"THE newly appointed RBI Governor, Dr. Raghuram Rajan, has said that there is no magic wand that will make India's current economic problems disappear. Indeed, however competent and brilliant he may be, he may not be able to stop either the rupee's fall or bring the economy back on track overnight.
The truth is that the economy has a very small window of opportunity for economic recovery and it has to be seen whether Mr. Raghuram Rajan can seize this opportunity. It would be a fallacy to think of India as 'too big to sink' because it is in dangerous waters like never before. Even the Finance Minister has taken note of the perilous situation and has announced a number of measures to shore up foreign exchange inflows because they are just enough to cover seven months' imports.
Although the Forex reserves are at $279 billion, India's corporate sector has huge debt obligations which it would have to pay off soon. The corporate sector borrowed merrily from Western countries at low interest rates in the past and this resulted in a short-term debt of $172 billion that would be maturing within a year. In 2014, India's short-term debt would amount to 60 per cent of India's Forex reserves.
Also External Commercial Borrowings (ECBs) were a boon for companies in the past but now they amount to 31 per cent of India's total external debt of $390 billion. The corporate sector's weak performance combined with higher interest rates due to the weak rupee is going to make the debt servicing obligations of these companies difficult. It would also weaken their prospects of recovery. Now the FM has increased the ECB limits further to enable companies to access dollars but the prudent amongst them will not go for big loans.
In the past, India had a safe situation of having more long-term debts and a small proportion of short-term debt. Today the proportion of short-term debt in India's total external debt has gone up three folds since 2008 and is at 44 per cent. The Current Account Deficit (CAD) is another problem which will put pressure on the Forex reserves. Imports have been exceeded exports, especially gold and oil. But perhaps due to the rupee's fall, export growth rose 11 per cent in July. Imports have also declined and the government has raised import duties on gold and silver by 10 per cent and it may also curb imports of non-essential luxury items in a bid to shrink the CAD to $70 billion. The CAD is around 4.8 per cent of the GDP currently which means it would require around $88 billion to meet the deficit. The newly unfurled game plan of the FM will be able to garner $11 billion more in foreign exchange inflows.
The sliding rupee could trigger capital flight. Several Indian industrialists are trying to take their money out of the country. The government has clamped down on overseas investment by Indians from $200,000 to $75,000 per year. This has shaken the confidence of the investors and the rupee fell to Rs 62 to a dollar. The lack of full convertibility of the rupee, however, would help in stemming capital flight. Thus bringing back confidence in the policies of the government will be a serious challenge for the new RBI Governor.
Turning to the fiscal side of the economy which is not directly under the RBI but is closely connected to its monetary policy, there would also be a problem if tax collections fall. Mr. Chidambaram recently announced that the 2012-13 fiscal deficit had been contained at 4.9 per cent of the GDP instead of the revised estimate of 5.2 per cent. This is good news though in the future, the government has to watch out against tax evasion, especially in times of inflation and falling profits. Instead of becoming a cashless economy, India is becoming more reliant on cash payments because hordes of people want to avoid paying taxes. Widening the tax net and implementing a system of efficient tax collection would require good governance. According to some economists, the political timing of the Food Security Bill cannot be questioned but its impact on the widening of the fiscal deficit by at least 0.2 per cent is certain. A rise in diesel prices because of higher oil prices on account of the falling rupee is imminent and will also push up food prices. Already the consumer price index (CPI) is at 9.6 per cent and food inflation is at 12.4 per cent. Any increase in the fiscal deficit will be inflationary. Inflation control will remain the primary challenge for the RBI Governor.
The choice before the new Governor would be: whether to control inflation or to promote growth. The previous Governor did not cut the repo rate (the rate at which banks borrow funds from the RBI) which is high at 7.25 per cent because he wanted to target inflation. High repo rates lead to high lending rates and this have already stifled fresh investments. Rajan will have to weigh the pros and cons of reducing the repo rates. If he reduces them, he would give a stimulus to industry and attract fresh investments without which there would be a further fall in industrial growth. Industrial growth declined by 2.2 per cent in June and what is worse, capital goods industry growth is shrinking by 6.6 per cent. This will impact productivity growth which is deteriorating. If the RBI lowers the interest rates it might trigger a further slide in the rupee because moreFIIs are likely to withdraw from the bond market.
He would have to restore the confidence of foreign investors in the economy's growth potential. Foreign investments are needed for infrastructure and industry. FDI norms were relaxed further by Chidambaram recently. The Governor will also have to attract more FIIs. Already $11.3 billion of FIIs have left India for more secure climes with the promise of higher interest rates in Western countries when Chairman of the US Federal Reserve Ben Bernanke announced that he would be winding up the 'quantitative easing' (the Fed buys $85 billion worth of Treasury Bonds every month) to revive the economy. In the past, FIIs flocked to the emerging markets and looked for higher returns. But as soon as growth prospects in India looked dimmer, they headed home. Recently their mass exodus resulted in the stock market's fall by 769 points. If the GDP growth rate picks up, they would stage a comeback. Unfortunately, investment rating agencies, the IMF and the ADB are predicting 4.5 to 5 per cent growth for India. Tough work ahead for the new Governor as he will have to bring back investor confidence, reduce CAD, stop the rupee's slide, control inflation and promote growth!
(The writer is a Senior Fellow at Observer Research Foundation, Delhi)
Courtesy: The Tribune, 19 August, 2013
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