Shrinking India

The decline in the rupee's value shows that the government's efforts to fix the economy have been too little, too late


Shankar Acharya
Yes, the Gandhi-Singh government appears to have achieved this through its disappointingly bad economic and social policies. The toxic brew of fiscal populism, crony capitalism and bad economic management has ensured the collapse of economic growth, industrial stagnation, stubbornly high consumer inflation, declining savings and investment, shrinking employment opportunities, and a dangerously vulnerable external financing situation.

The current economic crisis has been building for several years. For a brief while, since last autumn, it looked as if the government had, at last, grasped the gravity of India's economic predicament and begun to take steps to turn things around. After many years of a reforms drought, a significant economic reform, the opening up of multi-brand retail to foreign direct investment (FDI), had been announced. At long last, the massive diesel subsidies had begun to be tackled through a stated policy of incremental price increases, while the LPG subsidies were sought to be contained through a dual-pricing mechanism. A fiscal consolidation path had been laid out, which the February 2013 Budget manfully (if not entirely credibly) strove to approximate. A Cabinet Committee on Investment had been established to break the logjam in key infrastructure and industrial sectors that had built up since 2010 in the wake of several high-profile scams and the resulting policy paralysis.

However, as the decline in the rupee's value since April has shown, it was probably a case of too little, too late. This was particularly true of the government's management of external finances. After allowing the foreign trade deficit (in goods) to build inexorably from six per cent of GDP in 2005-06 to 11 per cent in 2012-13 and the current account deficit to quintuple from one per cent of GDP to five per cent over the same period, the vulnerability to external and internal shocks and uncertainties could not be reduced in a hurry. Besides, the government's approach in the past year seems to have been focused on finding ways to finance the mounting current account deficit through more borrowing and investment inflows rather than undertake the structural economic reforms necessary to reduce the deficit. Perhaps the underlying strategy was that the current account deficit could be somehow financed/managed till the next general elections, after which either a re-elected government could return to take the necessary tough measures or the mess would be dumped on the winning opposition combination.

Well, if that was the strategy, it isn't working too well. Against the dollar, the rupee has depreciated by over 10 per cent in less than two months, despite the government's frantic efforts to raise more external financing and discourage gold imports and the Reserve Bank of India's various measures to reduce "speculation". The basic problem is that India's external vulnerability is too high at a time when the medium-term outlook for global liquidity is getting bearish (QE tapering and all that) and capital flows to emerging nations are being reassessed. The chickens from the earlier "borrow to finance the current account deficit" approach are also coming home to roost. Even if the current account deficit comes down this year to $70-80 billion, over $170 billion of India's $390-billion external debt has to be paid off (or rolled over) during this year. These are all well-known, public facts, which suggest that the rupee will continue to be under downward pressure throughout the year and beyond. That, in itself, discourages new capital inflows and encourages exits by current holders of rupee assets. In this environment, the chances of staving off a deeper crisis till next May's general elections do not look too good.

As if these pressures were not enough, the government may have blundered in going ahead with two retrograde policies in the last fortnight. First, as many have pointed out (including Devesh Kapur in "The wrongs of rights", Business Standard, July 8), the decision to enact the deeply flawed food security Bill through an ordinance promises higher fiscal deficits, more inflation, bigger distortions in agriculture and greater water stress. It confirms the worry that in the midst of a developing macroeconomic crisis, this government remains inexplicably committed to ill-designed, populist initiatives. Second, the announcement of the new gold-plated, gas-pricing formula (including for existing capacities!) strengthens concerns about the government's susceptibility to crony capitalism, and further erodes the financial viability of the hugely stressed electric power sector. When India's economic policies are under increasing external scrutiny, such policies could further discourage external capital inflows.

So what now? Sensible economic reforms are not in sight. In any case, if they require legislative approval, that is unlikely to be forthcoming. Nor are ordinances likely to be deployed to implement sensible reforms, since, almost by definition, they lack the appeal of populist measures. Making earlier announced measures work through the exercise of administrative will and capacity offers some hope. This might be true for making the FDI in retail initiative actually workable, something that has eluded the government for quite a few months. Even more important is the work of the Cabinet Committee on Investment in ensuring necessary approvals and clearances for stalled and "shovel ready" projects. It is disheartening to note that the June 29th issue of The Economist estimates the "fresh capital investment" this committee has actually sanctioned in the six months since its inception last December amounts to only "0.4 per cent of GDP, spread over several years". If you are an incurable optimist, you could say that simply underlines the potential to do much more!

More realistically, we can expect external financing pressures to continue and perhaps worsen, while the economy continues to stutter. The recent bout of depreciation will, in time, discourage imports and encourage exports and import substitution. But that will take some time. What takes much less time is the adverse impact on the prices of imported goods and services, on the operating margins of import-dependent enterprises, and on the debt service obligations of companies loaded with external loans. So inflation could tick upwards again and the fiscal deficit widen (higher subsidies for oil and fertiliser), while quite a few Indian companies feel the heat of the declining rupee. And that pain is likely to be transmitted back to the banks that have lent them money, at a time when the banking system - especially government-owned banks - is under significant stress already. So the outlook for the rupee remains "volatile with a downward bias".

It's not a pretty picture. But then a stressed economy is rarely photogenic. The tragedy is that almost all of this was avoidable through better economic policy. It isn't rocket science. But it does require sustained wisdom, integrity and will in the political leadership. Otherwise, India shrinks.

The writer is honorary professor at Icrier and former chief economic adviser to the government of India.
Views expressed are personal
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of or the Business Standard newspaper

First Published: Jul 10 2013 | 9:50 PM IST

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