Fixing India’s Current Account Deficit

Joint Note with Prof. Charan Singh 

Dual Deficit Problem 

  The country is in the midst of twin deficits of gross fiscal deficit (GFD) and current account deficit (CAD). The GFD, though high, has been on a declining trend, while the CAD continues its uptrend and is expected to record a new high in the current year after 4.2% of GDP in 2011-12. According to the latest data released by RBI on March 28, the CAD for April-December 2012 was 5.4% of GDP (and 6.7% in Q3). Earlier, the highest recorded CAD of 3% in 1990-91 was followed by a major BoP crisis soon after. This is a worrisome situation

Sustainable Level?

     On the CAD, at the outset, it needs to be mentioned that the sustainable level varies over time. According to the High Level Committee on Balance of Payments (1993), CAD should be 1.6% of GDP which could be met through sustainable level of net capital receipts. According to the Committee on Capital account Convertibility (1997), growing degree of integration of the Indian economy with the global economy would imply variability in the size of the CAD and recommended a CAD of 2% of GDP, while the Committee on Fuller Capital Account Convertibility (2006) recommended a CAD of 3% of GDP. The parameters considered by the latter Committee and some more generally do not show a steady performance, especially rise in debt reflecting a weaker international investment position (table 1). This should be a matter of concern. 

Table 1: Select Indicators of External

Year	Total External Debt to GDP	Short term Debt to Total Debt	CAD/GDP	CR/CP	DSR	CR/GDP	Import cover of Reserves (months)
1995-96	27.0	5.4	-1.6	88.8	26.2	14.0	6.0
2005-06	16.8	14.0	-1.2	94.8	10.1	24.0	11.6
2011-12	20.0	22.6	-4.2	87.0	6.0	28.6	7.1
2012-13 End-Sep	20.7	23.1*	-5.4	na	5.8*	na	7.2

CR - Current Receipts; CP - Current Payments; DSR – Debt Service Ratio.

Source: RBI and GoI.

     The experience of other countries also shows that India’s CAD is not the only outlier in the global economy (table 2). An IMF study published in February 2013 mentions that a CAD of 4% for India in 2012 corresponds to a cyclically-adjusted 2.7% of GDP. However, as argued by Freund and Warnock (NBER WP 11823), high CAD is a cause of concern and should be addressed. 

Table 2: Current Account Balance as percent of GDP

Country	1996	2006	2012 Estimates	2013 Estimates
Australia	-3.36	-5.33	-4.08	-5.50
Chile	-3.98	4.60	-3.20	-3.00
Indonesia	-3.21	2.98	-2.11	-2.38
New Zealand	-5.86	-8.28	-5.37	-5.87
South Africa	-1.15	-5.31	-5.47	-5.85
Turkey	-1.00	-6.09	-7.54	-7.13
United Kingdom	-0.56	-2.93	-3.31	-2.71
United States	-1.59	-5.99	-3.11	-3.08

                   Source: IMF.

Trade and Exchange Rate

      The finance minister has argued that the CAD continues to be high mainly because of high oil, coal and gold imports, and slowdown in exports. The scheme to raise the limit of duty free import of gold jewellery is expected to raise the supply of gold and can also be expected to reduce the demand pressure reflected in rising imports and ballooning the CAD. It may be recollected that, in November 2009, RBI had purchased 200 metric tonnes of gold from the IMF. Since then, taking the cue, probably to hedge against numerous risks, gold imports have increased significantly from $21 billion in 2008-09 to $29 billion in 2009-10, and further to $56 billion in 2011-12

     The government could consider some more bold measures similar to those initiated in the latter period of the last year, including the politically-sensitive issue of oil subsidy. Similarly, the direct measure to correct the CAD would be to allow the exchange rate to be determined by medium term market forces that drive the CAD.

       It has been argued by many learned pundits that given the differences in inflation between the US and India, amongst many other variables, the current level of exchange rate would need a correction. As economic theory suggests that market-determined exchange rate, in this case implying a depreciation of the rupee, would boost exports and restrict imports. As commodity imports, consisting of essential commodities like fuel and fertilisers, which were highly subsidised, are relatively inelastic in the short run, the demand for these responds relatively slowly to exchange rates. But now, given that the subsidy on petroleum, oil and lubricants (POL) is being phased out, higher oil prices would lead to rationalisation of consumption by the public, private and household sector. The demand by households for other major imports like gold and silver, and electronic goods can be expected to be moderated by exchange rate adjustment. On the export front, manufactures and mineral fuels can be expected to respond to exchange rates.

