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Jaitley returns as FM

Jaitley returns

Arun Jaitley has returned to take charge as finance minister well before those who care for him would have advised. So what was the haste all about?

The uncharitable view would be that power abhors a vacuum. Politicians and film stars — no wonder the two often overlap — are most vulnerable to the prolonged loss of public face-time. What is most likely, though, is that he returned to his North Block corner office in order to cement his legacy as finance minister through the last and interim budget for 2019-20 of this government.

Chidambaram’s challenge to Jaitley

Chidambram 20142015 interim budget

This is a courageous move, very similar to his taking up Palaniappan Chidambaram’s implicit challenge in his interim and last budget in 2014-15 — a fiscal deficit target of 4.1 per cent of GDP — steeply reduced from 4.6 per cent in the previous year.

Mr Jaitley manfully accepted this unreal target and achieved it, noting in his budget speech: “One fails only when one stops trying”.

Fiscal stability has improved over Mr Jaitley’s tenure. The ambitious target for the current year is 3.3 per cent of GDP. Achieving this is crucially dependent on reduction in subsidies from two per cent of GDP in 2014-15 to 1.4 per cent this year, and a 0.6 per cent of GDP increase in tax collection (7.3 per cent in 2014-15 to 7.9 per cent in 2018-19).

The pressures for fiscal expansion come from the urgency to recapitalise publicly-owned banks; financing infrastructure via public funds in the absence of any appetite for India risk among foreign developers; the narrow base of unimpaired domestic infra developers and finally the compulsions of electoral politics.

Will Jaitley go for an endgame of Fiscal Deficit at 3 % of GDP

Other than achieving this year’s stretch fiscal deficit target, the finance minister needs to ponder on the target for 2018-19. Will he play the “Chidambaram card” and fix it at 3 per cent of GDP? Mr Chidambaram was pretty sure that he would not have to live within his interim budget. The jury is out on whether Mr Jaitley could reasonably assume a similar privilege. But reducing the fiscal deficit by a full percentage point of GDP below what he inherited would be in line with Mr Jaitley’s flair for challenges.

Chasing the UPA I go-go years of high growth

On growth — a sensitive issue for the BJP — Mr Jaitley has thrown a googly. He claimed recently that in trying to copy UPA-1 and chase high growth, both the banks and industry were destabilised through reckless lending and investment. This is a wise move.

It is unlikely that the growth record of UPA-1 (FY 2004-09) at an annual average of eight per cent plus would be achievable till after 2022. The IMF (August 2018 report) expects GDP growth to pick up over the next two years to 7.7 per cent. The “twin balance sheet problem” is likely to take three to five years to resolve, considering that “legal blustering” is a time-honoured mechanism for delaying a decision.

Public Sector Bank accountability and governance reform is key 

The Reserve Bank of India’s Financial Stability Report of June 2018 estimates that Gross Non-Performing Assets will worsen from 11.6 per cent in March 2018 to 12.2 per cent by March 2019. For the 11 worst-performing publicly-owned banks, the GNPAs will worsen from 21 per cent in March 2018 to 22.3 per cent by March 2019. For the six publicly-owned banks which the RBI has barred from fresh lending, the weighted average capital adequacy ratio will fall below the minimum required of nine per cent of loans.

The government has allocated Rs 2.1 trillion for bank recapitalisation, partly by increasing its own borrowings by 0.8 per cent of GDP. Additional borrowing of 0.5 per cent of GDP will be needed in the next fiscal year. Alternative schemes are being implemented like LIC, a publicly-owned insurance company, buying up the bankrupt IDBI Bank and infusing an additional Rs. 90 billion into it. This is mere fire-fighting. Unless bank lending and corporate governance become more market-friendly and transparent, investment levels will hover around the 30 per cent of GDP level — not enough for eight-plus per cent growth.

8 percent plus plus growth needs massive restructuring

Mr Jaitley’s is a nuanced claim. It implies that the growth during UPA-1 was not sustainable. The associated structural reforms to make the banks autonomous of government control; effective oversight of bank lending by the RBI and seeding economic liberalisation into field-level government regulations — labour laws, freedom from “inspector raj”, land regulation and transparent natural resources allocation, were all kicked down the road for successive governments — including the BJP, to manage.

Self goals are expensive

It is good optics to claim the present is hamstrung by the past misdeeds of others. But the BJP also scored some self-goals, most specifically demonetisation and the less than meticulously-planned implementation of Goods and Services Tax (GST)

Demonetisation was effective but cynical politics, which did not pass the “raj dharma” smell test. The GST snafu can be ascribed to the lack of expert skills or a tactical decision to trade off technical rigour against speed of implementation — a perfectly sensible trade-off in India’s fractious democracy.

India’s achilles heel- Twin deficit

India has a long history of carrying a twin deficit. The Fiscal Deficit, because government spends more than it earns annually and borrows, like the rest of us, who borrow to invest. But unlike most of us, it also borrows to fund consumption because we also run a Revenue Deficit. It is “effectively” small  at 0.7 per cent of GDP but typically we should run a revenue surplus to finance at least 20 per cent of our investment.

Our external account (net inflow and outflow of foreign exchange) is in a deficit. We have a Trade Deficit – imports exceed the export of goods and services.  60 per cent of the Trade Deficit is met from the surplus – ie. net inflow of expatriate remittances and foreign income versus outflow of interest on external debt.

What remains uncovered is the Current Account Deficit (CAD). This is met by net inflows of capital – FDI, portfolio investment and loans. The CAD is expected to increase from 1.9 per cent of GDP last year to 2.6 per cent of GDP this year, primarily because of the higher cost of oil imports. But India’s external debt is a moderate 20 per cent of GDP – of this short term external debt is just 9 per  cent, so both refinancing and debt servicing risks are manageable. And the fears of attracting American sanctions by buying oil from Iran have also receded.

The Indian Rupee is freed from its misplaced burden of being an icon of “National Strength”

A gradual rationalisation of the rupee exchange rate since January 2018 have made exports competitive and provide the required protection for domestic production from predatory imports feeding on an overvalued Rupee. The Reserve Bank of India, with its mandate for managing inflation, has kept domestic base interest rates competitive in tandem with trends in “safe havens” to manage the flight of foreign capital. The IMF estimates that the net inflows of foreign investment and portfolio capital increased from $28 billion in 2014-15 to $48 billion last year and anticipate $70 billion this year.

 

Burning his fingers once, while explicitly chasing growth, should not convert the finance minister into a growth wallflower. Rapid economic growth remains fundamental for equity. The trick is to use the lens of sustainable equity while laying our economic foundations. Growth will follow.

Adapted from the authors Opinion Piece in The Asian Age, August 30, 2018 http://www.asianage.com/opinion/columnists/300818/jaitley-returns-as-fm-to-cement-his-legacy.html

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