The External Crisis

The entire liberalisation process since 1991was meant to render India

internationally competitive and overcome the balance of payments
difficulties which had plagued it in one form or another since the mid-1950s.
It has instead deepened Indias dependence on foreign capital, increased
foreign ownership of Indian assets, and strengthened foreign dictation of
Indian economic policy. The part played by the IMF and World Bank in 1991
has now been taken over by credit rating agencies, whose employees
extensively monitor Indian policy-making and spell out the demands of
foreign capital.
[Note: one lakh = one hundred thousand; one crore = 10 million; one lakh
crore = one trillion]
I. Using the crisis
Since January the Finance Minister has been on a hectic roadshow across
the world Singapore, Hong Kong, Dubai, Frankfurt, London, Tokyo,
Toronto, Ottawa, Boston, and New York. The stated purpose has been to
reassure foreign investors regarding the economic policies and political
stability of the Indian government, and to attract fresh investments. It may
well be that in the last four months he has spent more time abroad than in
the country.
This relentless cabaret speaks of a certain desperation. In part,
this display of desperation is deliberate: the Government is using the crisis
of the current account deficit as a means of pushing through various
policies that have been facing resistance. Thus opening the multi -brand
retail sector to foreign direct investment (FDI), raising the entire range of
energy prices (diesel, gas, coal, etc), and granting permission for mining in
ecologically sensitive regions all these have been justified by pointing to
the need to reduce imports and attract foreign capital. Similarly, the
massive cuts in social expenditure in 2012-13 were justified simply by
saying that credit rating agencies would have downgraded India had the
fiscal deficit not been slashed. Recently a well -known economist, a fixture
in Government committees, called this a crisis too good to waste:
The country is in an economic crisis. The growth rate is coming down. The
current account deficit (CAD) has reached 6.7 per cent [in the third quarter
of 2012-13]. A crisis provides an opportunity to take much-needed
decisions that one could not otherwise take. [1]
In his speech to the nation last September justifying the decision to hike
petroleum product prices and to open the multi-brand retail sector to
foreign firms, Manmohan Singh conjured up the spectre of the 1991 crisis:
If we had not acted... domestic as well as foreign investors would be
reluctant to invest in our economy.... The last time we faced this problem
was in 1991. Nobody was willing to lend us even small amounts of money
then... we must act before people lose confidence in our economy....
Thus there is an element of deliberate exploitation of the crisis.
Nevertheless, it cannot be denied that there also is a crisis. Before going
into the facts, it is useful to go over the meanings of certain terms.
II.Explaining some terms
The balance of payments (BoP) is a set of accounts of a countrys financial
transactions with the outside world. Like any set of accounts, it has a
number of items, against which there are credits and debits. When all the
items are added up, they must total zero i.e., any deficit must be made up
from somewhere, and any surplus must end up somewhere.
(a) Merchandise trade is trade in visible commodities things you can see,
such as agricultural goods, petroleum, textiles, motor cars, and machinery.
India earns less on merchandise exports than it spends on merchandise
imports; thus it incurs a merchandise trade deficit.
(b) Apart from merchandise trade, there are three other types of current
receipts from, and payments to, those abroad.
First, services: for example, receipts from travel here by foreigners and
payments for travel abroad by Indians; or earnings on IT-enabled services
such as software and call centres, and payments for import of software.
Secondly, transfers: in the main, remittances to India by Indian workers
abroad and remittances out of India by foreign individuals in India.
Thirdly, investment income: receipts on Indian investment (including
loans) abroad and payments on foreign investments (including debt) in
India.
Because these three types of receipts/payments are not for visible
commodities, they are all part of the invisibles account. India receives
much more on the invisibles account than it pays out, thanks to its
relatively cheap labour (that is, its exports of software and software
workers, and the sweated labour of Indian workers in the Gulf). Hence, in
the net, India enjoys an invisibles account surplus.
(c) When you add the merchandise trade (i.e., visible trade) account and
the invisibles account, the sum is the current account (so called because
the sums paid/received generally relate to the current period). In Indias
case, its merchandise trade deficit is generally larger than its invisibles
surplus; hence India usually runs a current account deficit (CAD).
