As the RBI released the data on India’s external front for 2012-13 last week, one was reminded of the 1991 financial crisis. And these figures reveal what we have been suspecting all along — we are in a gargantuan financial crisis – one that makes the crisis of 1991 a mere walk in the park. But that does not worry me for we never had a robust external sector since independence.
What is galling is that this time around the Government is in denial mode. The PM, FM, the deputy Chairman Planning Commission and a host of advisors to the PM and finance ministry who responded to these data in the media are either oblivious of the implications are simply lying through their teeth. Either way let us brace for a disaster. Let me elaborate.
In 2012-2013 India ran a current account deficit (total imports less exports) aggregating to $88 billion. To fund this deficit we necessarily needed capital inflows. Mercifully, we had a capital flow of approximately $46 billion and debt and other flows aggregating to $45 billion in 2012-2013. But this is how we have been carrying on for the past several years – mortgaging or selling the family silver to pay the grocer.
Borrowings, as readers may be well aware, comes at a cost as well as with terms and conditions. India’s external debt, as at end-March 2013, was $390 billion showing an increase of $45 billion during 2012-13. What is worse – this increase in external debt was primarily on account of rise in short-term trade credit.
But the cumulative position of all these short term debt (i.e. those repayable within a year) aggregated to $172 billion as at March 31, 2013. This works out to approximately 60 per cent of India’s Forex Reserve as at March 31, 2013. Put pithily, India has to ready itself to repay this huge amount by March 2014. In the alternative we need to find alternative sources to finance this massive amount. Obviously, in these troubled times globally, this is not going to be easy.
On top of this we are likely to run a current account deficit of approximately $100-120 billion for 2013-14. Along with the possible repayment of short term debt of $172 billion, India desperately requires capital flows of approximately $300 Billions by March 2014 to take care of its external sector.
Let me put the matter in proper perspective. India has a Forex reserve of less than $300 billion as on March 31, 2013. International lenders know this for sure. Equally, they are well aware that should the demand on dollars mount, the Rupee will crack. And that explains why the Rupee is already depreciating by the minute.
All round failure
The Net International Investment Position i.e. international financial liabilities of non-residents exceeded the international financial assets liabilities held by residents by $307 billion as at March end, 2013. The corresponding figure for June 30, 2012 was $225 Billion. This implies a rise of $82 billion in a matter of a mere nine months.
While the Government seems to gloat over the fall in the current account deficit to 3.6 per cent of GDP in the fourth quarter from 6.7 per cent of GDP in the third quarter, the fact remains that the CAD for 2012-13 stood at a whopping 4.8 per cent of the GDP. If global history of the past decade or two is any indication, countries with far bigger economy and even with lower CAD than India have invariably faced an external sector.
What is worrying analysts is that on every count our external sector has recorded precipitous decline. The ratio of external debt to GDP in 2013 was 21 per cent. This compares to a similar position way back only in 2002. The ratio of foreign exchange to total debt stood at 75 per cent in 2013. In 2003 this was 73 per cent. Similarly, the ratio of short-term debt to foreign exchange reserves at 33 per cent compared unfavourably with 23 per cent of 1996.
At the root of our extant crisis is a gargantuan trade deficit (imports less exports of goods only) of $195 billion in 2012-13. This comes on top of $190 billion in 2011-12. We are importing goods far in excess of what we can actually afford. And should we fail to carry on such huge import, the Government fears that inflation could possibly soar.
There is yet another dimension — employment. The recent data released by the National Sample Survey Office [NSSO] on the basis of its 68th round of survey, brings about interesting trends in employment in India. In contrast to sixty – yes sixty — million jobs created in the five-year-period of the National Democratic Alliance rule, the job creation by UPA in its first term was a mere million.
This fact needs to be juxtaposed into our CAD conundrum. Whether high imports are leading to high unemployment? Or is it that we have collapsed our indigenous manufacturing and hence such imports? One is not sure whether imports have lead to the loss in job opportunities or whether closure of domestic manufacturing has lead to a surge in imports.
Whatever be it, one can be certain that there is a neat correlation between the myopic economic policies of the UPA and the precarious state of economic affairs of the country.
What needs to be done?
Added to this is the fetish towards stock markets by the economic managers of the UPA. And to keep the stock market going, the Government has been conjuring reasons to cut interest rates even as higher inflation prevailed within the economy.
An inflation rate of 9 per cent and a deposit rate of 7 per cent are surely unsustainable. This mispricing of interest rate, as experiences of last two years demonstrated, invariably shifted our precious savings to gold. That in turn widened the CAD to unsustainable levels.
SS Tarapore in an article titled “Let the Rupee Slide, and Fast” (The Hindu BusinessLine – June 13, 2013) captured this policy failure of the UPA when he comments: “With the Indian policy of lower and lower interest rates and a widening of the gap between savings and investments, the balance of payments current account deficit (CAD) rose to 5 per cent of GDP. Added to this, the Rupee was kept relatively strong.”
5% economic growth is clearly disappointing: PM
In short, in the Indian context, a lower interest rate regime and a relatively stronger Rupee are an economic impossibility given the prevailing levels of inflation.
Further, blaming it on our exchange rate policy he added: “The exchange rate is clearly unsustainable, given the high CAD and relatively high inflation rate. It is an article of faith that capital inflows will continue uninterrupted, that inflation will come down and that the large CAD will shrink.”
In conclusion, he points out to India running the risk of a disequilibrium trap — a possibility of a 5 per cent growth, a 10 per cent consumer price inflation and a 5 per cent CAD — a situation which would, in his opinion explode sooner than later.
It is in this connection that Tarapore opines the Indian Rupee at 58-59 to a Dollar is significantly overvalued. As a solution, he calls for a quick, decisive and planned depreciation — possibly devaluation — of the Indian Rupee to about 70 to a dollar. Implicit in this argument is that the pressure built through a decade long mismanagement of the Indian economy needs to be released.
Let us also not forget that potential foreign investors are well aware of the impending depreciation if not planned devaluation of the Indian Rupee. If there is no compulsion, they may well wait to bring in their money at an appropriate time. Why should they bring in their Dollar now when Rs 70 is eminently possible?
On the other hand, with each passing day, given the state of our economy existing foreign investors would seek to get out, resulting in a stampede. And this could dynamite the Rupee.
Let me hasten to add that one may not entirely agree with the suggestions of Tarapore for his remedy could be far worse than the disease for Indian economy in 2013 is not the economy of 1991.
His prescriptions could in turn necessitate fuel price increase leading to an inflation spiral. Further, his idea that we must increase our interest rates to drive our precious savings to proper domestic use could well make us a high-cost uncompetitive economy, unfit for global competition.
Damned if we devalue; doomed if we don’t. But frankly that is what UPA has done to the Indian economy.
Ironically, it was Manmohan Singh who carried out devaluation of the Rupee in 1991 to set right the economic mess created since independence. Strange as it may sound, the next Government may possibly have to decide on ways to clean the mess created by Singh Administration. Devaluation is one of them.
Devalue or not, the PM looks to be an economic disaster and his FM seems to be a sidekick.
(The author is a Chennai-based chartered accountant. He can be contacted at firstname.lastname@example.org)