An Ominous Portent

The immediate impact is the decline of exports in November by 0.4 per cent. The rise of 11.7 per cent in September and 9.7 per cent in October had raised the hope that after 10 months of stagnation (when exports had grown by less than 0.8 per cent), growth had been resumed. But the fall in November has dashed that hope. Till last year, this region accounted for 28 per cent of Indias exports. Had India been making any real headway in penetrating international markets, the decline would have been at least partly offset by high exports to the US and Europe. The US is enjoying an economic expansion whose vigour has not been equalled in more than three decades, and in Europe the long recession that began in 1991 gave place to accelerating growth in 1997. But instead of responding to this expansion, the rate of growth of exports to both the US and the EU has also declined.

 

In the medium-term, the East Asian crisis will impede the industrial recovery that every one is praying for. So far, the stagnation of exports has not caused an unsustainable widening of the trade deficit because with industry in deep recession, there has been a parallel fall in imports. But if industrial growth were to recover and imports were to rise without a parallel increase in exports, the external gap would widen dramatically and tempt the government to finance it by short-term borrowing abroad. The Rajiv Gandhi government fell for this and precipitated the crisis of 1990. Only a recklessly foolhardy government would do that once again. Unfortunately, the East Asian crisis has ruled out an early revival in exports, the other way of containing the trade deficit.

The still longer term impact of the East Asian crisis will be a shrinkage of foreign investment, especially export-oriented foreign direct investment (FDI). Much of the FDI that was coming to India was from Korea and Japan. Both economies have been badly hurt. But that is only half the story. With their vastly superior infrastructure and services, East Asian countries have been the preferred destination for OECD investors for decades. In recent years, their skyrocketing labour costs had made more and more companies look for alternate manufacturing locations in the region. China had hogged the lions share of such investment with Thailand, the Philippines and Vietnam following hard on its heels. India has so far failed to evince much interest except from those intent on exploiting its domestic market. Once the shock has worn off, the halving of the value of the East and Southeast Asian currencies will make them the favourite investment decisions for cost cutting transnationals once again. India will be left

out of the picture altogether. How much of an edge the devaluation has given East and Southeast Asia can be gauged from the 21 per cent cut in auto prices announced by Daewoo Motors in India. This reflects what East Asia will be doing in Europe and America next year.

The impact of the East Asian currency meltdown on Indias exports would not have been so great had the economy not already been out of balance. This lack of balance is reflected not in the weakness but, till a month ago, the strength of the rupee. For more than a year, the rupee has been getting more and more overvalued. Despite a 6 to 7 per cent higher inflation rate than the US, the rupee ruled steady against the dollar in 1996 and actually appreciated marginally between January and July 1997. But in 1997, the dollar appreciated sharply against all European currencies. Thus the rupee appreciated against all currencies in real terms in the worst possible way. The reason for this strange behaviour was the inflow of foreign financial investment, which was attracted by Indias apparent stability and high real interest rates. These high rates, however were a reflection of the very high fiscal deficit of the country and its even higher PSBR (public sector borrowing requirement the total draft of the public

sector on private savings).

A similar appreciation between 1993 and 1995 had not damaged exports because it was accompanied by rapid growth and a sharp rise in productivity. Thus, a part of the appreciation was offset by increase in productivity in the export sector, taken as a whole. But the appreciation in 1996 and 1997 took place against the background of falling industrial growth and a sharp decline (at the very least) in the growth of productivity. The result was a rapid weakening of Indias competitive position, especially in Europe.

There are two immediate lessons for policy makers in what is now happening. First, although the fall in the value of the rupee in recent months has corrected its earlier overvaluation, this will not suffice to raise exports or attract export-oriented foreign direct investment. Since this will make the servicing of foreign debt more difficult, and since foreign equity and loans are also nothing more than privately incurred debt, the next government will, if prudent, rely far less on foreign borrowings to finance infrastructure investment and will have to raise more resources at home. It will only be able to do this if it cuts back the Rs 200,000 crore of subsidies that it is giving, mostly to the middle classes, and well-to-do farmers.

Second, many businessman are clamouring for an easing of controls on money supply to kick-start an industrial recovery. According to them, there is a dearth of demand. Thus a little bit of deficit financing will not hurt. The next government would do well not to listen to these siren songs. This kind of stimulation will cause an industrial recovery but will simultaneously curb the growth of exports. The trade gap will widen, and foreign capital will come rushing in. The imbalance in the economy of weakening exports and strengthening currency will get worse. Even the lack of capital account convertibility will not stave off the next economic crisis for very long.