      A number of econometric studies have shown that exports respond to exchange rates and external demand. Illustratively, exports responded to depreciation in exchange rates in 2008-09 and 2011-12. Though global demand was muted in some of the traditional export markets of India in 2012-13 because of the global slowdown, it is expected to improve in the next year. However, India needs to explore how it can make a dent in China’s labour-intensive exports, given that wage rates are finally being allowed to rise in China. Exchange rates driven by short-term capital flow movements also distort prices and preferences in the economy, though the impact is difficult to quantify. Therefore, a bold decision to let the exchange rate be determined by medium-term market forces will help lower the CAD

A version of this article appeared as an Op Ed in the Financial Express of March 29, 2013, under the banner,"Fixing India's current account."

Will Political Uncertainty Gut Economic Reforms?

The withdrawal of the DMK from the UPA coalition government has raised questions in the public mind about the longevity of the government and the effect on the chances of passage of Economic reform legislation.   My tentative answer is possibly, but it could paradoxically also help in expediting some (real) reforms if managed skillfully.

Early Election?

The first question on everyone’s mind is whether the DMK withdrawal heralds an early election.  It does not appear to be in the interest of the DMK and the BSP to have an early election, because their opponents, the AIDMK and the Samajwadi Party (SP) respectively recently swept the State elections and are likely to win the corresponding Lok Sabha seats.  Thus an early National election increases likelihood of the DMK and BSP loosing many of the Lok Sabha seats they currently hold.  Given that the serious corruption charges against former Telecom minister A Raja(of DMK) and others in the DMK are still fresh, it is in their interest to give time for them to fade from public memory. 

The puzzle is, however, why the SP has not tried to pull down the UPA Govt. and why the TMC has become hesitant?  A few possible explanations come to mind.  One, that they need more time to recoup their State election costs and generate enough funds to fight the National election. Two, that this period of uncertainty could be used to extract concessions on legal cases and prosecutions. Three, that they need fiscal indulgence from the center and fear the next government may be less forthcoming.  The first two perhaps apply more to the SP and the last to the TMC.  On balance therefore, the DMK withdrawal, does not per se affect either the calculus of these parties or the probability of an early election.

End of Policy Reforms?

What about the effect on economic reform legislation?  The conventional wisdom on economic reforms is that political uncertainty slows down reforms, as opposition parties oppose any action that they can project to potential voters as “ant-people”. This argument, perhaps applies to expenditure (subsidy) policy reform but less to issues where old ideas or ideology play a role. If parties are looking to parley a positive vote on a bill, for favors for their leader, party or State, the government may also have greater opportunities for bargaining to pass reform bills. The current political uncertainty could be used to accelerate genuine economic reform (i.e. reform that restores growth and improves the efficiency of welfare delivery).  The likelihood of Narendra Modi becoming the BJP/NDAs candidate for PM has created uncertainty for its current and potential allies.  For instance Nitesh Kumar’s, JD(U)s public feelers to the Congress regarding ‘Special category status for Bihar,’ and Mulayam Singh’s hints that he could do business with an L. K. Advani led BJP (NDA PM) are indicators of this flux.  If handled skillfully, this could provide the Congress a counter opportunity to accelerate the reforms.

         The Congress led UPA government has repeatedly stated that it has a majority and will remain in power till the due date of the 2014 election.  Despite the optimistic GDP projections in the Economic Survey and in the 2013-14 budget, growth is likely to be around 6% (+/- 0.5%) in terms of GDPFC and between 5% and 6% in terms of GDPMP.  Thus it is critically important for the Congress to end its current term with an uptrend in growth that is visible and credible, and this is only possible if there is another spurt of reforms over the next six months.  The FMs recent statement about formulating and accelerating next generation reforms is an indication.  However, most of the financial sector reform legislation as well as the GST and perhaps even the DTC depends critically on BJP concurrence if not support.