(d) When a person spends more than he/she earns, he/she has to either
pay out of some money set aside for a rainy day, or borrow in order to
make payments. Similarly, when a country runs a current account deficit, it
must either draw down its foreign exchange reserves, or attract capital
inflows of investment/debt/grants. On the other hand, capital outflows
take place when Indians invest abroad, or when foreign investors sell off
their holdings here and withdraw their capital. Indias capital inflows are
generally larger than its capital outflows, giving us a positive net figure on
the capital account, or a capital account surplus.
(e) The current account plus the capital account gives us the balance of
payments. If there is a surplus in the balance of payments, the countrys
foreign exchange reserves must grow; if there is a deficit, the foreign
exchange reserves must be drawn down.
Thus:
(i) Merchandise trade account
(ii) Invisibles account
(iii) Current account [i + ii]
(iv) Capital account
(v) Balance of payments [iii + iv]
(vi) Change in the foreign exchange reserves [minus
sign signifies increase in the reserves; + sign signifies
decrease]
(vii) v + vi = 0; i.e., any balance of payments surplus
means a corresponding increase in the foreign
exchange reserves; any balance of payments deficit
means a corresponding reduction in the reserves.
Because of its capital account surplus, India has been able to bridge the
current account deficit without drawing down its foreign exchange
reserves. However, such capital inflows whether in the form of portfolio
investment, or foreign direct investment (FDI), or debt come at a price:
Payments on those inflows (whether in the form of profit or interest) flow
out. That outflow, as we saw above, shows up in the current account. So the
very success in attracting capital inflows may result in a higher current
account deficit, requiring more capital inflows to bridge the gap.
Moreover, there are various types of capital inflows. Some are relatively
long-term, and are tied up in assets here which are difficult to liquidate at
short notice. Some others are short-term debt, the official definition of
which is that they are to be repatriated within a year. Yet other forms of
capital inflow can be withdrawn at any time, instantly. The larger the share
of short-term or instantly repatriable inflows in total inflows, the more
volatile will be the capital account, and the more vulnerable the country
will be to the movements of financial capital (foreign or Indian).
III. Runaway growth of imports, trade deficit
Now let us turn to the facts. Let us look at the scale of imports; the
merchandise trade deficit; the current account; and the capital account.
Imports/GDP: As we can see from Chart 1, with the beginning of
liberalisation in the 1980s (India took an IMF loan in 1981), there was a
sharp rise in the imports/GDP ratio. This is partly understandable, as oil
prices rose sharply in 1980. However, oil prices plummeted thereafter:
Brent crude fell from $36.83/barrel in 1980 to $14.43 in 1986.
Nevertheless the imports/GDP ratio during the 1980s stayed at a much
higher level than in the 1970s. In the decade after the second IMF loan in
1991, imports/GDP rose even more sharply; and in the decade of runaway
growth, the 2000s, the ratio soared. [2]
Table 1 gives the figures from 2000-01 on. We can seefrom this table that
the sharp rise dates to the start of the boom period, i.e., from 2003-04 on.
By 2008-09, the ratio is double that of 2003-04; then there is a brief and
limited dip as a result of the slowdown; but by 2011-12 the ratio has
soared to even higher levels than the earlier peak. Imports are now more
than a quarter of GDP, implying a very high level of external dependence
and vulnerability of the economy. (By way of comparison, the import/GDP
ratio for the United States was 15 per cent in 2011.)
Merchandise trade deficit/GDP: While the exports/GDP ratio also rose in
this period, it could not match the steep rise in the imports/GDP ratio.
Hence the merchandise trade deficit too rose as a percentage of GDP. As we
can see from Chart 2, the merchandise trade deficit/GDP ratio deteriorated
sharply at the start of the 1980s due to the oil price hike. Thereafter,
despite the fall in oil prices, the merchandise trade deficit remained much
larger throughout the 1980s than it had been in the earlier decade. This
culminated in the foreign exchange crisis of 1990-91, at which point the
merchandise trade deficit was 2.9 per cent of GDP.
As a condition for extending a loan to India, the IMF imposed a structural
adjustment programme on India that began in 1991-92. The IMF and the
Government claimed this programme would reorient the economy so as to
increase exports and reduce the trade deficit. In the initial three years of
the programme, imports were compressed to some extent, bringing down
the trade deficit. But thereafter it began rising again to the earlier levels,
and the average for the second half of the decade (1995-96 to 1999-2000)
was 3.5 per cent, i.e., considerably higher than in the crisis year of 1990-
91. In absolute terms, in 1999-2000, the merchandise trade deficit was
$17.8 billion, compared to $9.4 billion in 1990-91. Hence, had it not been
for two developments that had nothing to do with the structural
adjustment programme, namely the revival of remittances from Indian
workers abroad, and later the export of software, the country would have
landed in another foreign exchange crisis by the early 2000s despi te a
decade of structural adjustment.
