Wednesday, January 15, 2014

Let’s not bring in the foreign-hand excuse: Financial Express 13th January 2014

For those who lived through the 1970s and the 1980s, it was almost axiomatic that all problems in the country would be associated with the ‘foreign hand’. With this ‘hand’ not quite being defined, it was assumed that discussion or speculation would end. Today, in an era of globalisation, which has been taken to new heights by the financial crisis and then the sovereign debt crisis, the connections are stark. The foreign hand has assumed a new form which is used for explaining why things are not working. Therefore, it is not surprising that the current problems with the Indian economy have been related to global economic conditions. So much so that even inflation has been driven to the starting point of being global in nature. How far can this be justified in this way?
One may recollect that when the financial crisis took place and the emerging markets came out relatively unscathed, there was this theory of decoupling that was enunciated, which proved that these countries were different and could take charge when the developed countries did not perform. And we in India showed how good our numbers were. Now, can we really go under the umbrella of global distortions to justify our condition? The arguments here show that India is not quite the country that runs on global factors, which, though important, are more peripheral in nature. As a corollary, the basic impetus has to come from within. Let’s look at GDP growth. Ours is a domestic-oriented economy. Agriculture is fully domestic, and while industrial growth is driven by exports, the pattern in the last 5 years shows that the ratio of exports to GDP (at current market prices) has actually increased from 14.9% in FY09 to 17.2% in the first 8 months of FY14, with the ratio being 16.3% in FY12 and FY13. This means that a global slowdown has not quite affected this ratio. We have actually diversified our export destinations away from the US and Europe to Asia and Africa to make them less vulnerable to such disturbances. Services, again, are primarily domestic in nature, and if one looks at the share of domestic advances to total advances of our banking system, it has been constant at around 90%. This means that growth is driven mainly by domestic factors and we cannot quite blame the global slowdown for our travails. How about inflation? Inflation in the last year has been driven by the primary and fuel segments, while manufactured goods' prices have been stable and just about moved by 2-3%. Global commodity prices have been benign across most sectors and, thus, have not quite pressurised domestic inflation. Food inflation has its genesis in production, supply, pricing and logistics issues, which cannot be linked with any of the global factors. Metal prices have remained low and, surprisingly, even crude oil price has actually moved downwards this financial year and averaged $107/barrel compared with $115 and $110 in FY12 and FY13, respectively. If fuel inflation was high, it was more on account of the government’s decision to strike prudence between fuel subsidy and market prices, which thus does not have a link with global prices. Inflation certainly appears to be driven from within. Therefore, the twin problems of growth and inflation have been driven by domestic factors. High inflation has come in the way of domestic consumption while ambivalence in policy as well as hold-up of projects has affected investment. These are domestic factors and require indigenous solutions. The fiscal deficit issue is again domestic in nature and low growth in GDP has affected revenue collections, while all expenditures are directed through policy aspirations that have no link with the global slowdown. Therefore, the classic debate between the government and RBI on fiscal balance is a domestic issue which cannot involve any global developments. How about monetary policy? With the tapering announcement in May having a major impact on foreign outflows, our balance of payments went into a negative frenzy with the rupee moving towards 69 to a dollar until RBI intervened. Here, definitely, there was a global impact when FIIs moved out and there was pressure on RBI to take corrective action, which included keeping interest rates high. But, interestingly, when conditions were corrected quite astutely by the government and RBI, it was not by influencing or countering global influences but correcting the fault line in our CAD, which was gold imports. By putting curbs directly and through taxation and liquidity, this was reversed. And this was strengthened further by opening the swap window for NRI deposits and bank capital. Counter-intuitively, it can be argued that when RBI and MoF say that the tapering programme to begin in January 2014 will not affect India, which sounds all right, it is not because the global environment has changed, but that we have corrected a wrong internally. FII funds continue to be negative in the debt segment and marginally positive in equities, and this major improvement in our balance of payments has not been due to any improvement in global conditions but some good housekeeping. What does all this put together indicate? First, global developments do affect economic variables, but these disturbances only need to be corrected through appropriate policy action. Second, growth stimulus has to come from within and require affirmative action from the government through direct intervention through the budget or provision of incentives to the private sector. By merely sitting back and blaming the global environment, we cannot reverse the trend. Third, inflation has been driven by domestic factors and the global conditions have, in fact, quite to the contrary, been quite favourable during the year where we have had that much of elbow width to address the cause. Fourth, interest rate policy will continue to be driven by domestic conditions and cannot be linked with global developments. While higher rates in the West will cause an outflow, this should ideally not be driving monetary policy, as investors look at the macro prospects when taking any such decision. Keeping interest rates high to invite FIIs may not work if our fundamentals remain weak. While using the bogey of global downturn sounds suave and is important as it does cause distortions, one should not use the route of inaction for exculpation. The strength of the Indian economy is the domestic consumption and investment opportunity as are the weaknesses on our supply-side and infrastructure. Deflecting attention will only take us back, and recognising this situation will help to move forward.

No comments: