New Delhi | Updated: September 21, 2018 9:33:57 am
Rathin Roy, Director, National Institute of Public Finance and Policy, since 2013, is a member of the Prime Minister’s Economic Advisory Council. While he thinks that the sharp depreciation of rupee in 2018 needs to be taken seriously, what he is more concerned about is the structural problem that the current account deficit (CAD) poses for the economy. In an interview to P Vaidyanathan Iyer, he says the increase in the CAD is partly a result of the goods and services like four-wheelers, higher education, civil aviation, and recreation travel consumed by a small percentage of the population, say 100 million.
Is the rupee depreciation a cause for concern?
It is something that needs to be taken very seriously not because the short-term drivers of this depreciation cannot be managed, but because it reflects there are structural weaknesses in the Indian macro economy which cause colds every time the world sneezes.
Did the Govt or the RBI wait for this long to take stock of things?
IMF predicted a widening of CAD to about 2.6% of GDP this year. In my view, this would have been consistent with 6% depreciation of the rupee. What we have to explain is the balance. The causes can be permanent, or temporary.
So, what are the reasons for this?
There are three: 1) A black swan event has occurred i.e. the US economy is growing at levels at which normally only emerging economies do, which means that attractiveness of investment in the US has gone up. The way the financial markets react to this – they have quotas for investments in US and China, and they have quotas for emerging economies based on certain algorithms. They allocated more for US economy, and less for India.
2) The rise in oil prices which raises demand for dollars
3) Given these events, speculators and financial players may try to short the rupee. They would take bets that the value of rupee will fall, and make that bet work by selling the rupee in international forward markets. If this happened then it would be right and proper for the govt to take action to counter that shorting. I think shorting happened relatively less in the case of rupee because the govt correctly conveyed over the last two years it was committed to using the reserves to preventvolatility in the foreign exchange market. The rupee has depreciated, but it has not been volatile.
What can the govt do going forward?
There is a set of actions the govt must take bearing in mind that the structural CAD would continue. This is because our current phase of development transformation is fairly unique in contemporary history. All other developing countries that have transformed into developed economies like China and South Korea have done so by meeting the demand of consumers in rich countries by supplying them with goods and services at a cheaper price. This was export-led growth. China is the last country to be able to do this. India’s growth is not going to come by supplying the demand of foreigners, but by supplying the demand of Indians. Therefore the current count will be in deficit for some time, because we will not need the rest of the world to buy goods and services from India, but to provide finance to India, so that India can make goods at affordable prices to meet the domestic demand and in this process become competitive enough to be able to sell to foreigners too.
Promoting domestic consumption based growth is a double-edged sword because there is always a choice between imports and producing at home. Our current growth pattern is such that we need many things in India, but we import the things we need to make them, for example, electronics, or aircraft. So, the import intensity of domestic products is high. Things that we traditionally import, we have not been able to start producing in India. The best example is defence. Certain sectors where the consumption demand was very low in the past, like, mobile phones, have become very important sources of demand, but we are unable to supply them in India.
In the very extreme, the problem is compounded by the fact that even things that used to be non-tradeables like education and recreation travel have become tradeables. The import bill on this is sky rocketing. We are now talking of billions of dollar-worth imports like education and recreation travel. A combination of these three things have meant that our import pressures have increased. Either we need to increase import substitution or see an uptick in exports to finance the increased import intensity of consumption. Or we moderate imports.
So, the CAD is a structural problem?
CAD, it is deeply structural. So really what you are seeing happening now is a symptom of a structural issue that we need to remedy.
Import basket, coal imports have gone up, despite availability of coal. It’s more of a policy issue not a structural issue.
Coal is more a productivity issue. The reason we are importing coal is that the efficiency of imported coal given the technologies we currently use in the coal ecosystem – whether how we mine the coal, or how we transport it or burn the coal to produce energy- the entire ecosystem is unproductive. So, we import higher quality coal, which has lower sulphur content..
So, the structural problem you refer to, is more because our growth is completely consumption-led?
