target and you miss the fiscal deficit target. And, all of these are quite easily possible. What, then, happens to the rupee?

Instead of worrying about the rupee and constantly looking at whether it’s breached some level or not, 95% of the government’s energy at this moment should be spent trying to make sure the impediments to growth are removed. We have done a lot but at the moment, there isn’t evidence yet of a response. I am still hoping.

 

People turn around and say the multiple assurances Montek Ahluwalia used to give on this programme about how the Cabinet Committee on Investment has cleared obstacles and so projects that were on hold will now start moving and  growth will pick up have not  begun to materialise.

When I said that earlier, we had a situation where 78,000 Mw of power generation capacity had come on stream after 2009 and would begin to be on stream by 2015 did not have fuel supply arrangements. They now have. This is a very big change.

 

Your third largest conglomerate, the Aditya Birla Group, told the Financial Times  in June that $10 bn worth of its projects were held up. He (Birla) certainly doesn’t reflect any great confidence in the ability of the CCI to rapidly clear projects. That’s what industrialists say, the governments talks but it is not delivering.

The first priority the CCI rightly gave was for projects supplying power to the grid. Projects of his kind are the next round and are being considered now.

 

The fiscal deficit first, the other deficit that worries people enormously. Can you bring that in at 4.8 (per cent of gross domestic product) or will the FM miss that promise altogether?

Oh, I think you can make it.

 

I give you three reasons why I think you can’t. First, this target is predicated upon growth of 6.4%, which isn’t going to happen, as a result of which your revenue targets will fall short. Second, with the rupee sliding perhaps as much as 20%, your subsidy on fuel and fertiliser will overshoot the Rs 65,000 crore allocation.

Third, you have a disinvestment target of Rs 40,000 vrore and a target of money raised by sale of other shares of Rs 14,000 crore more, neither of which look as if they can be met in present market conditions.  

If you are serious about meeting the fiscal deficit and you find there isn’t enough revenue, you just have to cut expenditure. It’s unpleasant but then, he (the FM) has to do it.

 

This year is particularly difficult and unpleasant. Last year, you reined the fiscal deficit in by cutting expenditure by Rs 92,000 crore but it wasn’t an election year. This year is.  

You have to judge the fiscal situation as it evolves. The fuel subsidies, by the way, are not necessarily reflected in the budget. They simply lead to a squeeze. 

 

Well, you got an allocation of Rs 65,000 crore last year and it was short by some Rs 30,000 crore. This year, people believe it will be short by the same. Your real solution is that he has got control over one thing, expenditure, and he can cut it sufficiently even if it is unpleasant to do.

That’s the only alternative unless you can do better in mobilising resources.

 

Why, then, go ahead with the food security Bill, which is going to add possibly Rs 40,000 crore more?
 

It is a long-standing political commitment of the government. The extra expenditure will depend on the rate at which it is rolled out. States have to do a lot to be ready to take up the offtake of additional amount. But that Bill is just one component of subsidies.

 

Cut the others?

Absolutely.