My column for "Wealth Insight" for July 2013. It was a follow up on the earlier theme.
Rupee weakness continues
In July, a desperate RBI allowed asset financing non-banking
financial companies (NBFC’s) to raise external commercial borrowings (ECB’s)
under the automatic route for financing import of infrastructure equipment.
This comes as part of a series of moves by the government and the RBI to raise
foreign resources. The rupee continues to remain under pressure.
Earlier moves to “allow” investments in Indian debt have
boomeranged. Starting in Jan 2013, India increased the limit for foreigners seeking
to invest in government debt in India. Instead, by the end of June, foreigners
had withdrawn $1.2bn from Indian debt in the calendar year. Most of the outflow
happened in June. The rupee fall was collateral damage, but once it started, it
added to the panic and the outflow. The government has blamed the current
account deficit for the falling rupee, but is that the whole story?
A look at the theory
A country’s current account is defined by the following
equation:
Current account = (private savings – Investments) + (Tax –
Government expenditure)
If the government runs a fiscal deficit i.e it spends more
than it earns as taxes, it has to be financed either by a fall in investments
(for a given level of national income/savings) or, the country will run a
current account deficit(CAD). In other words, domestic consumption has to be
financed by foreign inflows. This in itself is not a problem. Countries like
the USA and Australia have managed persistent CAD’s without negatively
impacting growth rates, or pressuring their currency. India too has had many
years of CAD without the rupee depreciating. Of course, these years had
increased inflows from invisibles or investments.
Fiscal deficit too is not always bad. In fact for developing
countries running below full employment of resources, it can be argued that the
government can increase growth rate by running a deficit. Indeed, it must. In
effect, an economy operating below potential will benefit from government spend
and foreign investment. India has for long run these twin deficits. So why are the
policy makers acting as if they have been caught unawares?
Perfect vision –
imperfect solution
In 2010, the ministry of commerce put out a strategy plan
and a paper. The paper was titled “Strategy for doubling exports in the next
three years”. In it, the ministry, assumed that near term trend growth of
exports and imports would continue. Based on this, it forecast that India would
have a negative merchandise trade balance of $210bn by 2013. This has proved
remarkably accurate (the actual figure is $196bn).
Interestingly, the paper also identified areas where India
would have to improve to increase its exports – necessary to avoid pressure on
its currency. To quote “Infrastructure bottlenecks remain the single most
important constraint for achieving accelerated growth of Indian exports”. Specifically, it identified a shortage in
port capacity of 600 Million MT, 4400kms of 6 lane and 66000 km of 4 lane
highways, 750 million tons of cargo handling capacity by the Railways. The
other areas noted for improvement were bilateral trade agreements, lowering of
transaction costs by simplifying compliance and regulatory requirements, and a
stable policy environment.
Anyone following the developments in the economy over the
last few years would be aware of the lack of forward movement on most of these
identified problems. In fact, significant problems have since been created, among
them the uncertainty of application of tax laws to foreign investment
transactions. The end result is seriously eroded investor confidence and
investment climate. It is noteworthy that the likely pressure on the rupee was
identified as a problem over 3 years ago, and the current blame attributed to
the US Fed action is only perhaps a trigger for the inevitable. The real
problem is high CAD and a decline in invisibles.
Trade Deficit worsens
while invisibles decline
Government focussed
on “foreign money”
Of late, it is rare to hear any pronouncements from the
finance ministry without it being focussed on foreign direct investment (FDI).
Ignoring the findings of the commerce ministry outlined above, North Block
continues to believe that all that is needed to remove the pressure on the
rupee is to raise FDI limits across various sectors. This appears a “solution” reflective of a mindset
of a “command” economy. With India’s “growth story” seemingly in the past –
“permission” to invest is no longer the constraint for international investors
– “reason” to invest is!
Even this “liberalization” comes with micro controls. Having
risked becoming a minority government by pushing FDI in single brand retail,
the government has managed to ensure that there is not a single credible
proposal for investment on the table.
Among the most difficult to understand requirements in this case, is
that foreigners cannot invest in an existing venture. If allowed, the local
entrepreneur would release capital - which would have the same effect as
foreign investment in fresh capacity. For some, money is not fungible. Perhaps
“our” money is not as green!
Lack of consistency
in policy and a persistent “central micro planning” mindset will ensure that
the economy performs below par. Undue focus on financial markets while
completely ignoring the problems of the real economy is not likely to make India
an investment destination of choice. The faster our government understands this,
the better for our unemployed millions.
