India - Sky is not falling yet but urgent steps needed

Rajiv Kumar

The wolf is at the door. I had written in January that decoupling is a myth. Painfully, we are learning the truth that actions far away, like the El Nino, which happens because the waters of the South Pacific get warmer, affect us here in India. Some urgent actions are therefore called for to restore market confidence and prevent investment sentiments from turning sour.
The first step the economic policy managers must take is to restore their credibility which as we know was the highest any team could ever hope to have. To achieve this they have to forthrightly reject the dangerous goldilocks CMIE story of GDP growth being 9.4 per cent this year and a roughly similar level next year. They would do well to say how a short and shallow cyclical downturn is the best we can hope for and that they are focusing now on reforms to raise the potential growth rate to above its current level of 8.5 per cent.
Second, they should use the pile of foreign exchange reserves that has been accumulated to intervene in the market and put harder brakes on slowing down the rupee’s slide. I have always favoured a relatively weak currency as it keeps the price of labour relatively cheap and thus helps labour embodied manufactured or service exports. But the current slide in the rupee is beginning to seriously affect market sentiment and investors confidence and is nullifying the gains from softening of oil prices and so action is needed to stop this steep decline. Very often signals are important and this will be one of them.
Third, while I have not looked at the numbers, clearly a faster unwinding of the MSS facility is perhaps called for to introduce greater liquidity in the market.
Fourth, a concomitant condition to facilitate liquidity expansion is for the RBI to meet with the financial sector CEO on a daily basis and identify the causes for the liquidity crunch and ensure with their help that overnight rates are prevented from shooting up unexpectedly. This step will minimise surprises, improve anticipation and show to the markets that RBI has its hand firmly on the rudder.
Fifth, following the Chinese and south African central banks lead, the authorities can signal that the circumstances require a higher threshold for inflation and in any case with global commodity prices and oil prices on a southward trend, the pressures are gone and we can expect more benign inflationary situation in the months to come. This will prevent outcries from misguided ‘inflation targeters’ against expanding liquidity.
Sixth, the government should direct the DIPP to come out with inflation numbers once a month henceforth. I am hoping this will not violate any constitutional or statutory provisions.
Seventh, and last, the government must announce as it did in the case of scotching the negative market rumours against ICICI that all bank deposits or other financial savings in the provident fund, insurance policies etc are safe and guaranteed. I know these are protected but the last thing we need at this stage is for depositors to get cold feet and start a run even on a small private bank somewhere. Make this announcement and let those who talk of costs of moral hazard etc. discuss this with the US Treasury Secretary who has shown us the way!
Some structural factors make us less vulnerable to the turmoil in global financial markets. First, our banking sector is only marginally integrated with global flows and financial exclusion is so widespread that the real economy will not be disastrously affected. It will be affected by weakening external demand but that will happen with a lag. Second, in sharp contrast to China, net exports contribute a negative 10.5 per cent to our current GDP growth, domestic investment (57 per cent) and consumption (53 per cent). This makes us less vulnerable.
Finally, the private economy in India including the infamous parallel economy remains hugely surplus. Starting from unaccounted payments for real estate to gold purchases and consumption of services, this will buoy up domestic demand. So the sky is not falling down yet. Policy makers need to highlight these and take cognisance of these and other India-specific factors. An ‘Indian strategy’ for achieving growth with macro stability has to be crafted by putting heads together from the government industry and the academia.
The author is Director & Chief Executive, ICRIER