India must build on macroeconomic stability, use trade as growth engine

Maintaining economic and financial stability at all times is a necessary condition for sustained economic development. However, this is not easy to achieve, particularly for developing economies. There have been several episodes of economic crises in developing economies over the past few decades. India was also exposed to a balance-of-payments crisis in 1991. However, over time, things have changed, and a significant number of developing economies have adjusted their policy frameworks to enhance economic resilience. Reserve Bank of India (RBI) Deputy Governor Poonam Gupta on Wednesday, at the Business Standard BFSI Insight Summit, spoke about the evolution of such policies. In a world that is moving from one crisis to another, Indian policymakers have managed to preserve macroeconomic stability, which has helped the Indian economy grow at comparatively high rates. In fact, it must be recognised that India has not had an external crisis since 1991.

 

In the context of India’s macroeconomic management, some of the important aspects, also touched upon by Dr Gupta and others, are worth discussing here. They offer a broad sense of where India stands and what it needs to do next. For instance, India has adopted a flexible exchange-rate policy, which is largely market-driven. But the RBI does intervene in the foreign-exchange market to quell excess volatility emanating largely from sudden capital inflows or outflows. For instance, as large central banks flooded the global financial system with liquidity along with near-zero policy interest rates in the initial months of the pandemic, Indian markets witnessed significant capital inflows. The RBI intervened to absorb excess flows, and built reserves. India’s foreign-exchange reserves went up by over $100 billion in 2020-21. When large global central banks increased interest rates in a coordinated manner in 2022, it resulted in large outflows from emerging markets, including India. But active intervention by the RBI helped contain volatility in the foreign-exchange market. Foreign-exchange reserves declined by about $100 billion between March and October 2022.  As things stabilised, the RBI rebuilt its reserves. Currently, at over $700 billion, foreign-exchange reserves provide enormous strength to economic stability.

 

However, foreign-exchange management has not been the only pillar of India’s resilience. In 2016, for instance, India moved to a flexible inflation-targeting framework for conducting monetary policy. The shift has not only helped contain the level and volatility in inflation outcomes but has also increased policy transparency and enhanced faith in Indian policymaking. India also has a rule-based fiscal policy. In this regard, the government has done well, particularly after the surge in fiscal deficit owing to pandemic-related disruption. The government is on course to meet the fiscal-deficit target of 4.4 per cent of gross domestic product (GDP) this financial year, a significant improvement from 9.2 per cent in 2020-21.

 

This mix of policy choices made over the years has enabled a stable macroeconomic environment. As some other speakers noted at the summit, both the bank and corporate balance sheets are in excellent shape. Although all these factors provide solid foundations, they may not be sufficient to push India’s growth rate to desirable levels in a sustainable manner. The external environment remains fairly uncertain, largely because of trade uncertainties driven by the United States (US). It is hoped that India and the US will soon arrive at a mutually beneficial trade agreement. But India needs to go beyond the expected agreement with the US and exploit trade as an important driver of long-term growth. India will also need to push internal reforms to build on stable macroeconomic foundations.