Manmohan may have got his mojo back and India may have hit a homer with all bases loaded but the stark reality hasn't changed all that much. Andy Mukherjee has a succinct piece on the twin-deficit issue in a BreakingViews column where he points out politely that fiscal profligacy (more like idiocy), took off in February 2008, when the government irresponsibly announced a $15 billion "farm-debt waiver".
What he goes on to state is that the current account must be viewed from the savings-investment dynamic. (Note that if a nation earns more than it spends the overall effect will be to build up savings, unless those savings are being used for investment. If consumers can be encouraged to spend more instead of saving; or if the government runs a fiscal deficit to offset private savings; or if the corporate sector divert more of their profits to investment, then any surplus will tend to disappear).
Look at this from the Indian view - the corporate sector diverting profits towards investment? Consumers spending more? Government running a fiscal deficit thus offsetting private savings? Check
Mukherjee then says that households, seeking cover as an inflation-hedge to this fiscal profligacy turned to imported gold and the household investment in 'valuables' increased 5 times over the past five years! Hence, the domestic corporate sector couldn't maintain the pace at which they were issuing debt and equity securities which further led to an increased reliance on external financing.
Current account deficit - up. Stock of foreign debt - up. Reserves - down.
I never thought (and still don't think) we're close to a BOP crisis a la 1991 but significant and persistently high deficits feeding off each other tend to lead to a sense of drag and extremely negative sentiment in the broader economy adversely affecting investment and consumer behaviour.
Anyway, here's the interlinked and tricky solution!
1) Competitive exchange rate - The rupee has taken blow after blow of late, unable to sustain itself due to (among numerous other factors), persistent dollar demand and India's import composition, but what's happened to the REER?
Nomura's Sonal Varma says this year there's been a real depreciation of only 3% last FY (i don't get that - looks more like 10-11% to me), and 7.7% YTD which should narrow the CA gap by about 0.8% subject to the price of crude oil. The problem is that this is an unfavourable scenario for competitiveness because global demand is damp and tepid and on the domestic front, higher inflation leads to less of a 'real' adjustment.
2) Further Reductions in Subsidies - The issues here are more than a few. Further reductions in subsidies could lead to a bullish sentiment in equities and thereby put pressure on the rupee to appreciate. The counter-move would be for the RBI to snap up dollars and maintain the level of liquidity in the economy which leads to a dilemma on the direction of monetary policy during a period of relatively stagnant growth.
3) Inflation - This would certainly be the most worrisome and sensitive issue. As experienced over the past year, any depreciation of the rupee coupled with a jump in the price of crude oil could have a significant negative effect in the form of imported inflation. Poor infrastructural bottlenecks and negative sentiment make the issues of supply-side solutions that much harder.
The whole FDI-reform saga could encourage more private investment but this is far from a short-term effect. Fiscal reform in the form of a disinflationary GST tax for example can be thrown out of the window as a result of parliamentary legislative gridlock.
Mukherjee concludes that the whole inflation nightmare is why the RBI has to tread extremely cautiously and remain hawkish to "control aggregate demand" even though it might not be the popular move to make. Those expecting and demanding a further rate cut must be postponed for later, only after the government has demonstrated some semblance of fiscal resolve.
Which means, that in the face of volatile headwinds further exacerbated by the moves of the Fed and the ECB's fluctuating sentiments, India would do well to leave the "growth-fixation" aside very temporarily and attend to far more difficult matters at hand.
A prolonged sense of malaise and despair is the last thing that any economy needs and neither is a more austere agenda. What can push it along in a favourable direction is accepting that there are serious structural flaws and constraints and that most of the time, good economics must trump good politics.
What he goes on to state is that the current account must be viewed from the savings-investment dynamic. (Note that if a nation earns more than it spends the overall effect will be to build up savings, unless those savings are being used for investment. If consumers can be encouraged to spend more instead of saving; or if the government runs a fiscal deficit to offset private savings; or if the corporate sector divert more of their profits to investment, then any surplus will tend to disappear).
Look at this from the Indian view - the corporate sector diverting profits towards investment? Consumers spending more? Government running a fiscal deficit thus offsetting private savings? Check
Mukherjee then says that households, seeking cover as an inflation-hedge to this fiscal profligacy turned to imported gold and the household investment in 'valuables' increased 5 times over the past five years! Hence, the domestic corporate sector couldn't maintain the pace at which they were issuing debt and equity securities which further led to an increased reliance on external financing.
Current account deficit - up. Stock of foreign debt - up. Reserves - down.
I never thought (and still don't think) we're close to a BOP crisis a la 1991 but significant and persistently high deficits feeding off each other tend to lead to a sense of drag and extremely negative sentiment in the broader economy adversely affecting investment and consumer behaviour.
Anyway, here's the interlinked and tricky solution!
1) Competitive exchange rate - The rupee has taken blow after blow of late, unable to sustain itself due to (among numerous other factors), persistent dollar demand and India's import composition, but what's happened to the REER?
Nomura's Sonal Varma says this year there's been a real depreciation of only 3% last FY (i don't get that - looks more like 10-11% to me), and 7.7% YTD which should narrow the CA gap by about 0.8% subject to the price of crude oil. The problem is that this is an unfavourable scenario for competitiveness because global demand is damp and tepid and on the domestic front, higher inflation leads to less of a 'real' adjustment.
2) Further Reductions in Subsidies - The issues here are more than a few. Further reductions in subsidies could lead to a bullish sentiment in equities and thereby put pressure on the rupee to appreciate. The counter-move would be for the RBI to snap up dollars and maintain the level of liquidity in the economy which leads to a dilemma on the direction of monetary policy during a period of relatively stagnant growth.
3) Inflation - This would certainly be the most worrisome and sensitive issue. As experienced over the past year, any depreciation of the rupee coupled with a jump in the price of crude oil could have a significant negative effect in the form of imported inflation. Poor infrastructural bottlenecks and negative sentiment make the issues of supply-side solutions that much harder.
The whole FDI-reform saga could encourage more private investment but this is far from a short-term effect. Fiscal reform in the form of a disinflationary GST tax for example can be thrown out of the window as a result of parliamentary legislative gridlock.
Mukherjee concludes that the whole inflation nightmare is why the RBI has to tread extremely cautiously and remain hawkish to "control aggregate demand" even though it might not be the popular move to make. Those expecting and demanding a further rate cut must be postponed for later, only after the government has demonstrated some semblance of fiscal resolve.
Which means, that in the face of volatile headwinds further exacerbated by the moves of the Fed and the ECB's fluctuating sentiments, India would do well to leave the "growth-fixation" aside very temporarily and attend to far more difficult matters at hand.
A prolonged sense of malaise and despair is the last thing that any economy needs and neither is a more austere agenda. What can push it along in a favourable direction is accepting that there are serious structural flaws and constraints and that most of the time, good economics must trump good politics.
No comments:
Post a Comment