Economic Survey 2016: Plan needed for currency readjustment in Asia

With the frequency of global shocks increasing, the Economic Survey cautioned that one tail risk scenario that India must plan for is a major currency readjustment in Asia in the wake of a similar adjustment in China, as such an event would spread deflation around the world.

“Another tail risk scenario could unfold as a consequence of policy actions — say, capital controls taken to respond to curb outflows from large emerging market countries, which would further moderate the growth impulses emanating from them,” it noted.

In either case, foreign demand is likely to be weak, forcing India — in the short run — to find and activate domestic sources of demand to prevent the growth momentum from weakening. At the very least, a tail risk event would require Indian monetary and fiscal policy not to add to the deflationary impulses from abroad, the economists in the finance ministry said.

The consolation would be that weaker oil and commodity prices would help keep inflation and the twin deficits — fiscal deficit and current account deficit — in check, they noted.

Reflecting India’s growing globalisation, the correlation between India’s growth rate and that of the world has risen sharply to reasonably high levels. For the period 1991- 2002, this correlation was 0.2. Since then, the correlation has doubled to 0.42.

In other words, a 1 percentage point decrease in the world growth rate is now associated with a 0.42 percentage point decrease in Indian growth rates.

Accordingly, if the world economy remains weak, India’s growth will face considerable headwinds. For example, if the world continues to grow at close to 3% over the next few years rather than returning to the buoyant 4-4.5% recorded during 2003-2011, India’s medium-term growth trajectory could well remain closer to 7-7.5%, notwithstanding the government’s reform initiatives, rather than rise to the 8-10% that its long-run potential suggests, the Survey noted.

Shock warning
* The Survey warned that one tail risk scenario that India must plan for is a major currency readjustment in
Asia in the wake of a similar adjustment in China
* A 1 percentage point decrease in the world growth rate is now associated with a 0.42 percentage point decrease in Indian growth rates