Economy Feb 27, 2013
We have asked this question before, but it needs to be asked again: Is the UPA landing us in an external mess as big as the one in 1991? And are Manmohan Singh and P Chidambaram doing enough to ensure the country does not end up owing its underpants to the rest of the world?
The answer is probably no. They are not doing enough. They are going to leave their successor government with a ticking time-bomb that could explode any time.
Every single metric shows that the country is increasing its vulnerability to an external crisis - and there is no lack of reason for that to happen, including a crisis in the US or eurozone. Consider some of our acute vulnerabilities.
#1: As at the end of September 2012, India's external debt was 25 percent higher than our total foreign exchange reserves at $365 billion. It is worse now.
#2: The proportion of short-term debt, 23.1 percent of external debt, is rising faster than long-term debt. While the former grew at 8.1 percent, the latter grew at 5.1 percent. Skittish, hot money is what India is attracting more of right now. What comes in easily can go out even more easily - to our cost.
#3: Hot money is even hotter in stocks. A BusinessLine report says that as on 18 February, foreign institutional investors (FIIs) had poured Rs 1,47,268.2 crore into the Indian markets in this fiscal year, the bulk of it in equity - Rs 1,27,896.9 crore - and just Rs 19,371.2 crore in debt. Money invested in equity can result in double jeopardy: it can leave at a moment's notice, and in also crash the markets. This is vulnerability squared.
#4: The current account deficit - the gap between the country's external earnings and expenses - is heading for an all-time-high record of over 5 percent of GDP this year.
#5: However, the real disaster has been the merchandise trade deficit - the physical stuff we export and import. Last year (2011-12), this deficit was over $189 billion - or 10.3 percent of GDP, according to Aditya Puri, CEO of HDFC Bank. This year, in the first 10 months upto January 2013, the figure is already $170 billion - and heading for over $200 billion by March-end - which could be over 11 percent of GDP. The country is simply consuming significantly more than it is producing - and this is simply unsustainable.
We can go on and on, but the point is simple: India has now mortgaged its future to the whims and fancies of foreign investor flows, and especially hot money.
Everything that Chidambaram has done or left undone has only increased the lopsidedness of this dependency. Consider:
One, domestic debt limits for FIIs has been raised to $75 billion to bring in dollars. But given inflation, not much is flowing into debt, but it nevertheless opens a window for future vulnerability.
Two, the key to fixing this problem is to boost exports. But Chidambaram has tried to hold the rupee firm against the dollar to keep his subsidy bills in check (on account of oil imports of oil and fertiliser). In the process, exports are not competitive in a difficult external environment.
Three, our export figures will get worse as petrol and diesel are slowly deregulated. Currently, private refiners like Reliance and Essar export petro-products since prices in domestic markets are ruling below costs or below global prices, or both. But once this reverses, domestic refiners will sell more at home. Reliance, for example exported petrochemicals and petro-goods worth $32.7 billion in the first nine months of this financial year.
A full year would be closer to $42-45 billion of export earnings. If an exporter who currently accounts for nearly 15 percent of the country's exports starts selling more at home, the impact on the CAD will be significant. The only way this can be balanced is by raising petro-goods prices faster, so that import demand comes down, and domestic production is raised quicker. Neither is happening too soon.
Fourth, Chidambaram has been pressuring the Reserve Bank to cut interest rates. But while this may marginally help domestic business, it deters domestic savers and forces them to look at other assets like gold. This, in turn, worsens our dependence on external capital flows (for, if you don't save enough at home, you have to borrow abroad). As Indians invest more in gold to protect their savings against inflation, the CAD gets badder and badder.
Fifth, the consequence of trying to hold the rupee firm are two-fold: one, it improves short-term hot flows, thus enabling the rupee to strengthen against the dollar; and two, in the process, it keeps the prices of imported commodities like oil steady, and, therefore, inflation.
Chidambaram is trying to artificially keep the rupee up and inflation down because his party has to contain its electoral losses. Let inflation rip, and Sonia Gandhi can kiss goodbye to any chance of a return to power in 2014. This, in fact, is why even she is backing Chidambaram's "reforms" Chidambaram.
However, in the process, Chidambaram and Manmohan Singh are going to leave an Indian economy that will be totally exposed to external shocks after 2014.
This is what they should be doing: eliminate diesel and LPG subsidies quickly for all but a very deserving few, so that import demand is curtailed. This will push up short-term inflation, but allow the economy to rebound faster.
On exports, Chidambaram should stop offering sops to FIIs and debt inflows, and let the rupee find its own level. SS Tarapore, former Deputy Governor of the Reserve Bank, thinks the rupee should be at Rs 70 to the dollar, not Rs 53-54. This too can push up imported inflation as the rupee slides in the short-term, but the beneficial impact will be a higher exports, and higher domestic profits. The two will together spark a revival of business confidence. That, in turn, will bring in long-term foreign capital flows instead of hot money.
Inflation is a like a Jack-in-the-box. By trying to artificially curtail it, you only make it spring back harder when you open the box. It is best to let both the rupee and fuel find their own levels.
By doing the opposite - letting the rupee remain overvalued, chasing hot money, letting exports slide and imports zoom - Manmohan Singh and Chidambaram are thus working against the long-term interests of the country to protect their short-term political ones.
Whoever wins the next election will inherit an economy in a bigger mess than ever before. Unless Budget 2013 targets the real issues of the economy, never mind the short-term political consequences.
More From R Jagannathan.