Introduction
The sharp depreciation of the Rupee during the
last thirty days has set off a flurry of comments, discussion and articles on
the rupee. Some of it is confused and
confusing. The purpose of this article
is to clarify the issues and the solutions.
The most important thing to understand is that the Rupee depreciation is
not the problem but merely a symptom of
the underlying problem. Think of it as a
red flag or a red alert that has arisen to warn us of the need for correctly
identifying and addressing these underlying problems. The second thing to understand is that though
the trigger for the depreciation is external (global capital market reaction to
anticipated changes in US monetary policy), the fundamental problems and
solutions lie within not outside the country.
The external actions can provide only temporary palliatives and give us more time and/or space to solve
our internal problems.
The Problem
What is the problem? The
fundamental problem is a creeping loss of competitiveness that needs to be
reversed. Experience of countries in Eastern Europe and Latin America has
taught us that there are three visible symptoms of this loss of
competitiveness. One is a high inflation relative to our trading partners
coupled with low nominal depreciation, resulting in a “real appreciation” of
the rupee. Second a sustained increase
in the current account deficit to levels that are high by historical standards
of the country as well as in comparison to current account deficits currently
prevailing in other countries. Third, an excessive growth in credit resulting
in an increase in potential and actual Non-performing assets. All these symptoms, with the possible
exception of high credit growth have been present in India in the recent past. In
the case of credit growth the ambiguity arises, because in the last year or two
the expansion in credit to government and the public sector has been partially
offset by slower growth of credit to the private corporate sector, moderating
total credit.
The recent depreciation of the
rupee has substantially if not entirely, corrected/offset the earlier “real
appreciation” of the rupee. Though this
correction will have positive effect on the current account deficit the need to
address the underlying saving-investment imbalances and distortions remains.
Underlying the rise in NPA s and the fall in private credit are governance and
regulatory actions (and in some cases inability to take actions) that have
increased the controls, constraints and regulatory burden on the corporate
sector reducing its competitiveness.
Solution
There are three underlying
problems that need to be addressed to attain a stable macro-economic
environment in which the economy grows at a sustained high rate despite global
risks and uncertainties (QE3 withdrawal, Euro/EU depression) that are present today and are likely to
persist for several years. These are, to
(1) Reduce the high growth
of government consumption (Cgd) and thus
reduce the governments (departmental) Saving-Investment imbalance, through a
reduction in distorting subsidies(energy, fertilizer), inefficient current
expenditures and ineffective transfers.
If done successfully it will manifest itself in a reduction in the
fiscal and revenue deficits and play a vital role in reducing inflationary
pressures and the current account deficit (CAD).
(2) Ease monetary policy and
reduce the nominal interest differential with global capital markets. A reduction of the domestic Investment-saving
gap will reduce the incentive for short term capital inflows, reduce the real interest
of the economy and thus allow a non-inflationary reduction in the nominal
interest rate.
(3) Raise the growth of corporate
investment, through structural/policy reforms. These will attract enough long
term foreign capital to finance any sustainable current account deficit. There
are two dimensions of reform that require action: One is an effort to identify and
reverse/remove controls, regulations and administrative-bureaucratic measures,
particularly those introduced over the
last five years, that have increased the costs or risk of investment. These
include tax laws, rules and procedures. The second are measures that will
increase the opportunities and incentives for investment. For instance, sectoral FDI limits have
outlived any utility they had earlier.
These need to be completely abolished through a cabinet decision, even
though implementation of legal changes may take some time. Similarly the cabinet should take a decision
to denationalize coal and railways and ask the coal ministry to draw up an
implementation plan to introduce competition.
The combination of (1) and (2) is
what I have earlier called (in the IE)
the, “Macro-Pivot.” They are intimately linked, in that the second
cannot be successfully undertaken without the first. (3) Is
what I recommended in a post-budget IE article as an essential third phase of
economic policy reforms for restoring growth to a higher level. International developments since then, as
manifested in reduced capital flows and a depreciation of the rupee, have made
even stronger action on all these fronts more urgent.
This article appeared on the Op Ed page of the Indian Express on Wednesday, 26th
June under the banner, “Unlucky Dip”. http://www.indianexpress.com/news/unlucky-dip/1133733/