Finding Convergence

        Why should the BJP support this legislation?    First, it gives the BJP an opportunity to redeem itself in the eyes of former and potential Urban BJP voters who were thoroughly disillusioned by the BJP’s unthinking opposition to economic reforms that support investment and growth.  A BJP spokesperson has stated that the country is now in an election mode.  Earlier BJP leaders have asserted that Congress would be thrown out of office during the next election. If the BJP truly believes in these two statements, then it is in its interest to expedite reform legislation in Parliament and vote to pass it.  There are two reasons for this.  Firstly, these reforms are critical to India growing at 8% during the tenure of the next government (whether it is Congress led or BJP led or a third front) and second that Congress is likely to oppose the same reforms if the BJP in power, just as the BJP in opposition has opposed reforms that it introduced when it was in power. 

Bold 

     As both parties need some time to consolidate their support base and organize their aprties (under the leadership of Narendra Modi and Rahul Gandhi respectively), they have enough time to co-operatively pass such legislation before getting into a full-fledged election fighting mode. The Parliamentary affairs minister therefore has two important tasks before him: Get the budget and the finance bill approved and work out with the BJP leadership the changes in reform legislation needed to get their immediate approval.

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A version of this article appeared as Op Ed in the Times of India on March 26, 2013.

A New Regional Doctrine for India

Introduction 

Nepal has been in flux since the overthrow of the monarchy.  Since the Soviets left Afghanistan, the Pakistan Army has used Jihad as an instrument of State Policy against India.  More recently a Golden opportunity of settling many issues with Bangladesh was available and half grasped, but is in danger of slipping away.  The Maldives has been in flux with a dictatorship giving way to democracy and possible reversal/setback.  Sri Lanka, after eliminating a terrorist and secessionist threat, seems to be diluting its historically strong democracy and undermining democratic institutions.  These developments in the Indian sub-continent and the maritime region around it, challenge us to think about a regional doctrine to replace the abandoned “Indira doctrine” and “Gujral Doctrine.”  We can take a cue from the strengths and weakness of these doctrines and apply them to the changing strategic environment.  Domestic developments, such as the greater interest and involvement of State Governments or State parties in International policy also argue for a clearer enunciation of a regional doctrine.

National Interest

Why are we interested in the region?  What is the National interest of India in the South Asia region.  Anybody who has followed India’s international affairs since independence knows that most if not all the threats have originated in this region.  Leaving aside conventional territorial threats the most important threat has been from terrorism.  This threat has taken many different forms including financing, training, directing, provision of safe havens. It was nurtured and developed long before it became an explicit known public threat.   Any regional doctrine must have a strategy for addressing the short, medium and long term aspects of this threat.   The second regional threat that we have faced is the acquisition of nuclear weapons either through explicit or tacit support of nuclear weapons powers and the use of nuclear weapons for nuclear blackmail in various forms.  It would be naïve to believe that this threat cannot worsen either on the intensive or extensive margin.  A regional doctrine must try to ensure the minimization and/or elimination of the threat of nuclear blackmail and blackmail using other weapons of mass destruction.   Finally on the positive side it would be in the interests of all countries of the region, including India, would gain from free trade in goods and services and mutual FDI.

Geographical Spread

What should be the Geographical reach of such a regional doctrine? That depends on the degree to which developments in the country/region can either benefit or harm us.   There is general agreement that developments in South Asia (Afghanistan to Myanmar, Nepal to Sri Lanka) have this potential.  Whether Maldives in the Arabian Sea has this potential is less clear.  What about other more distant island nations in the Indian Ocean? This depends partly on the amount of resources we are able to commit to the overall task and our strategic reach and partly on the presence of larger, stronger potentially hostile external powers operating in the Indian Ocean (a circumscribed version of ‘Indira doctrine’).   By these criteria, Maldives could be included within the region of operation of the doctrine, while other islands may be added over time, as capabilities and potential threats grow.

Democracy, Secularism, Peace

Our own culture, secular traditions and democratic principles must form the bedrock of any external doctrine. The basic thrust of the doctrine must be to actively support friendly, peaceful, secular democratic forces, in the region.  This would include civil society organizations, political forces and parties and governmental institutions that believe in a peaceful democratic future for their own country and for peaceful, friendly and co-operative relations with neighboring countries (including India).  One operational consequence would be for Indian elites, media, and public to clearly and openly back genuinely pro-peace, political parties in these countries. They must, however, be mindful of creating public pressure on the government to adopt a blunt approach that can prove counter-productive.   There should also be less inhibition in co-operating with Civil society organizations in other democratic countries that share the same objectives.  
      Government of India must be much more subtle and nuanced in its approach than civil society organizations, think tanks and media need to be. If and when such friendly parties are in power, the Indian Government should however, provide asymmetric inter-governmental benefits to assure them and their supporters of the benefits of their positive approach (a selective version of Gujral doctrine).  On the other hand government per se should not “unabashedly back Pro-India political parties (Nitin Pai BS 8/2/13),” in these countries, as in our view, this could be counter-productive in promoting friendly peace loving forces. 