Since the start of the boom of the 2000s, the merchandise trade deficit has
risen alarmingly (Table 2). From 2.2 per cent in 2003-04, the first year of
the boom, it more than doubled the following year, and rose to five
times the level by 2012-13.
What is remarkable is that even the slowdown in the economy since 2011-
12 has not reduced the import/GDP ratio or the trade deficit/GDP ratio;
rather, these ratios have increased sharply. That indicates that the demand
for imports is arising from sections whose incomes are not affected by the
slowdown, or who at least have the capacity to spend despite it.
Current account deficit/GDP: Despite the high merchandise trade deficit
during the 1990s, the current account deficit actually shrank over the
course of that decade. The reason was the rise of invisibles receipts. The
mainstay of invisibles receipts in the 1980s had been the export of cheap
labour power to the Gulf; while this was briefly interrupted due to the first
Iraq war and its consequences, it soon revived after the war ended. By the
end of the 1990s, earnings from Gulf labour were joined by two new forms
of export of cheap labour power: the export of software services using new
communications technology, and the export of software workers on short -
term visas to the US. The combined growth rate of two items exports of
Information Technology Enabled Services (ITES) and workers remittances
averaged 24 per cent between 2001-02 and 2007-08. As a result,
invisibles receipts rose so sharply that during 2001-02 to 2003-04 India
actually ran a current account surplus.[3]
However, in recent years the invisibles account miracle seems to be fading.
The net invisibles surplus peaked at 7.4 per cent of GDP in 2008-09.
Thereafter it fell to 5.8, 4.9, 6.0, and 5.7 per cent respectively in the next
four years. The Prime Ministers Economic Advisory Council (PMEAC)
projects that the invisibles surplus will fall to 5.3 per cent in 2013-14. The
combined growth rate of ITES-related exports and workers remittances
fell to 4 and 8 per cent in 2009-10 and 2010-11 respectively. It recovered
to 20 per cent in 2011-12, but then fell again to an estimated 4 per cent in
2012-13. The future of ITES-related exports, as a mainstay of Indias
invisibles receipts, is uncertain.
Meanwhile, as mentioned earlier, the merchandise trade deficit, which
grew rapidly in the period of rapid growth, continued to rise in the period
of slowdown as well. It has peaked in 2012-13. As a result, the invisibles
surplus covered less and less of the merchandise trade deficit. Thus,
whereas the invisibles surplus covered 92.6 per cent of the merchandise
trade deficit in 2004-05, that figure fell to just 52.9 per cent in 2012-13.
As the invisibles surplus has fallen and the merchandise trade deficit has
kept rising, the current account deficit has risen to historically
unprecedented levels. Before 2011-12, the highest current account
deficit/GDP recorded in all of post-1947 India had been in 1957-58 (3.1
per cent) and 1990-91 (3.0 per cent). In 2011-12, however, it
reached 4.2 per cent; in 2012-13, over 5 per cent (the final figure has not
yet been released). It is worth noting that the RBI itself considers a current
account deficit/GDP ratio over 2.5 per cent to be unsustainable.
Another useful way to present the data is the ratio of total current receipts
to total current payments. This gives us (i) a measure of how much current
receipts (principally exports of goods and services, and worker
remittances) have to expand in order to pay for current payments; and (ii)
whether the gap is closing or growing. As can be seen from Table 3, since
2004-05, the gap has been steadily growing. For receipts to expand fast
enough to close the gap, they would have to grow at near-impossible rates.
For example, let us say the ratio is 85 per cent in 2012-13, and current
payments rise in 2013-14 by 25 per cent.[4]
Current receipts would have to rise 47 per cent in order to close the gap. If,
instead, as is more likely, they rose only 21 per cent, [5] the ratio would
sink to 82 per cent. That is, the mountain to be scaled would become even
higher. This points to a conclusion we will return to later: namely, that the
only way to scale this mountain is not to attempt to clamber up, but to
reduce its size, i.e., reduce imports and invisibles payments.
