Is govt ready for a European crisis? Plans to ensure macroeconomic liquidity must be in place.
Concern over the Indian economy’s vulnerability to external shocks is becoming ever more widespread. European banks, which may be forced by circumstances to shed external risk, have considerable exposure to Indian domestic debt; firms wishing to roll over that debt may find doing so increasingly difficult. The government has downplayed these fears, saying that debt to European banks is less than 10 per cent of international banks’ total claims due from India. Certainly, India’s trade deficit continues to balloon. According to figures from the Reserve Bank of India (RBI), over the first half of 2011-12, the overall trade deficit stood at $73.5 billion. The current account deficit is similarly problematic, with the second quarter of 2011-12 setting a near-record, at $16.9 billion. Exports and remittances are unlikely to salvage the situation, as they did last financial year; exports because external demand will collapse, especially if the euro zone crisis is not contained, and remittances because they may be too small in absolute numbers to make up the shortfall. Comparisons to the crisis of 1991 are beginning to be made. True, at that point India’s foreign exchange reserves were tiny, and now they are stable at around $300 billion, supposedly enough to finance imports for eight or nine months. But reserves have stayed steady even as the import bill has risen by over 30 per cent. Meanwhile, the threat of euro zone collapse hangs over the world economy, and India’s. The question needs to be asked, therefore: what is the government doing to prepare for a crisis?
The 2008 financial crisis played itself out as a crisis of liquidity. Yet India’s macro numbers were much more stable then, and the government had considerable room to manoeuvre fiscally. That fiscal space no longer exists. Macroeconomic liquidity is likely to be a problem this time, again — but there are no longer easy answers. Lessons from the 2008 response of the securities regulator, the RBI, and the finance ministry need to be applied. The comparison to 1991 is even more worrying. After all, the only way out of a crisis is to be able to reform, but the low-hanging fruit of reform has all been plucked. Quantitative restrictions on trade are a thing of the past. Government capital expenditure has been trimmed to the bare minimum; any further reduction in spending will have to come out of politically sensitive current expenditure, such as subsidies. Any response, thus, is necessarily constrained by the government’s own over-expansion.
The only reasonable answer, therefore, is to ensure that the RBI is working on plans to make dollars available as essential liquidity, were a crisis to hit. Recent moves to push the attractiveness of non-resident Indian savings accounts, as well as to open up investment in shares to qualified foreign investors, are thus a step in the right direction — as long as proper safeguards to prevent money laundering are in place. Investors need to be reassured that an action plan for the worst contingency – a European collapse followed by a draining out of external credit – is in place. The government needs to ensure that it is doing everything necessary to restore liquidity to India’s external account, if current tensions become a full-blown crisis.
