Chuck Prince’s statement that “we have to keep dancing till the music stops” should figure on any list of famous last words. Mr Prince was the chairman and CEO of Citibank when he said this. The “music” was the market in mortgage-backed securities, and it collapsed just a few days after his statement. Mr Prince was sacked and Citibank needed a government bailout to survive. Some of the other “dancers” were wiser: J P Morgan stopped going long in these securities towards the end of 2006; Goldman Sachs went a step further and started shorting the securities by buying credit default swaps, even as it was structuring and selling more mortgage-backed securities to other players.
Looking at the stock and currency markets in India, one wonders when the music will stop. Our policy makers seem to be continuing their benign neglect of the exchange rate even as it reaches highest-ever levels. In his speech at the High-level Conference on The International Monetary System jointly organised by the Swiss National Bank and the International Monetary Fund in Zurich on May 11, the RBI governor said: “Last fiscal (2009/10), the rupee appreciated by 13 per cent in nominal terms but by as much as 19 per cent in real terms because of the inflation differential.” Considering the changes in the exchange rate and the domestic price level since then, the rupee has appreciated 25 per cent in real terms against the dollar over the last 18 months.
No wonder the current account deficit, conventionally calculated (i.e. considering remittances as current account receipts) as a percentage of GDP, has gone up from 1 per cent in 2006-07 to 2.5 per cent of GDP in 2009-10. (Incidentally, the figure 2.5 per cent used in the governor’s speech seems questionable. The actual amount was $38.4 billion.) Data released last Thursday show that the deficit has tripled from $4.5 billion in the first quarter of 2009-10 to $13.7 billion in that of 2010-11. At this rate, it could cross 4 per cent of GDP in the current financial year. Our policy makers seem to be willing to keep dancing so long as financing the deficit is not a problem.
I have used the expression “as conventionally calculated” to describe the current account number. Conventional accounting fails to give a “true and fair” picture of the competitiveness of our economy. Though classified as receipts under “invisibles”, remittances are not “earnings” of the domestic economy. For economic analysis, they need to be considered capital transfers, albeit of an irreversible nature; they are a means of financing the gap between our current external earnings and expenditure. This gap was of the order of $90 billion last year, and may cross $100 billion in the current year. Its easy financeability through remittances and capital flows should not blind us to its implications for output and jobs.
In fact, it seems our policy makers are still looking at the current account from a balance of payments perspective. If so, it is high time this changed. Compared to a reasonable balance between current earnings and expenditure, we are currently missing out an output of Rs 4,50,000 crore (equivalent to the gap between external earnings and expenditure). Wages constitute about 30 per cent of GDP. The output loss then translates into lost wages of Rs 1,50,000 crore — far larger than UPA’s much trumpeted MGNREGS! Another way of looking at the number is that it represents a loss of a crore of reasonably paying jobs. Can we afford such reckless neglect of job creation in the external sector (whether in exports or in domestic industry competing with imports) when the extreme left keeps gaining strength every year, in district after district, and the need for employment creation should be the paramount objective of policy makers?
Is the number of potential jobs resulting from a reasonable balance between current income and expenditure fanciful? Not really. In the debate in the US Congress on the Bill authorising the imposition of up to 20 per cent duties on Chinese imports, the argument for it is that it would create a million jobs. If a million jobs can be created by the devaluation of the dollar against the yuan alone, which is what the 20 per cent duty amounts to, despite the huge gap in wages between the US and China, my estimate of the potential additional jobs in the tradeables sector hardly seems unrealistic. What is needed is an exchange rate aimed at the domestic economy being reasonably competitive globally.
Who are the biggest gainers from the not-so-benign neglect of the exchange rate? The FIIs and the Chinese exporters: our bilateral trade deficit with China alone could well come to around $40 billion in the current year. It is high time we managed our exchange rate in the interest of optimising growth, jobs and consumption, rather than being carried away by the efficiency and sanctity of markets, the possible immediate impact on stock prices and so on.