The root of the problem lies in the nature of growth process. Over the last 30 years, the process has been based on feeding the consumption of the top, to be charitable, 100 million Indians. That is a huge market by global standards. But what the top 100 million demands in the first phase are things like two-wheelers, automobiles, FMCGs, etc. The suits in Bombay call this the leading indicators of economy. Our growth story is based on this consumption demand. But if you ask what are the things that all Indians want to consume at affordable prices – a nutritious meal, textiles, housing, health and education -one of these are produced at affordable prices, the prices at which people with minimum wages, can go to the market and buy without subsidy. Affordable shirts costing Rs400 are not made in India anymore. Affordable housing programme needs a subsidy. Healthcare is affordable for the rich, but not for the rest of the people without subsidy. Quality education is affordable for the top echelons, but not without subsidy for those earning minimum wages or even those earning double the minimum wage.
CAD is a symptom that our growth story is not based on consumption demand for, (not rich or poor) all Indians. The consumption demand for rich Indians is of a different kind, one that is not produced in India, like higher education, aviation, and recreation travel.
It is clear that the domestic market is short in supply even for basic services…
At affordable prices. It’s alright to subsidise people earning less than the minimum wage. But something is seriously wrong if we have to subsidise these basic items for people earning the minimum wage. We are not creating jobs anymore because we are not producing these basic items – health, education, textiles, construction and food – for the next 200 million at affordable prices.
Why do you need the rupee at particular levels?
To say the rupee should find its own value is to say that a traumatized child should find inner peace on its own. If the rupee falls, exports should increase and import demand should fall. But most of our exports do not respond to a fall in prices. Many key imports too are price inelastic. The recent fall should have made aviation more expensive, the demand for aviation should have dropped. When that is not happening then the free market laws of supply and demand are not working and then the govt is quite right to consider intervening.
What you say may be unfair to one segment of the society… for instance, the consumers of civil aviation, higher education…
More people are flying now, and people are also traveling by train. Rail travelers are not causing a current account deficit, aviation travelers are… I need to take this factor explicitly into account when I frame my macroeconomic policies. The incremental demand for petrol is coming at the margin from increased sales of four-wheelers and two-wheelers, and civil aviation, not from sales of cycles. So, if I intervene nationally to lower taxes on petroleum, then there will be no demand fall and the CAD will worsen. So if you say I will hurt somebody, then I need to see the evidence. But I am not against states taking decisions to reduce taxes on petrol based on specific circumstances.
To penalize another segment of people, does it make sense?
It’s not a matter of penalty or reward. People who are rich should consume less of something when prices go up, at least in the same proportion. If that is not happening, then I do not see a case for intervention because the opportunity cost of intervention in these circumstances is greater than the benefit to those segments of such intervention. The opportunity cost of lower taxes on petrol now is to further increase petroleum demand. So, consumers must walk the talk. If it’s hurting you, how come I see you are not consuming less. Elasticity of demand for petroleum products is -0.24, that means for every 1 rupee rise in prices, the consumption falls by just 24 paise.
Speculators story is not convincing… Confusing signals from govt and RBI.
I disagree. There is complete consensus as of this time that the interest rate will not be used as an instrument to manage short-term depreciation in rupee, but would be used only for inflation control. No dissonance on this. Fiscal rectitude will be maintained, FM has said it himself. So the finance ministry is doing its job. The RBI’s job is to manage volatility. The rupee has not been volatile, so the RBI has done its job. The RBI has said that as long as fiscal discipline is maintained, the will keep the monetary policy as market friendly as possible. Neither has suggested a mixing up of instruments.
So there is complementarity in policy stance
If the rupee has depreciated or in the band, why worry about speculators?
I worry about speculators. We need to be vigilant about them. In this case, they have been thwarted. They have either understood that the risks of speculation are large, and are not engaged, or they have engaged and got burnt.
There were market expectations, FCNR B or separate window? Was this something that the govt felt was not needed at this time, or not wise to do?
What the govt did was to signal its readiness to look at a variety of measures. The time has come, in the age of Trump, and given our structural CAD, to look at import substitution more seriously… the govt did not announce any quantitative restrictions, or even tariffs. It did indicate that the analytical window is open. So, should circumstances arise, the government can take suitable action.
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