IV. Massive build-up of foreign liabilities
How is this giant current account deficit ($94.2 billion in 2012-13) being
financed? At the moment, by an equally large capital account surplus
foreign investment and foreign debt. Policy-makers are unperturbed by
this level of dependence on large capital inflows, which are additions to the
stock of Indias foreign liabilities. In the words of the chairman of the
Prime Ministers Economic Advisory Council, financing the current
account deficit has not been a problem. In 2012-13, India attracted as much
as $94 billion. This shows the trust investors and others placed in
India.[6]
It is revealing that official economists like Rangarajan ring the alarm bell
when the fiscal deficit (i.e., Government borrowings, largely domestic)
rises, or even if it does not fall as fast as they want it to; but they see no
problem when the current account deficit has to be financed by ever-larger
capital inflows. Actually, from the angle of national interest, the reverse
should be the case: the growth of Government borrowings from domestic
parties is not necessarily alarming, whereas the growth of Indias foreign
liabilities is alarming. The reason is that increased Government spending
(financed by domestic borrowing, a large part of it from public sector
institutions), especially when it goes toward i nvestment, can lead to
increased domestic economic activity. Apart from being desirable in itself,
this increased activity also generates additional tax revenue, which
reduces the need for further Government borrowing. Whereas a growing
current account deficit, financed by taking on fresh foreign liabilities, does
not as such generate any additional foreign exchange with which to service
the foreign liabilities. The servicing of the fresh foreign liabilities adds to
the current account deficit, which may necessitate even larger capital
inflows in the next round. Rangarajan says that the capital inflows of $94
billion in 2012-13 show the trust investors and others placed in India; but
that implies that, if their trust is shaken, India would be unable to cover its
current account deficit with capital inflows.
Consider what happened in the second half of the 1980s. As the
Government liberalised imports and industrial licensing, imports grew
faster than exports. Then, too, it seemed for a while that there was no
problem in financing the current account deficit with external commercial
borrowings, no doubt a sign of the trust reposed in India by foreign
creditors. However, it very quickly became evident that India was entering
a debt trap. A 1988 study noted: If adequate and timely adjustments are
not initiated now,the possibility of more painful adjustments being forced
on us later, similar to the Latin American type, cannot be ruled out. [7]
The external debt doubled, from $40.6 billion in 1985 to $85.7 billion in
1990. While the quantum of external commercial borrowings rose, the
debt-servicing payments on these borrowings too rose so steeply that by
1990-91, after subtracting debt-servicing payments, the net transfer on
commercial borrowings turned negative. That is, there was a net outflow
from India instead of an inflow on account of commercial borrowings. At
that point, Indias merchandise trade deficit was 2.9 per cent of GDP.
Despite the fact that the trade deficit had been considerably higher earlier
in the same decade, India had been able to fund it with foreign borrowings.
In 1990, however, international credit ratings agencies made their
presence felt for the first time in India: when they downgraded India, it
became near-impossible for it to get fresh commercial borrowings. India
was forced to go to the IMF for a loan, forcing a Latin American type
structural adjustment. In other words, the availability of foreign finance
today is no guarantee of its availability tomorrow.
Indias total external debt has risen steeply, from $225.5 billion in March
2009 to $345.5 billion in March 2012 and $376.3 billion in December 2012.
Apart from external debt, foreign investment (i.e., FDI and portfolio
investment in equity) also constitute liabilities which entail payments.
Thus Indias gross foreign liabilities (foreign debt plus foreign investment)
have shot up from $409 billion in March 2009 to $723.9 billion in
December 2012.
True, India also has foreign assets, but these have risen much more slowly.
Let us look at Indias net external liabilities. That is, Indias international
assets (its loans to others and its investments abroad) minus its
international liabilities (Indias external debt and foreign investment in
India). In the last decade, Indias net external liabilities have grown
dramatically: from $66.6 billion in March 2009, net external liabilities
have quadrupled to $282 billion by December 2012 (see Chart 4).
Two developments have taken place on the investment account (i.e.,
foreign investment in and loans to India, and Indias foreign investment
and loans to others). The countries in which India invests its own foreign
exchange reserves have reduced their interest rates to rock-bottom levels,
so Indias returns from its foreign assets have fallen further from their
already abysmal levels. The rate of earnings on Indias seemingly massive
foreign exchange reserves plummeted from 5.1 per cent in 2007-08 to 1.5
per cent in 2011-2012; that is, from RS 51,883 crore in 2007-08 to Rs
19,810 crore in 2011-12.[8]
On the other hand, the returns on Indias foreign liabilities remain
relatively high.
