With simple ideas that do not require big bang reforms, India can weather the storm caused by global and domestic economic factors
There are ways of looking at India’s present economic woes marked by a rapid fall in the value of the rupee caused by persistent inflation of the past few years and the high current account deficit (CAD) of about $85 billion (4.5 per cent of GDP) which needs to be funded through uncertain capital inflows year after year. The description of the present crisis by various economic and political analysts by itself tends to carry shades of ideological bias. Some well known economists on the far right prefer to describe the external sector situation as worse than the 1991 economic crisis India had faced. This narrative suggests the 1991 crisis was marked by a severe, external sector crunch and it acted as a trigger for the big bang reforms of the early 1990s. This section believes that the present crisis may be worse than that of 1991 but the government this time round is much more complacent, and less inclined to implement drastic reforms to revive growth.
Then and now
Of course, not everyone agrees with the narrative that the India of 2013 is worse than it was in 1991. Actually it is not. And more of the same kind of reforms is perhaps not the answer either. The world was very different in 1991 when western economies were still strong and looking outward, trying to deepen the process of economic globalisation. Today, major OECD economies are looking much more inward than before, trying to fix their own domestic economy and polity. Emerging economies like India, which managed to avoid until 2011 the negative impact of the global financial crisis, began to dramatically slowdown after 2011. Most of the BRICS economies have lost over four per cent off their peak GDP growth rates experienced until 2010.
After 2010, excess global liquidity flowing from the West, the consequent high international oil and commodity prices fed seamlessly into India’s domestic mismanagement of the supply of key resources such as land, coal, iron ore and critical food items to create a potent cocktail of high inflation and low growth, and a bulging CAD. The key difference between 1991 and 2013 is the availability of global financial flows. In 1991, western finance capital had not significantly penetrated India. Now, a substantial part of western capital is tied to India and other emerging economies where OECD companies have developed a long-term stake. The broader logic of the global capital movement is that it will seamlessly move to every nook and corner of the world where unexploited factors of production exist and there is scope to homogenise the modes of production and consumption in a global template. This relentless process may indeed gather steam after the United States shows further signs of recovery. Indeed, some experienced watchers of the global economic scene have said that a recovery in the U.S. will eventually be beneficial for the emerging economies. This basic logic will sink into the financial markets in due course. At present, the prospect of the U.S. Federal Reserve withdrawing some of the liquidity it had poured into the global marketplace is causing emerging market currencies to sharply depreciate.
In a sense, the depreciation of 15 to 20 per cent this year of the currencies in Brazil, South Africa, Turkey, Indonesia and India can be seen partially as a knee-jerk reaction to the smart recovery of the housing market in the U.S. and the consequent prospect of the Federal Reserve gradually unwinding its ongoing $40 billion a month support to mortgage bonds over the next year or so. But eventually, a fuller recovery in the U.S. will mean better economic health globally.
Besides, some tapering of liquidity by the U.S. Federal Reserve is inevitable as such an unconventional monetary policy cannot last forever. The U.S. Federal Reserve balance sheet was roughly $890 billion in 2007. It has ballooned to a little over $3 trillion today simply by printing more dollars. Such massive liquidity injection by printing dollars in such a short period is probably unprecedented in American history. This is also unsustainable because sooner rather than later, such excess liquidity could send both inflation and interest rates shooting up in the U.S. — which again may not be good for the rest of the financially connected world.
So what should India learn from the current situation? One, it needs to understand that cheap, finance capital flowing in from the West is a double-edged weapon. If not used judiciously to enhance productivity in the domestic economy, such finance will tend to become an external debt trap. This lesson is as important for the government as it is for the Indian capitalist class which has shown a tendency to use cheap finance and scarce resources such as spectrum, coal, land and iron ore to play stock market games in collusion with the political class. Of course, this is a systemic issue and needs to be addressed at the level of electoral funding reform. Indeed, this is more important than “fresh economic reforms” that blinkered economists advocate.
Using natural resources
India still has time to work towards insulating itself from the vagaries of global finance causing much weakness in the currency and the current account. To begin with, the government can easily generate $20 billion or one per cent of GDP by allowing higher coal and iron ore production from its large reserves. Our annual coal imports have gone up from roughly $7 billion five years ago to about $18 billion now. The increased dollar outflow was largely avoidable because India has among the largest coal reserves in Asia. India could have saved $10 billion simply by producing more domestic coal. The government must, under a specially regulated dispensation, maybe under the Supreme Court’s watch, revive the export of iron ore from Karnataka and Goa where much of the mining has stopped following judicial intervention. Prime Minister Manmohan Singh spoke about making a special plea to the Supreme Court to restart mining and exports from here. This could add another $7 to $8 billion to the foreign exchange reserves. These are simple ideas which do not require “big bang reforms,” as some overzealous economists might suggest.
If some of these resources are produced optimally and gold imports are brought down by about $20 billion, to the levels that existed before 2011, the CAD should be back to the comfort zone of less than three per cent of GDP. The moment CAD comes below three per cent of GDP, the overall sentiment would definitely change for the better.
Food security mechanism
Further, a more rounded food security mechanism can help insulate the poor from rising food inflation. This can free up the Reserve Bank of India to then look at the manufacturing inflation as a dominant basis for making monetary policy and help ease interest rates for industry. All this needs a dramatic improvement in governance and a return to normality in the strained relations between the bureaucracy, the political class and the judiciary. Some argue that this can only happen after the general election, whenever it is held.
The capitalist class also has a big lesson to learn. It merely used cheap, western finance all these years to ramp up stock prices based on cornering scarce resources like land and minerals. All such companies are today quoting at 80 per cent below their peak values seen in 2010 when the economy was still doing well.
These companies today are in a huge debt trap and their interest payments far exceed their earnings annually. Worse, Indian companies have a massive exposure of close to $200 billion of loans from abroad and the sharp fall in the rupee is making their repayment even more difficult.
Many big business houses thought they could use cheap, global money to create financial, not real wealth. For a while this worked and some of the stock market-created wealth went into the funding of elections. This game is over now. So, the big learning is that there is no substitute for creating real wealth accompanied by higher productivity. Excessively cheap global money is an illusion which gets shattered in a business downcycle.