By Raghunath Nageswaran
Edited by Namitha Sadanand, Associate Editor, The Indian Economist
Over the last few weeks, we have been witness to a sensational stock market rally which foreshadows the possibility of India’s right-wing political outfit-led alliance assuming office after the ejection of an alliance which is alleged to have been “populist” and “corrupt” throughout its currency, notwithstanding the fact that our macroeconomic fundamentals have not come out of the woods. Everything seems hunky-dory against this backdrop and many are given to believe that our economy will grow leaps and bounds under the new regime.
Rewind to July 2013 to remind ourselves of the tragic unabated fall in the value of Indian rupee vis-a-vis the other major currencies and the mass exodus of speculative money from our stock markets. No prizes for guessing who stemmed the fall and turned it around for us. Dr. Raghuram Rajan’s economic acumen and canniness were manifest in the instruments he employed to arrest the currency debasement. He opened the ‘swap window’ for Oil Marketing Companies and to garner FCNR (B) deposits. The corollary was a much-needed recovery which laid the foundation for subsequent developments.
The question that merits a rational response is – should we be worried about stabilizing the exchange rate or should we focus on internal price stability? Currently, the Central Bank has applied its Zen-like focus on fighting the bogie of price-rise, and the retail inflation calibration in the last 3 months, which was predicated on the recommendations of the Urjit Patel Committee, is indicative of that focus. But the RBI governor seems to have pooh-poohed the criticism that the Central Bank is not paying enough attention to financial and exchange – rate stability. To quote Dr. Rajan, “…does the Patel committee intend to turn the RBI into inflation ‘nutters’ focused on bringing down inflation to the exclusion of all else, including financial stability? Of course not!”
To engineer sustainable growth, moderation of inflation is sine qua non. When the Foreign Institutional Investors (FIIs) were booking profits and repatriating dollars, the value of the Indian rupee depreciated. If one goes by the rule of thumb, the falling rupee would strengthen exports as argued by several “well-meaning” economists, policy makers and businessmen. In sync with that rule, Indian exports recovered from a slump, marking double-digit growth in the July–October period. Imports recorded a marked slide due to curbs on the import of gold (gold has other friendly channels to reach Indian masses) leading to a contraction in the Trade Deficit, consequently bringing positive news on the Current Account front. Since there was no remission in price-rise, the pecuniary benefits that accrued to the economy were of little relevance.
The problem with our economy is that we have a weak supply-side (which subsumes the equally shoddy supply-chain). Languishing supply coupled with erosion of purchasing power floods the market with increased supply of money which snowballs into an unmanageable problem of skyrocketing prices. Now, it is the Central Bank’s responsibility to intervene and rein in inflation. In this situation, the apex bank is forced to hike interest rates which raises the cost of borrowing. Since the problem is with the supply-side, ideally speaking, the RBI should cut rates and incentivise businessmen who want to borrow and invest to expand their operations. If this is the case, why is the RBI doing something which is antithetical to practical demands?
A rate-cut for specific sectors would be desirable; but a rate-cut across the board will intensify the problem. The problem is two-fold – 1) reduced cost of borrowing will not automatically translate into productive investment 2) additional money supply will lead to further fall in the value of rupee. Though many argue that the Reserve Bank is behaving like an “inflation-hawk”, I personally believe that it is following the “rule based monetary policy” doctrine. The responsibility of fixing the supply-side problems should be shouldered by the State by bearing a portion of the cost of production of those industries/sectors that cater to the immediate demands of the public. Taking the bigger picture into consideration, the supply-chain overhauling needs to be the onus of the government (of course, it can make the private sector the junior partner) because of the gestation lags involved.
In totality, my argument is pointed towards the imperativeness of bolstering the domestic economy. My views in this regard are shaped by Dr Ambedkar’s proposition. When the Colonial government representing British business interests and the Indian businessmen were embroiled in a debate over the exchange rate of the rupee vis-à-vis the British currency, Indian businessmen believed that the Government was keeping the value deliberately overvalued because that would favour British exporters who sold their goods in India. Indian businessmen, taking a cue from the benefits they received during the fag end of 19th century by dint of a devalued rupee, made a pitch for devaluation.
Ambedkar came forward to trouble-shoot the problem and presented the impasse in a very practical way which remains pertinent till date ‑ “At the outset, it is necessary to realize that this controversy involves two distinct questions: (i) Should we stabilize our exchange and (ii) What should be the ratio at which we should stabilize?”
He was very much concerned about the distributional impacts of increased devaluation in favour of Indian businessmen/exporters. Dr. Ambedkar advocated “limited devaluation”, because that would benefit the business class as well as the earning class. He understood the pain and anguish of an average consumer. A steep downward revision of the exchange rate will not benefit the nation as a whole because while export trade might flourish, the local economy will be engulfed by soaring prices and dwindling supply. This fundamental logic underpins the need to strengthen the domestic economy while reconciling the differences with the external sector.
Raghunath Nageswaran is a B.A. Economics graduate from Loyola College, Chennai. He is a civil services aspirant, having a natural inclination towards understanding the nature of public discourse and policy framework in India. He has served Loyola Economics Association for Development (LEAD) in the capacity of Editor and Associate Secretary. His multitudinous interests gravitate towards the ideals of Daridranarayan and Antyodaya. He writes on socio-economic and political issues. Can be reached at [email protected] .