The foreign exchange reserves have been built up from inflows of foreign
debt and investment, on which India pays high returns; whereas the
reserves have to be invested abroad in secure assets such as US
government debt, on which India earns very low returns. One study
calculated that the net annual drain on account of foreign investment and
debt by end-2007, as a percentage of Indias annual national income, was
comparable to the percentage drained annually from India under the
British Raj.[9]
Moreover, Indias foreign liabilities are growing fast. As a result,
the negative net balance of investment income too is growing fast. From -
$5.5 billion in 2009-10, it has shot up to an estimated -$24 billion for 2012-
13 and a projected -$28 billion in 2013-14.[10] In other words, the capital
inflows are themselves one of the causes of the widening of the current
account deficit, because they are leading to major outflows of investment
income.
Further, the drain of foreign exchange as a result of FDI is not limited to
the payment of dividend, royalty, technical fees, and so on; a larger sum is
expended on imports of goods by the foreign firms (which would be
reflected in the merchandise trade account). For example, the net drain of
foreign exchange as a result of the operations of 745 FDI companies
studied by the Reserve Bank rose from $6 billion in 2008-09 to $9.7 billion
in 2010-11.[11] Unfortunately, the study does not provide data whereby
we can determine how much foreign investment actually came in via these
745 foreign firms.
V. Foreign exchange reserves defence against foreign exchange
crisis?
Despite all these alarming indicators on the external front, we are told not
to worry: We are told that, unlike in 1990, when Indias foreign exchange
reserves fell at one point to $1 billion and the countrys gold reserves too
had to be shipped out secretly, today we have a vast sum in the kitty. As of
March 15, 2013, the foreign exchange reserves stood at $292.3 billion.
Earlier, the adequacy of foreign exchange reserves would be judged in
terms of how many months imports they could pay for. The traditional
norm was the ability to pay for three to four months imports. At one point
in 1990, Indias reserves could cover scarcely two weeks of imports, and
officials desperately tried to raise a few billion dollars from all sorts of
sources. By contrast, in September 2012, when the reserves were $294.8
billion, they were estimated to cover 7.2 months imports. By another
measure, the reserves could pay for 6.8 months imports and debt-
servicing payments.[12]
It has been recognised by numerous official committees that these
measures are no longer meaningful, if they ever were. After all, the
strength of a defence must be judged by the forces against which it must
defend. Apart from paying for imports and debt-servicing, the reserves may
be called upon to repay capital liabilities. Total external liabilities in
September 2012 were $713.2 billion (more than twice the size of Indias
reserves). While Indias external assets were larger than the foreign
exchange reserves on that date, the remainder of the external assets
largely the direct investment abroad by Indian firms obviously cannot be
called on to repay the countrys external liabilities. Thus external liabilities
in excess of the foreign exchange reserves were $418.4 billion.
However, not all of these external liabilities are liable to be repaid on short
notice, which is what is relevant in relation to the foreign exchange
reserves. So let us look at the following items, which comprise what we can
call the short-notice liabilities: (i) short term debt (i.e., debt repayable
within a year); (ii) portfolio investments (i .e., FII investments in the share
markets and in debt instruments), which can be withdrawn at any time;
and (iii) those NRI deposits which are fully repatriable at any time
(Foreign Currency Non-Resident and Non-Resident External Rupee
Account).
(i) Short-term debt[13] in September 2012 stood at $159.6 billion. As a
proportion of the foreign exchange reserves, it is 54.1 per cent. This
proportion has been rising with alarming rapidity as recently as in March
2012, it was 50.1 per cent of the reserves.
(ii) Portfolio investments by FIIs in September 2012 stood at $164.6
billion. As a proportion of the reserves, they are 55.8 per cent.
Two qualifications need to be mentioned here.
