The Narendra Modi regime has announced many welcome new initiatives in its first year. But the economy, the revival of which was its main mandate, remains weak. If the economy is to be revived, the government must move on several key reforms. Certain macroeconomic stances also need to be rethought.
The RBI has been maintaining high real interest rates and an overvalued exchange rate, which are not good for India. Inflation continues to decline because of the huge drop in commodity prices and better use of foodgrain reserves. Yet the RBI has so far continued to tilt at windmills and fight a battle that has already been won. By delaying substantial interest rate cuts till now, it has hurt growth.
The same applies to its exchange rate stance. The rupee is hugely overvalued when measured using the CPI-based real exchange rate. But the RBI cites the WPI-based real exchange rate index to justify the current value of the rupee. India needs to allow the rupee to depreciate by at least 10-15 per cent to regain competitiveness. But this would endanger the balance sheets of corporates with large unhedged foreign borrowings. Pressure must be brought to clear unhedged foreign borrowings and gradually allow the rupee to reach a competitive level.
This is far more important than talking about rupee convertibility, which is a long way off.
While inflation has declined, largely because of external factors, the recovery in growth looks fragile. The new GDP numbers surprisingly show that the economy began recovering in 2013, well before the last election. But these numbers lack credibility, as no other indicators — investment, corporate profits, credit uptake, tax intake and capacity utilisation — show improvement. Rather than celebrating the GDP numbers, the focus should be on reforms that would improve our manufacturing sector.
Lower interest rates are needed now to boost consumption and investment and provide a stimulus to revive growth. Higher interest rates are also keeping the rupee strong. India remains a “sweet spot” in the global economy for short-term portfolio investors, as most other emerging economies have lowered interest rates. The RBI must not persist with a high real interest rate regime despite the sharp decline in inflation and the lack of signs that it might spike again soon.
With the rupee higher than it should be, the non-oil trade deficit continues to rise, with China as the largest contributor to it. The recent MAT controversy had led to a sudden outflow of short-term capital. But this should not be such a huge concern, as India’s export revival needs a weaker, not stronger, rupee.
The impact of fiscal policy on macro indicators has become harder to read after increased devolution. India can no longer just focus on the Central government’s fiscal deficit — the states are now more significant players. Like many federal economies with large state companies, India must also shift to monitoring the overall financing need of the public sector through the public-sector borrowing requirement. Without a consolidated set of fiscal accounts, it’s hard to know if public-sector capex is up or the consolidated fiscal deficit is on target.
India appears to be missing the opportunity created by the respite that global factors gave us in 2015. Inflation and the current account deficit have been contained and new social security schemes have been announced. Fiscal devolution is under way but economic revival remains elusive and India’s inherent competitiveness has not yet seen any improvement. Capex of the consolidated public sector may not see any increase. The much-heralded bankruptcy law is not heard of anymore and the clean-up of stalled infrastructure projects, which blight the balance sheets of public-sector banks, is still being debated. It’s not surprising that the business community remains wary of putting their money in long-term, job-creating investment.
The writer is visiting scholar, Institute for International Economic Policy, George Washington University, Washington DC.