This exclusive monthly article series, courtesy of Al Mulla International Exchange Company, is devoted to Indian macroeconomic policies against the backdrop of an increasingly integrated global economy. These articles would be oriented towards addressing the concerns of overseas institutions/individuals with interest in the Indian economy.
This article discusses the need, in India, for a short-term macroeconomic damage containment policy in the first half of 2014, against the backdrop of political uncertainties with the General Elections in the ensuing few months.
Political Economy Backdrop
Since the new government would need to be in place by the third week of May 2014, logistics require that the General Elections be staggered over a period 4-6 weeks prior to that date. The Central Election Commission’s Code of Conduct would prevent the present government from introducing any new major schemes and /or passing of legislative reforms. Thus, the time for any big-ticket reforms is, for all practical purposes, over and major policy/legislative changes would need to await the formation of the new government. It would be imprudent to attempt rushing through major legislative reforms in the ensuing few weeks.
The Goods and Service Tax (GST) reform would require the concurrence of the States, which would be difficult in the present surcharged atmosphere. On the Direct Tax Code, the Standing Committee on Finance has made elaborate suggestions and it would not be possible for the government to fast-track the total overhaul of the present Income Tax Act, which was adopted in the 1960s and has been subject to numerous amendments over the years. The Financial Sector Legislative Reforms Commission (FSLRC) submitted its Report in March 2013.
As Governor Raghuram Rajan has aptly put it, it would be first necessary to work out a consensus on the kind of financial structure desired and only after that can the financial legislative proposals be formulated. The FSLRC has unfortunately put the cart before the horse. There is talk among some top government honchos of immediately implementing the FSLRC recommendations without the necessary legislative changes; this is a contradiction in terms. The upshot of all this is that any meaningful implementation of the FSLRC recommendations would just not be on the cards in the ensuing few months before the new government is formed.
The history of India, in the past 67 years since Independence, has been that while there have been periods of intense political uncertainty, the administrative steel frame of the government together with the regulatory authorities have taken such measures as would keep the economy on an even keel. It is possible that the 2014 General Elections could throw up different political configurations i.e. (i) a single party could form the government, (ii) there could be a coalition with a single large party along with allies and (iii) a third front with predominance of small parties and Regional interests. In any of these formations, what can be assured is that there would, by and large, be responsible economic policies. In the run up to the General Elections there would be media frenzy but this should not be construed to reflect economic instability.
The Sinews of Short-term Macroeconomic Policies (January-June 2014)
The administrative/regulatory authorities would have to undertake a holding operation in the ensuing six months. This does not mean a policy paralysis but of active damage containment macroeconomic management. Some of the key areas are: (i) Control of inflation and monetary policy (ii) Maintaining the growth momentum (iii) Avoidance of fiscal window-dressing (iv) A sustainable balance of payments current account deficit (CAD) and a viable exchange rate policy. These issues are discussed below in some detail.
Inflation and Monetary Policy
The Urjit Patel Committee Report on the Monetary Policy Framework, which is expected to be released shortly, would, hopefully, provide focus on the conduct of monetary policy. The more immediate policy imperative is to bring about a significant and enduring reduction in the inflation rate. While there can be multiple price indicators, for the Common Person what is relevant is the retail Consumer Price Index (CPI).The present year-on-year CPI inflation is 11.2 percent. A year-on-year inflation rate concept has inherent fluctuations; as such what is relevant is a sustained reduction in the inflation rate. While the rate of inflation is important, what is more relevant is the level of inflation.
Monetary policy is admittedly a blunt instrument and could have collateral damage to the growth of the economy; however, as monetary policy is central to the control of inflation, a proactive monetary policy provides a stable price environment which contributes to longer-term growth. The retail inflation is way above the tolerance limit and hence inflation control is of overriding priority at the present time. As Professor Gita Gopinath of Harvard University, a specialist in trade cycles in Emerging Market Economies, said: “If you wanted to kill inflation, it can be done through monetary policy. If you raised interest rates high enough, you will bring down inflation… I cannot think of a single country in the world that has been able to bring down inflation without some pain.”
The choice is between bringing inflation down now, with a certain degree of pain, or delay the adjustment till a future date when the pain would be significantly more intense. The hope that inflation would go away on its own is wishful thinking which can be disastrous for the economy. The monetary policy instruments need to be used aggressively in the ensuing few months to compensate for the constraints on using other instruments of macroeconomic policy. As such, policy interest rates, reserve requirements and other instruments of monetary policy need to be tightened sharply in the ensuing period. There is often reference to monetary policy not being effective when there is food inflation. At the present time the public sector food grains stocks are well above the buffer requirement and there is a shortage of storage space for the rice crop which has just been harvested and keeping rice stocks in open storage results in heavy damage. Dr. Ashok Gulati, the Chairman of the Agricultural Costs and Prices Commission, has advocated that the food grains stocks should be reduced by 20 million tonnes by releases in the domestic market which would lower prices.
Given the multiple constraints faced by the economy, the slowdown in savings, the imperative need to contain the CAD and the inability to use some policy instruments till June 2014, it would be unrealistic to generate aspirations of a sharp revival of growth in 2014-15. A growth rate of 6.0 – 6.5 percent should be considered a good performance. There are, however, influential official voices talking about a growth rate of 7.5 – 8.0 percent in 2014-15. Such expectations are bound to be belied.
Fiscal Deficit: Need to Avoid Window-Dressing
The gross fiscal deficit of the Centre at the end of November was 94 percent of the targeted figure of 4.8 percent of GDP for the full year 2013-14. Since the figure of 4.8 percent has been repeatedly set out as a red line, the fear is that there could be recourse to window-dressing. Illustratively, there could be throw forward of expenditure, booking of next year’s revenue in the current year (e.g. public sector units have been asked to pay advance dividends) and a step up in public sector disinvestment by cross-investments among public sector units. Thus, more than the red line of the deficit is the quality of the fiscal deficit.
CAD in 2013-14
The official projections for the CAD in 2013-14 have swung between despair (3.7 percent of GDP or US $ 70 billion) to euphoria (2.1 percent of GDP or US $ 40 billion). The crucial factor has been the reduction in gold imports through official channels following the raising of the import duty and other administrative curbs. Before the euphoria becomes deeply entrenched in the system it would be useful to assess the quality of the CAD. There is strong anecdotal evidence which points to a quantum jump in illicit imports of gold. The World Gold Council figures on imports into India would differ significantly from the official figures. The illicit imports are paid through lower remittances, over-invoicing of imports and under-invoicing of exports. All this points to curbs on gold imports being ineffective. These curbs should be expeditiously lifted. The least that should be done is that the authorities should not be too euphoric about the reduction of the CAD. All that has happened is that there is a gross under-reporting of the CAD.
Exchange Rate Management in the First Half of 2014
The received doctrine is that the exchange rate is ‘market determined’ and all that the RBI does is to ‘control volatility’. A tracking of forex operations points to the focus of the RBI on an undisclosed range for the nominal US dollar-rupee rate. The authorities appear averse to a depreciation of the rupee while an appreciation is perceived as reflective of good macroeconomic management. It would appear that the authorities are comfortable with a nominal US dollar-rupee peg within a range.
Given the very large inflation rate differential between India and the US, the nominal rupee exchange rate should be depreciating vis-à-vis the US dollar. As such the implicitly desired policy exchange rate is anti-gravity. In the ensuing few months pressure from the US tapering could build up. It is conjectured by some analysts that at every USA Fed meet there could be a tapering of US $ 10 billion. This could trigger some capital outflows from India. Moreover, there could be some adverse blips in the run up to the General Elections. Against these imponderables, any appreciation of the rupee should be squelched by purchases by RBI while depreciation should evoke a passive non-intervention policy by RBI unless there are extremely sharp movements in the exchange rate.
The path of the US dollar-rupee exchange rate during January-June 2014 is unpredictable. To the extent NRIs intend to remit funds to India, they would be well advised to undertake systematic remittances rather than bulk one-time remittances based on mere conjecture of the exchange rate.
Given the democratic Indian traditions that foster debate and dissent and the presence of an over-active media, it is noteworthy that foreign assessment of the future of the Indian economy is far more optimistic than the dissenting voices within the country. Whatever the emerging political configurations after the General Elections, there would be broadly reasonable macroeconomic policies and the free debate and dissent should be considered as a major positive from the viewpoint of foreign investors and NRIs.
-By S.S. Tarapore
Savak Sohrab Tarapore, B.A. (Honours Economics) Sheffield University (1958), MSc.(Economics) London University (1960) and Doctor of Laws honoris causa, Sheffield University (1996) was a career central banker. He joined the Reserve Bank of India in 1961 as a Research Officer in 1961 and retired as Deputy Governor in 1996.During 1971-79 he was seconded to the International Monetary Fund. Since retirement he has chaired a number of official Committees/Boards and he is a regular columnist in financial newspapers.