Dictatorship, Fundamentalism, Terrorism

The second aspect of this doctrine must be a hard headed strategy for opposing dictatorial and militaristic forces that have no compunctions about using violence against their own citizens,  supporting terrorists, or engaging in hostile actions against neighbors such as India.  This requires us to undermine fundamentalist/extremist elements and organizations, whether religious or ideological, which have a philosophy, ideology or history of violence.  We have to rid ourselves of our extreme squeamishness in confronting forces, which have no moral or social compunctions about harboring, sheltering, training and financing militant groups that use violence against innocent civilians (in any country in the region).  We must be prepared to use every feasible means to thwart such forces.  We must also undermine their supporters - Political parties which provide open or tacit support, countries or organization outside the region that provide funds and safe heavens. 

It is essential that the Indian elite, media and public adopt a clear and open stand against extremist forces, organization, elements in supposedly moderate political parties and organs of the government (e.g. Army). They must have an equally clear stand against terrorist killing of innocent civilians.  Though government’s stand should be equally unabashed with respect to hostile non-govt. organizations, its public posture towards extremist forces within the government (of these countries) would have to be more nuanced.   It is more important for the government to act quietly and forcefully against such institutions than to talk a lot about it.  It can however, take a much more active diplomatic stance in private dealings with other countries who profess the same values and approach with respect to terrorist forces threatening them.

Ethnic Cleansing

       Government should, however, take a more active role in international forums in exposing genocide and ethnic cleansing by an anti-India governing party or organ of government, perhaps through an announced policy. For instance India should have supported international efforts to expose the genocide in East Pakistan (now Bangladesh) and to punish the guilty, including elements of General Tikka Khan’s army (a la Justice Hamood-Ur-Rahman Commission) and its agents and collaborators in the Jamat-e-islami (Razakars).  The main argument against this proposition is that, it will open us to foreign interference and questions from other governments about how we have handled the insurgencies in J&K, the North West and in Maoist areas.  There are two approaches two this: If the questioning is from Western ‘do gooders’, we must confidently question their own record of supporting dictators and murderers to further their national objectives.  If the questioning is from oligarchic and dictatorships we must quietly but firmly tell them how their own record can and will be questioned.  This requires a little hard work, including building a dossier on these countries historical record, and an awareness among our analysts, commentators and diplomats about this record.

Civil Society Idealism

The main modality for supporting positive forces and opposing negative ones in the region, should be Civil Society organizations funded or supported by the government.  These would need to have a clear program for study and analysis of neighboring countries to identify the positive and negative forces, the socio-political dynamics and the organization that need to be supported or ostracized.  Based on this analysis they would have to work out country strategies to support the positive forces and oppose and undermine the negative forces in each country.  They may need to hire development experts, former diplomats and intelligence experts with knowledge and expertise in these countries to formulate and implement these strategies.  This knowledge and expertise would also be invaluable in government decision making in emergencies.

Government Pragmatism

Though this doctrine will help in the medium-long term, in the short run,  National Interest should play a dominant role in deciding how to deal with Army led Pakistan (Musharraf after his coup), a Military led Myanmar (with sole friend China), or democratic countries veering towards oligarchy.   We must ignore the self-interested advice of Western human rights activists who have never been able to stop their own countries from coddling dictators who made life hell for neighboring countries.

Conclusion

                Independent think tanks, Government supported organization and perhaps the National Security Advisory Board should try to formulate a full-fledged Regional Doctrine along these lines.  It should then be discussed by the media and political parties.  Once there is a broad agreement we should also invite think tanks in friendly countries such as the US to comment on it, before reaching a final understanding among ourselves.  For any policy doctrine to succeed there must be a tacit understanding among all elements of society on its broad contours and the role of different institutions in propagating and promoting it.  In my limited experience successful foreign policy and diplomacy (the US, Pakistan till 5 years ago) always has this tacit co-ordination behind it.

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An earlier version of this article appeared on the Op ed of The Hindu, on Friday March 22, 2013, and at http://www.thehindu.com/opinion/op-ed/a-case-for-a-new-regional-doctrine/article4538836.ece.