A slippery slope: Why India must prioritise growth over rupee fears

High oil prices, a weakening rupee and global capital shifts demand bold policymaking to protect growth and build resilience against external shocks

Earlier this year, in a private conversation, I had alluded to concerns about possible high oil prices and their implications for the Indian economy.  

Private conversations do not make for credible forecasts. If the forecast was credible, it would have been public. Even though I did not have much confidence in the forecast, the reality is that the Indian economy now finds itself at a familiar point. High oil prices, concerns about the current account, foreign capital outflows and a weakening rupee. 

At the surface, it looks like a repeat of 2013. But look a bit deeper and there are many differences. Domestic growth is okay at around 6 per cent, but yeh dil maange more. Inflation has been below the target. This is unlike 2013, when India had witnessed 

successive years of double-digit inflation.  

This time, it is different and yet it feels familiar. 

The other key difference is what is happening outside India. The US 10-year bond continues to offer a risk free dollar return of above 4 per cent. There is significant demand for capital to satisfy the desired investments in AI and related sectors in several parts of the world. Countries in Europe are thinking about borrowing more to spend on defense. The same is the case in Japan. Capital therefore is spoilt for choice. It can invest in risk free US bonds and earn around 4.5 per cent in dollar terms. It can buy fixed income securities offered by Europe or Japan. It can finance new technology investments. This is a different reality from what Indian policymakers faced over the last two decades. The symptoms of weakness in the rupee or pressure on the current account may seem similar to before, but the world has certainly changed. 

So, what is to be done? Some suggest letting the rupee find its natural value. As the rupee weakens, foreign goods and foreign travel become more expensive. As a result, more Indians may prefer to stay in India during their summer vacations. Some also argue that a weaker rupee will help exports and eventually help with growth. Once growth returns, things will go back to being normal. That is a fair argument to make. But then, if the issue is growth, why not go for growth directly? Higher growth means higher returns. Capital will follow where returns are to be made. 

Some suggest that restoring the pre 2015 Bilateral Investment Treaty framework will help. I have in the past advocated for going back to the pre 2015 BIT framework. That should be a desirable goal. Be that as it may, it will not help deal with the current situation. BIT reform can improve the investment climate over time, but it cannot immediately reverse capital outflows, lower the oil import bill or strengthen the rupee. 

The other suggestion is on taxation, particularly the taxation of capital. Some have suggested reducing taxes on foreign investors who invest in Indian capital markets. That is a fair ask. The tax residence of investors should determine their tax liabilities rather than the place at which the profit was made. But even that may not be sufficient. 

All of this is not to suggest that policies do not matter. They do matter. But the challenge now is as much an issue of confidence as it is of policy. Restoring confidence and reviving investor sentiment will require many policy changes. The changing reality of the global economy means that a simple one size fits all solution to the present situation does not exist, unless there is a sudden end to conflicts in Europe and the Middle East. 

It is precisely for this reason that there is a need to go back to the iterative policymaking that was displayed during the growth slowdown of 2019 and during the Covid pandemic. Policymakers must try different interventions. They must be bold enough to experiment. Some of the experiments may fail. Some may only partly succeed. But only through several such experiments will we find what works. 

The primary objective should be to figure out a way to grow at 7 to 7.5 per cent with inflation around 4 per cent. Any policy that can help us get there must be experimented with. Those that work should stay. Those that do not should go. 

After all, we must recognize that in the grander scheme of things, the present crisis shall pass. The bigger challenge is to ensure that the domestic growth process can be cushioned from external shocks. That can happen only through resilience and bold policymaking. 

The danger is that India responds to the current situation only defensively. Excessive concern about the rupee can lead to tighter financial conditions, weaker investment sentiment and slower growth. Slower growth then makes India less attractive to capital, which puts further pressure on the rupee. That is the slippery slope.

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Karan Bhasin is a New York-based economist.

karanbhasin95@gmail.com