There are many feasible crisis-proofing policy actions, but when markets are nervous and fragile, confidence building is the prime requirement.
Only measures that are credible will be effective. These can be divided into short-term and short-lived measures and long-term structural reforms. Movement on the latter will improve expectations today.
Short-term measures to reduce the current account deficit include import taxes, and allowing full rupee pass-through, including for fuel prices, to reduce imports. This will make the announced subsidy cap at two per cent of GDP credible despite the food security Bill and allay fears about the fiscal deficit. Secondly, stable financing such as through wealth funds and PSUs has to be demonstrated quickly.
Policy-makers’ reassuring talk has to be backed by action and by data. The relevant comparative data put in the public domain can show why the Indian situation today differs from past crises episodes. Firms’ foreign borrowings are longer-term and a relatively smaller proportion of total debt. In general, the size of domestic exposure to external shocks is much lower.
International reserves are high enough to smoothen even an extended period of volatility. All reserves except about half that cover short-term debt can be used. That is what they are accumulated for, and can be built up again later. The IMF, for example, thinks India holds too much of reserves. It stands ready to help moderate spillovers from systemic countries.
Since the rupee has overcorrected it should strengthen, so the short-term interest rate defence should be abandoned. Higher growth and lower interest rates will also reduce the fiscal deficit. As the large output gap and a good monsoon moderate the inflation from rupee depreciation, a reversal of the policy softening cycle will not be necessary.
(As told to Lalatendu Mishra)