First, this is the historical value of cumulative portfolio investments, i.e.,
simply the sum of all the amounts that came in at different times over the
past two decades, but at the value at which they entered. The current
market value of portfolio investments in equity would be much higher than
these historical values. The exact value at which they would be repatriated
would depend on the market price on that date. [14] Although the historical
value of cumulative portfolio investments in the equity markets stood at
$129.1 billion in September 2012, the market value stood at $236.2 billion
at the end of March 2013, according to a recent report by Citi
Research.[15] Thus as a proportion of the foreign exchange reserves in
March 2013, FII investment in equity alone (i.e., excluding FII investment
in debt) comes to nearly 81 per cent of the reserves in March 2013.
Secondly, much of what is classified as FDI may be hardly different from
FII capital. FDI is supposedly more stable than FII capital, since it is not
merely financial investment, but is a long-term stake in Indian assets,
associated with management control. However, a recent comprehensive
study has found that, because of changed official definitions as well as
official eagerness to project a larger figure of FDI, more than half of what is
being classified as FDI is of the nature of purely financial investment, such
as by private equity firms, venture capital funds, and hedge
funds.[16] While it could be argued that such investments are not as
unstable than FII investments in the share market, they cannot be
considered to be stable.
(iii) Thirdly, the outstanding sum in Foreign Currency Non-Resident
(FCNR) deposits and Non-Resident (External) Rupee Account deposits
(NRERA) deposits was $54.7 billion in September 2012.
The total of the above three items, even taking portfolio investments only
at their historical value, comes to $378.9 billion in September 2012 128.5
per cent of the reserves. In other words, while the foreign exchange
reserves appear impressive, they cannot withstand a serious panic flight of
capital out of India.
At any rate, the negative effects of the large current account deficit would
be felt well before the foreign exchange reserves get exhausted. The RBI
Governor has pointed out recently:
Even as the CAD has been high, we have been able to finance it because of a
combination of push and pull factors. On the push side is the amount of
surplus liquidity in the global system consequent upon the extraordinary
monetary stimulus provided by advanced economy central banks.... In
trying to finance such a large CAD, we are exposing the economy to the risk
of sudden stop and exit of capital flows. This will be the case to the extent
capital flows in pursuit of short-term profits. Should the risk of capital exit
materialise, the exchange rate will become volatile causing knock-on
macroeconomic disruptions. (emphasis added)[17]
This is a remarkably direct warning, and it shows that the authorities are
alive to the dangers in the present situation, regardless of the seeming
security of the foreign exchange reserves.
Refusal to reduce imports
Despite this awareness, what is remarkable is that none of the authorities
even consider the idea of restricting imports by various means, including
by physical restrictions. The most glaring example is that of gold, imports
of which, already very high, have soared since 2009. In 2011-12, gold
imports (net of re-export) accounted for half the current account deficit of
4.2 per cent of GDP. Despite various authorities taking note of this
phenomenon and raising the alarm, at no point did any of them even
mention the possibility of banning that part of gold imports not required
for exports. This despite the fact that (i) import of gold is pure
consumption, a diversion from savings; (ii) gold is obviously not part of
essential consumption, but elite consumption; (iii) gold imports have been
driven by speculative investors, attracted by the long rise in gold prices.
The RBI Governor himself noted recently that The concern about the
quality of CAD arises from the composition of imports. If we were
importing capital goods, we can maybe countenance a higher CAD because
investment in capital goods implies building production capacity for
tomorrow. On the other hand, import of gold... is a deadweight burden,
especially at a time when the CAD is beyond the sustainable level.[18] As
an official RBI committee notes, since 2006 gold imports have been
negatively correlated with share prices. [19] It appears that during the
2003-08 share prices boom domestic speculators got accustomed to annual
returns on shares in excess of 20 per cent. With the 2008 crash they
increased their purchases of gold, the rising price of which gave them rich
returns.
Since the liberalisation of all imports, including gold imports, is a tenet of
the post-1991 policies, the authorities gazed mutely as gold imports soared
in the post-2008 period. At the time of the presentation of the 2013-14
Budget, we witnessed the strange spectacle of the Finance Minister
appealing to the people not to buy gold, but himself failing to levy any
additional duties on gold.[20] With the bursting of the bubble in gold
prices, speculative purchases may decline, but the other component of
domestic gold demand middle class jewellery consumption may pick up
and keep gold imports high.
