Finance Minister Palaniappan Chidambaram’s press conference on 22 August, even as the rupee hit new lows, went on rather expected lines. The minister called for calm, went along with some research reports which said the rupee was undervalued, and promised to stick to his target of bringing down the current account deficit (CAD) to $70 billion by FY14.
But more importantly, he said two things which merit scrutiny. He said most emerging markets were witnessing forex volatility, and the rupee volatility needed to be viewed in that context. Besides, he said the Indian economy was facing challenging times owing to a global slowdown and some domestic factors. The minister also advised the markets against ‘excessive pessimism.’
Given the enormity of the problems the Indian economy is facing currently, it would seem a bit like missing the woods for the trees. Given the limited success the actions of the government and the Reserve Bank of India (RBI) have seen in their attempts to stop the continuing slide in the rupee, the writing on the wall for the Congress-led United Progressive Alliance (UPA) government and its economic think-tank would be to get back to the drawing board – despite the limited time in hand – and focus on the causes which have brought the economy to this state in the first place.
Falling growth, low investment activity and turmoil in the foreign exchange markets thanks to a high CAD make a dangerous cocktail for an economy. View that in the context of a government seriously hamstrung by corruption, scams and an Opposition growing in confidence by the day and the picture turns even more bleak.
Is this an excessively pessimistic scenario, the kind Chidambaram has advised us against? Probably not.
A close look at RBI’s latest document, its Annual Report for 2012-13, makes it clear what Chidambaram and his North Block colleagues are actually up against.
“Over the past two years, although part of the slowdown has been driven by cyclical factors, structural constraints have played a major role in the slowdown. Mining activity was impacted adversely by governance factors. The slack in manufacturing activity was largely due to poor investment on the back of structural issues facing the infrastructure sector. In addition, global factors played an important role in the current growth slowdown,” RBI says.
Fortunately for Chidambaram, RBI does give him credit for some of the steps taken, particularly on the fiscal consolidation front after his 2013 Budget. But the central bank says a recovery, in these times, must be ‘earned.’
“…Recovery has to be earned in this difficult economic environment through concerted action. The economy is currently cruising in slow-speed mode along a rough road. Strategically, it is necessary to first patch the rough spots by putting in place a set of complementary policies to address the structural constraints,” RBI says in the Annual Report.
The immediate objective must be to maintain stability without compromising growth further, and for that RBI advises that macroeconomic and monetary policy must be carefully calibrated. The emerging macroeconomic scenario for the year 2013-14, it says, is challenging amid the wide CAD, risks to fiscal targets, persistence of high consumer price inflation, risk of exchange rate depreciation feeding into inflation, slowing growth and deteriorating asset quality.
In other words, the crashing rupee is just a symptom of a much larger malaise afflicting the economy and merely resorting to the kind of ‘plumbing’ which has been undertaken won’t work.
According to the central bank, a recovery is possible and can take shape later in 2013-14, “but is predicated on better governance, the removal of supply constraints and maintenance of stability.”
With Indian industrialists openly saying they would prefer to invest overseas rather than in India, the task of galvanising domestic private sector investments seems more difficult than ever. A recent report in The Economist also analyses in detail why business has begun leaving India. Providing several telling examples of how various segments of Indian business – from manufacturing to even e-commerce – is moving offshore, the report says ‘coercing’ Indians and foreigners to do business in India would be self-defeating. “Any rise in the share of offshore activity is best viewed as a warning system about what is most in need of reform at home,” the report says.
Growth slowdown to a substantial extent has been the result of investment downturn. Investment climate for the private corporate sector remained weak in 2012-13, RBI adds in its report.
“Simple institutional reforms such as better regulation of natural resources, improved harnessing of water resources, investing more in skill formation, digitalising land records, land consolidation, better integration of regional agricultural markets, freer labour markets and more competitive domestic markets can go a long way in improving India’s potential as well as actual growth. As such, efforts in the direction of macroeconomic stability and structural reforms can pave the way for the recovery,” the central bank says.
It’s clearly time for the UPA and its finance minister to walk the talk. Announcements are one thing, execution quite another. The falling rupee is not the problem; it is a wake up call that unless the government acts swiftly, the other vital parameters of a gasping economy may follow the currency in its southward journey. That, Mr Finance Minister, is not excessive pessimism.