S.K. Khosla
Indian economy is passing through an extremely critical phase wherein not only the external factors rather internal factors are being held equally responsible for this vulnerable condition. Free fall of Indian Rupee that started almost in mid 2011 touched a low of 68.85 against the US dollar on 28th August 2013. Previously too, Indian economy has suffered similar rupee crisis in the years 1966 and 1991. In both these years, massive fiscal deficit and current account deficits (CAD) were experienced before the crisis. Existing crisis may also be attributed to large fiscal and current account deficit but the fundamental difference between crises that transpired earlier and this one is that 2013 crisis continue to persist. Whereas before 1993, India practiced a fixed exchange rate system in which rupee was pegged to the value of currencies of major trading partner countries, policymakers of the country experimented current managed floating system since 1993 in which exchange rate is determined by market forces while Reserve Bank of India steers the target rate and purchase and sell foreign currency in order to meet the targets. Also, in the liberalized regime, government initiated the reforms that either reduced licensing requirements for establishing/investing in Indian enterprises or removed restrictions on expansion by foreign enterprises and facilitated easy transmission of Foreign Direct Investment (FDI) in India. Governmental efforts helped India gain a quantum jump in FDI inflows to the extent of US $12492 million (125 percent) in the year 2006-07 from US $5540 million in 2005-06 and 88 percent increase in FDI inflows from the year 2010-11 to 2011-12. Despite sturdy inflow of FDI in the Indian economy and high rate of growth in the recent past, Indian economy is grappling with currency depreciation along with the pitiable state of macro economic indicators i.e. slow growth rate, high fiscal and current account deficit and high inflation. Reasons for these imbalances are cited in the following paragraphs.
Incoming of FDI into the Indian economy put an additional pressure on the Indian rupee to appreciate. Since India’s share in world’s exports was on a growth spree (0.7 percent in the year 2000 and 1.7 percent in 2011) and the appreciation of Indian rupee was speculated to bring a fall in India’s exports, government did not let the Indian rupee appreciate and kept it artificially devalued ranging between Rs. 45 to Rs. 48 from 2000-01 to 2011-12 (average exchange rate year to year). Infact, Reserve Bank of India started issuing more Indian currency which resulted in increased inflation in the economy. Annual Inflation level at consumer price index that used to be 3.72 percent in December 2003 increased to 6.53 percent in December 2006. To ease inflation levels, Central Bank resumed the issue of market stabilization bonds scheme in the year 2007 (first issued in 2004) for two years that acted as a temporary sterilization and financially insulated the economy from inflation. Once the money was retuned alongwith interest amount it again fueled inflation. To control inflation, between the time periods January 2010 to October 2011 repo rate was changed 13 times by a cumulative 375 basis points from 4.75 per cent to 8.5 per cent. What’s more, impact of tightening the monetary policy soon became visible by way of decline of Gross Domestic Product (GDP). In between the fourth quarters (January – March) of 2010-11 and 2011-12, GDP growth in India slipped drastically from 9.2 percent to 5.3 percent. Persistence of stagflationary trends experienced in the economy, brought the economy towards catastrophe atleast partly, if not completely. Reforms and structural adjustments initiated since 1991 turned out to be the temporary phenomenon that rendered current account surpluses only in the years 2001-02 to 2003-04. However, widening deficits plagued the economy afresh since the year 2004-05 onwards.
Experts attribute the problem of high current account deficit to rising import prices of crude oil along with an increase in prices of gold and silver. A surge in prices of petroleum and gold have accounted for almost 8 percent rise in import bill from 40 percent in second half of 2011 to about 48 percent in the second half of financial year 2012-13 bringing current account deficit to an alarming state. It is pertinent to mention here that government tried to reduce the import of gold into the country by increasing the duty from 2 percent to 10 percent but to no use as the import of gold in the April-June quarter this year stood at 336 tons. Demand for gold is expected to shoot more due to the arrival of festivals and marriage season beside payment of money to farmers for the produce.
In order to improve the situation from further deterioration, immediate action needs to be taken to arrest the outflow of foreign currency or acquire the foreign currency through exports that also seems to be a colossal task owing to the worldwide slowdown. Moreover, prospects of exports are also dim due to the non-competitive nature of Indian exports owing to high prices vis-à-vis competitive countries. Tenuous outflow of precious foreign exchange also led to the weakening of Indian rupee. Capital inflows that came from US on account of recession (low interest rates in US) from 2007 onwards were not utilized in a justified manner. Foreign exchange that could have been utilized for financing more investment was infact used to finance larger imports. It pushed the economy into a vulnerable position on two fronts. Firstly, domestic production came down due to larger imports leaving industrial slowdown inevitable and second due to the spiraling impact of this slowdown, saving rate decreased rapidly owing to unutilized capacity and stock piling. Had foreign investment entering the economy as net capital inflows been directed by the government as public expenditure for developmental activities and subsequently for the collection of tax on the same due to the multiplier effect, scenario that we are confronting today would have been undeniably different.
Owing to the poor health of Indian economy, propositions of getting investment from foreign investors, in particular, has also lost much relevance. Rating agencies left no stone unturned in spoiling India’s chances of earning foreign exchange. Leading rating agency Standard and Poor has accorded BBB minus rating to India that created a platform wherein many speculators from foreign countries have started withdrawing their invested capital from India, though short term. Adding fuel to the fire, United States Federal Reserves announcement of Quantitative Easing on May 22nd this year is also burdening the volatile currency market on account of outflow of foreign exchange. Economic boom as propagated by a class of politicians even today appears to be an outcome of a mismanaged debt driven consumption and directionless investment extravaganza that relied on fallacious tall claims. Sound monetary ecstasy seems to be fabricated with the asset boom in the sectors like construction and real estate instead of goods trading that led to massive credit intake by the corporate as well as the households. Precisely, in the year 2013, 41 and 37 percent of outstanding credit of scheduled commercial banks is vested in the hands of private corporate and household sector respectively. Strict measures being introduced by the banks with respect to the disbursement of credit may be the resultant of the fear of repayment of the loan taken. Reality is the companies that amassed loans close to $200 billion from abroad are distressed on account of lesser production on one hand and repayment of loan attributable to depreciation of rupee on the other. The tumult witnessed today that primarily emerged from the availability of cheap inflow of foreign exchange from western economies has chimed warning bells for India. The question is what can be done to stop the situation from further deterioration.
Primarily, the exports need to be enhanced to control the merchandising trade deficits which may in turn impart sound muscle to the depreciating Indian rupee and revive the upswing, of course, gradually. Keeping in view, feeble chances of reviving exports with old trading partners, there is a quick need to knot ties with new partners which are not experiencing excess capacities or supporting protectionist policies besides pursuing the strategic import substitution. Like Brazil, Indonesia and South Korea who have already imposed capital controls on foreign institutional investment and India due to its volatile nature need to be replicated by India.
In order to save foreign exchange, there is a need to sensitize the citizens about its thoughtful use while in the long run substitutes like Jatropha biofuel, solar power energy, algae biofuel and off shore wind power need to be developed at war footing pace. Quantitative Restrictions like compulsory 20 percent export of gold arrived through consignment need to be imposed to discourage gold import. Not only this, there is a desperate need to revive good governance and reduction in waste in government programmes alongwith innovations to improve productivity.
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