On June 25, the Reserve Bank of India, in consultation with the government, announced a package of measures aimed at boosting dollar flows into the country. The fact that it has commanded so little attention so far is most certainly because the context in which it was announced, the extraordinary hype before it was made and its inevitable failure to lift the sentiment of the markets have all become prime topics for discussion, completely overshadowing the RBI’s package. A closer look at the extraordinary developments would throw up many useful lessons for policy-makers and lay people alike.
Much anticipation
It is not difficult to see why there should be so much anticipation this time over a proposed announcement on economic policies. There are two principal reasons. One, economic circumstances of the day certainly required some kind of assertive statement from the highest levels of the government if only to boost sentiment. As the Prime Minister was to say subsequently after taking direct charge of the Finance Ministry, the ‘climate of pessimism’ needed to be reversed. Reviving investor sentiment is a top priority. Economic growth has slowed down: the annual growth last year (2011-12) was 6.5 per cent, considerably below the 8 per cent plus trajectory that was the norm before. Industrial output has remained sluggish, with a mere 0.1 per cent growth in April. Inflation remains elevated and well above the RBI’s target range. According to the recently-introduced consumer price index, inflation is above 10 per cent. So concerned has been the RBI over the persistently high inflation, that it desisted from cutting interest rates, the way it was widely expected to do, at the last policy review meeting.
Fall in rupee value
Important as all these dismal data are in depressing the sentiment, it has been the precipitous fall in the rupee’s external value that seems to embody all that has gone wrong with macroeconomic management. Certainly it has been the most damaging in a psychological sense. Having lost 25 per cent over the last one year, it breached the 57 to the dollar mark on June 22 and threatened to fall further in the medium-term.
It is not surprising, therefore, that many people believed that the government would deliver a robust package centred on the declining rupee. More optimistically, it was hoped that the government would unleash some economic reform measures, the logic being that economic reform would take care of the rupee’s decline as well.
The second reason contributing to so much hype before the announcement flows from the first. If the rationale for an announcement of robust economic reforms is understood, surely it should come from the highest levels of the government, the Finance Minister, possibly even the Prime Minister. The UPA government let it be known that a package was round the corner. Over the week end, the Finance Minister had reiterated it. An announcement was scheduled for June 22, Pranab Mukherjee’s last full working day as the Finance Minister. Speaking to reporters on his way back from the G-20 and Rio plus 20 summits, the Prime Minister also helped talk up sentiments.
Investors, markets and even lay people began to think that the UPA government would display an uncharacteristic vigour and push through with economic reforms, which it had first proposed but quickly shelved in the face of opposition from its alliance partners and even from within the dominant Congress party. That explains the hype before the announcement and the huge disappointment when it came nowhere near to expectations.
That outcome is unfortunate. It was extremely doubtful whether the government had the wherewithal, including political support, to make a big bang announcement of economic reform. On their part, the Finance Minister and the Prime Minister talked up expectations. It is incomprehensible as to how they did not anticipate the negative reaction.
RBI measures
In these circumstances, the content of the RBI announcement has received far less attention than what it deserves. Entitled “Further liberalisation measures for capital account transactions,’’ the RBI Press Note of June 25 has listed out measures that seek to relax capital inflows over the short-term for certain specified purposes. For instance, the cap on foreign investment in government securities has been raised by $5 billion to $20 billion. Companies in manufacturing and infrastructure sectors with foreign exchange earnings can borrow in dollars to cover rupee loans, up to a ceiling of $10 billion, subject to certain conditions. Sovereign wealth funds and pension funds can invest in government securities.
Important as these measures are in a short-term dollar mopping exercise, they are a knee-jerk response and in essence represent a reversal of policies that have kept the external economy in a sound state.
Opening the capital account to volatile capital flows at a time of high fiscal and current account deficits and decelerating growth is not a sound policy. One really hopes that the RBI’s traditional caution will assert itself when the next round of similar policy measures is framed.
