Downside Of The Upside

No cause for optimism

There is no particular reason to expect that the next financial year will be much better. Agriculture may see some fresh momentum, but this is always iffy because of the uncertainty with regard to the monsoons; in any case, this sector now contributes barely 25 per cent of GDP. In industry, it is difficult to see the originating points for fresh momentum. Public spending is not going to grow, indeed the fisc will be under tremendous pressure because the finance ministry is bequeathing to next year large unpaid bills of several thousand crores of rupees. Exports cannot be expected to spur growth in the face of the short-sighted policy on propping up the rupee; indeed, even production for domestic sale may be affected by the expected wave of price competition from East Asia. Even without this, demand is likely to fall short of supply in several key sectors, thus sustaining the mood of pessimism in companies and suppressing investment demand (no one wants to create fresh capacity). This is not a scenario that

 

warrants great optimism about an industrial recovery. And if there is prolonged uncertainty because of a fresh lease of life for coalition politics, it will contribute to the general sense of things not being quite right with the world.

This is the backdrop against which the finance secretarys comments last week, on the impact on India of the East Asian crisis, must be judged. Mr Ahluwalia put a brave face on events by repeating the well-known facts with regard to Indias current account deficit, its short-term external debt, the restraints on external capital transactions, the accumulated foreign exchange reserves, and so on. Everything that he said is true, but in many cases the full truth is more complex, and less re-assuring.

For instance, while it is true that the short-term debt is about $7 billion, it is not wise to ignore the exposure to non-resident Indians (who were the first to pull their money out when trouble cropped up over the horizon in 1991), or even the portfolio investment in India by the foreign institutional investors (FIIs). At least a portion of both these categories of inflows can flow out at fairly short notice (say, in six months), and if one accounts for this on top of the short-term debt, and also factor in the possibility of trade credit drying up in a crisis, the reserves of $24 billion are somewhat less than comfortable.

Besides, while India has successfully managed to avoid too much of a backwash effect of the Asian crisis (other than a 10 per cent drop in the rupee value and a similar drop in share prices because FIIs began pulling out), the country needs to worry about the second wave that will come through trade. Mr Ahluwalia has given some figures on the effect of the Asian crisis on global trade, but what are the assessments of the impact on Indias own imports and exports? Even if it is 3 or 5 per cent on both sides of the trade equation, it could mean a difference of a couple of billion dollars. At todays numbers, the rese-rves cushion is not nearly large enough to countenance this with equanimity.

Mr Ahluwalia has argued that Indian exporters must learn to compete overseas on factors other than price. But most Indian exports build on a price advantage, and it is impossible to wish this away in the short run. Also, while it is true that East Asian economies have been disrupted by collapsing financial structures and the inflation that follows the huge devaluation of currencies, it is fairly certain that an export thrust will be mounted as soon as credit lines get restored. It would, therefore, be short-sighted to ignore the trade backlash that can come, and there is no getting away from re-assessing the policy with regard to bolstering the rupees external value.

To some extent capital inflows can make up for current account deficits, although the East Asian experience shows that this can be a risky strategy. Nevertheless, Indias capital needs are so great that the system can certainly absorb upwards of $10 billion in capital inflows next year. This is about double the inflow this year, if one counts both portfolio investment as well as foreign direct investment in projects. And the inflow can come into key infrastructure sectors like power, telecommunications, oil and gas, and even transport (road development, for instance). The bottleneck here is the continuing lacunae in the policy framework that governs many of these sectors, and this explains why reformers argue so forcefully that the key to faster economic growth lies in faster and more comprehensive reform. If reform were indeed to get a fresh boost, and facilitate capital inflows, the foreign exchange reserves and liquidity position would cause much less worry.

The right policy mix

The alternative to a package of measures that includes comprehensive sectoral reform and a cheaper rupee is slower economic growth. In a sense, this is what the authorities have already opted for by squeezing out demand from the system (through a tighter monetary policy that raises interest rates), and this brings back into focus the latest bout of statistics on the key indicators of economic performance. If domestic demand is suppressed and imports kept out through higher tariffs (which a BJP government might be tempted to try out), the slower growth will certainly prevent an external macro-economic crisis, but what then is the value of all the talk of India becoming the next Asian tiger, lion, elephant or rhinoceros? If the economy is indeed to grow at 6 to 7 per cent in the next few years, the choice of options is clear. But if you get the wrong policy cocktail (ambitious growth targets combined with todays broad policy stance), the International Monetary Fund beckons.