The recent nose-diving rupee prompts me to draw a simile with the South-East Asian currency crisis of the late 1990s. The crisis rang a warning bell to countries going overboard to attract foreign money. All the hot money can reverse its direction on the slightest hint of trouble, leaving the economy with a fast-depreciating currency, bigger current account deficit (CAD), depleting forex reserves, fallen GDP growth rate and high inflation. Must India depend so much on foreign money that we don?t even feel the need to look for alternatives? A so-called progressive answer would be ?yes?, but extraordinary times warrant extraordinary thinking. Letting India?s huge CAD get financed by volatile capital inflows is rather risky since it can take us the ASEAN way, and so we must consider alternatives. Management education needs to make students think out of the box even on major macroeconomic issues such as this one and be prepared to sacrifice a bit in national interest.
In the late 1990s, Thailand, South Korea and Indonesia had huge current account deficits, and the debt-to-GDP ratio shot beyond 160% for the ASEAN economies. South-East Asian countries maintained high interest rates to attract foreign investors and Asia accounted for half of total inflows into developing countries. The excessive credit pushed up asset prices resulting in real estate speculation. These prices started crashing subsequently, causing defaults on debt obligations. At the same time, US interest rates were being raised to ward off inflation, making America a more attractive destination. The signs of trouble in the South-East Asian economies led lenders to withdraw credit, creating a credit crunch, further bankruptcies and fast-depreciating currencies. To hold foreign credit back, some crisis-hit governments raised interest rates, which played havoc on the already weak economies. IMF bail-out conditions made things worse. Is something similar possible in India? Well, it cannot be totally ruled out if our policymakers? mindset doesn?t change quickly.
India?s CAD stands over an alarming 6% of GDP, mostly financed by capital inflow in various forms such as FDI, FII, ECB etc. Our interest rates are very high, causing a ?carry trade? from low-interest countries, the liquidity keeping inflation high. Our growth rate has already dropped below 5% and we have lost the cushion to let it drop further. Thus, India faces an inflationary recession, a challenging situation for the policymakers. The rupee has depreciated beyond 58 levels and 3 months forward rate is 59! Depreciating rupee is not helping exports as it should, thanks to the global weakness. Imports are costlier, but oil and gold, major components of our imports, have proved to be price-inelastic, leading only to an ever bigger CAD. Economic reforms have helped India to come out of inflationary recession in the past (early 1990s and the LPG?liberalisation, privatisation and globalisation?model), and if anything can help us today, it?s major reforms again. Unfortunately, almost all that we saw in the name of reforms was FDI in retail. India is going overboard to woo foreign investors to set shops here, at times even offering them concessions and facilities that are not available to domestic companies. Will foreign money hence keep flowing into India? I doubt.
American Federal Reserve has kept pumping dollars into the US economy since the 2008 liquidity crunch, and Ben Bernanke has promised to keep the tap on till the economy recovers. With the US jobless on the decline and growth firming up, their ?Quantitative Easing? may soon be curtailed. Bank of Japan is injecting billions of yen every month to create some inflation and get their economy out of the liquidity trap, but will stop it once the job is done. Billions of euros are being flown into the crisis-hit European nations. Some of the easy money created by central banks around the world has escaped across their borders into more lucrative destinations, one of them being India. Thus, the huge liquidity being pumped into troubled economies has not really reached and helped their ?real? economies. Some of it has found its way into Indian economy, covering our CAD. So far, so good. But with the US economy propping up, followed by Japanese yen firming up and European sovereign bonds recovering, this hot money will have better destinations and India will experience out-flight of capital. In fact, it has already started happening, and hence the nose-diving rupee. We are likely to find it increasingly difficult to attract foreign capital to finance our CAD and the rupee will likely continue its southward journey. RBI intervention will put a drain on our forex reserves while further tightening liquidity and raising interest rates. So, what are the alternatives?
First, reduce CAD at all costs: hasten oil price deregulation to curb demand and create alternatives to gold. Second, push exports, but short of letting our economy become export-dependent. Third, calculate the cost of deploying foreign capital and go easy on it. Fourth, in case of capital scarcity coupled with huge unemployment, will industry consider using more labour-intensive techniques wherever possible without sacrificing productive efficiency? Fifth, will industry oblige sectors like agriculture, education, infrastructure, health, sanitation etc on a no-profit-no-loss basis or outright philanthropy? Sixth, can the nation?s 30%-plus savings be channelled into capital formation for the starving sectors? Can we go the Gandhian way and reduce our appetite for an endless pursuit of ever more of everything? Will management education re-discover some ancient philosophies and teach the next generation to sacrifice a bit of their profits in national interest? The answers will determine the course the Indian economy will take in the immediate future.
The author is a professor of economics, Symbiosis Institute of Management Studies, Pune. She can be contacted on shubhada.s@sims.edu