Similarly, the growth of consumption of petroleum products in India is not
a natural phenomenon like the weather. It is related to the overall pattern
of production and consumption, which are themselves the product of
economic policy, macroeconomic choices. It is glaringly obvious that the
reigning economic policies encourage vast, wasteful consumption of all
energy resources, including petroleum products. For example, the
Government has systematically promoted the shift of transport away from
railroad to road transport, and constructed vast road infrastructure to
facilitate this; it promotes and subsidises the automobile industry in
multiple ways, and degrades public transport; it promotes the civi l aviation
industry (the number of passengers has more than quadrupled in the last
decade).
The scope for reduction of imports is much larger than just these two
categories, however. The import of electronic goods was $32.8 billion, or
Rs 1.57 lakh crore, in 2011-12. Much of this can be eliminated right away,
and some of it can be eliminated by systematically developing truly
indigenous production (i.e., not mere assembly of imported parts). The
latter involves planning. The trade deficit in manufactured goods has risen
steeply in the last decade as a result of Government policy. The entire
telecom revolution in India has been based on imported equipment, down
to the handsets. India is considered a major software exporter, but it has
not developed any significant production base in computers. Its civil
aviation industry has grown on the basis of imported aircraft. [21]
We have seen earlier that, given the low and declining ratio of our current
receipts to current payments, it is impossible to address the external crisis
merely by scrambling to hike exports. It is necessary to suppress imports.
The inability of the rulers to take any steps in this direction is not an
incidental flaw or shortcoming: it has deep roots in the political economy
of India, in the character of its class rule.
The entire liberalisation process since 1991was meant to render India
internationally competitive and overcome the balance of payments
difficulties which had plagued it in one form or another since the mid-
1950s. It has instead deepened Indias dependence on foreign capital,
increased foreign ownership of Indian assets, and strengthened foreign
dictation of Indian economic policy. The part played by the IMF and World
Bank in 1991 has now been taken over by credit rating agencies, whose
employees extensively monitor Indian policy-making and spell out the
demands of foreign capital.
To take just the latest example: a news report of April 12 informs us:
Armed with the Budget proposals to bring down the fiscal deficit, the
finance ministry would pitch for a ratings upgrade at a series of meetings
with global agencies over the next few weeks, beginning with Fitch
tomorrow.
The Fitch team will come tomorrow. Representatives from Standard &
Poors and Moodys are scheduled to visit on April 25 and May 5
(respectively), a senior ministry official said. The officials, sources said,
would impress upon rating agencies the resolve of the government to
follow a path of financial prudence and bring down the fiscal deficit to
three per cent of GDP by 2016-17....
The Fitch representatives would meet Economic Affairs Secretary Arvind
Mayaram and officials from various departments, including capital
markets, infrastructure, revenue and disinvestment, the official said. Both S
& P and Fitch had earlier threatened to downgrade Indias credit rating as
an aftermath of the expansionary policy which led to a rising fiscal deficit....
After the presentation of Union Budget, S & P and Fitch had said Indias
sovereign rating was unaffected but had warned that policy execution and
controlling subsidies would be the key risks to look out for during the year.
S & P currently rates India has BBB-, lowest in the investment grade, with
a negative outlook. Any further downgrade would push Indias rating to the
junk status, making it difficult and costlier for Indian entities to borrow
funds overseas.[22]
What could be more pathetic, indeed, than Montek Singh Ahluwalia, the
deputy chairman of the Planning Commission of sovereign India,
supplicating tuppenny inspectors of international rating agencies in the
following fashion?
My guess is that if the rating agencies were to look at the Plan document, I
think they would be quite pleased. It conveys after all the two key signals
that any rating agency would want to know about, and one is are we
serious about fiscal consolidation. I think the Plan quite clearly says we
are.
The decisions that were taken on the diesel price are indicative even in a
politically difficult situation that the government is serious about taking
those decisions. Some of the other things that have been done on the policy
front along with what we have said is necessary should persuade rating
agencies that we are well set on to a high-growth path.
Now they may or may not believe that we are going to reach 8.2 per cent
but in my view if they feel we are on a 7 per cent plus path and they
perceive that we are serious about medium-term fiscal consolidation, my
guess is that they will not downgrade us in September....
I personally feel that the direction outlined in the Plan, the fact that the
government has endorsed this broad direction, the fact that the
government has taken some concrete steps in the last few days which point
in this direction all of them should persuade the rating agency that its
too early to write off India.... Some of the steps have already been taken
which are not recent. For example, the finance mini stry responding very
smarly to the concern of investors by setting up the Parthasarathi Shome
Committee and also the Rangachari Committee. If the Shome Committee
recommendations are actually implemented and accepted, it will take care
of a lot of concerns and I hope that the Rangachari committee also will
address some of these issues... There is a whole agenda and I expect that in
the next two months, we will see positive actions on all these points. So
taken together, it will definitely alter the perception and anyone worrying
about Indias grading position would have to take the view that the
situation is a lot better now that it was three months ago.[23]
Notes:
[1] Kirit Parikh, who recently chaired an official committee which
recommended an increase in energy prices.
http://epaper.timesofindia.com/Default/Scripting/ArticleWin.asp?From=A
rchive&Source=Page&Skin=TOINEW&BaseHref=CAP/2010/02/08&PageLa
bel=16&EntityId=Ar01600&ViewMode=HTML&GZ=T (back)
[2] 2012-13 data for imports, trade deficit and current account deficit are
projections by the Prime Ministers Economic Advisory Council. The source
of the remaining data is the Reserve Bank of India. (back)
[3] This was also due in part to the slowdown in industrial growth, which
led to a slowdown in imports, and hence the trade deficit. Nevertheless, it
is important to note that invisibles receipts nearly tripled, from $9.8 billion
in 2000-01 to $27.8 billion in 2003-04. (back)
[4] The average growth rate of current payments (in dollars) during 2004-
05 to 2011-12. (back)
[5] The average growth rate of current receipts (in dollars) during 2004-05
to 2011-12. (back)
[6] C. Rangarajan, Why the India story is intact, Hindu Business Line,
4/5/13. (back)
[7] S.K. Verghese, Wilson Varghese, Indias Mounting External Debt and
Servicing Burden, Economic and Political Weekly, 26/11/88. (back)
[8] Reserve Bank of India, Annual Report, 2007-08 and 2011-12. (back)
[9] See N.K. Chandra, Indias Foreign Exchange Reserves: A Shield of
Comfort or an Albatross?, EPW, 5/4/08. (back)
[10] Prime Ministers Economic Advisory Council, Review of the Economy
2012-13. (back)
[11] That is, Rs 27,820 crore in 2008-09, and Rs 44,363 crore in 2010-11.
Finances of Foreign Direct Investment Companies: 2010-11, RBI Bulletin,
December 2012. (back)
[12] RBI, Half-Yearly Report on the Foreign Exchange Reserves,
September 2012. (back)
[13] Here we are referring to short-term debt by residual maturity, i.e.,
including not only debt that was originally contracted as short-term debt,
but also that portion of long-term debt which falls due within a year from
the date. (back)
[14] N.K. Chandra, op cit. (back)
[15] Foreign investors increase stake in India Inc., Times of
India, 10/5/13. (back)
[16] K.S. Chalapati Rao, Biswajit Dhar, Indias FDI Inflows: Trends and
Concepts, ISID Working Paper, 2011. Also see N.K. Chandra, op. cit .(back)
[17] D. Subbarao, Indias Macroeconomic Challenges: Some Reserve Bank
Perspectives, RBI Bulletin, April 2013. (back)
[18] Subbarao, op. cit. (back)
[19] RBI, Report of the Working Group to Study the Issues Relted to Gold
Imports and Gold Loans NBFCs in India, February 2013. (back)
[20] The argument the Government and pro-liberalisation economists trot
out against restricting gold imports either physically or through higher
duties is that such measures will revive smuggling of gold. However, this
argument does not hold. First, whether or not the State machinery is able
to check gold imports depends primarily on the availability of political will
to do so. Secondly, even if smuggling does revive, the total amount of gold
imports (including smuggled gold) would fall quite sharply, compared to
the present situation of free availability. Thirdly, whether gold is smuggled
or brought in legally makes no difference to the two negative impacts of
gold imports, namely, diversion of potential savings to luxury consumption,
and drain of foreign exchange. Hence whichever option results in a
reduction in total imports should be chosen, in this case, physical
restriction. (back)
[21] Sudip Chaudhuri, Manufacturing Trade Deficit and Industrial Policy
in India, EPW, 23/2/13. (back)
[22] FinMin to pitch for ratings upgrade with Fitch, other
agencies, Business Standard, 12/4/13. (back)
[23] Interview, We are serious about fiscal consolidation, Mint, 17/9/12.
(back)