I had concluded last week’s column by quoting the following two statements from the Governor’s remarks in his intervention in the Monetary and Financial Committee of the International Monetary Fund (IMF), and promised to return to the subject:
- Global rebalancing will require deficit economies to save more and consume less, while depending more on external demand relative to domestic demand for sustaining growth.
- That not resorting to currency interventions as an instrument of trade policy should be central to a coordinated approach at a multilateral level.
The first one exhorts deficit countries to consume less and save more. However reasonable the advice is for the rich countries in deficit, particularly the US, is it equally relevant for India? Actually, India’s savings rate has gone up sharply in the last two decades, from 21.1 per cent of GDP in 1991-92 to 34.7 per cent of GDP in 2009-10. Is there much room for increasing savings in what is still a poor country? (I will come back to the savings/investment imbalance.)
This brings us to the second part of the statement, namely depending more on external demand for growth. Shorn of jargon, this means promoting exports. What exactly does the statement mean for an economy like India? Much of the external demand for its output is for relatively labour-intensive manufactures of “non-differentiated” goods bought primarily on prices (India does not, at least as of now, make too many high-technology, branded goods). Also, World Trade Organisation (WTO) rules bar member countries from giving export subsidies. So what is the way left for a greater reliance on external demand for growth? Logically, there is only one answer — an exchange rate that makes the exports more competitive. Even “believers” in the virtues of free capital mobility and a market-determined exchange rate have, perhaps inadvertently, confessed the relationship between the exchange rate and the tradeable sector. To quote from the article “Did the Indian capital controls work as a tool of macroeconomic policy?” by Ila Patnaik and Ajay Shah, “the economy was able to benefit from this 32.8 per cent increase in the prices of tradables (in 2008-09) which helped sustain the economy in the global crisis.” (Incidentally, this is the only reference to the real economy in the paper that refers to the “stock” market or prices nine times.) The “believers” rarely, even inadvertently, concede that the contrary is equally true, that the tradeables sector suffers with (real) appreciation of the exchange rate. This dichotomy in thinking is equally seen at the global level, where China’s surpluses are supposed to be the result of its exchange rate policy, but the US’, or India’s, deficits are not the result of their exchange rate policy or the lack of it!
Against this background, it is difficult to justify the second statement quoted above, in favour of market-determined exchange rates. One wonders of course whether, on this issue, we are more anxious to be on the “right side” of the US in the G20 debate on global imbalances, without giving adequate weight to what should be the prime objectives of our macroeconomic policies. These can be summarised as “growth, jobs and reduced inequalities”. Can these be achieved by following Anglo-Saxon models giving primacy to the financial economy over the real economy? Incidentally, during this period, the average growth rate of the US has fallen from 3.09 per cent a year between 1945 and 1980 to 2.68 per cent a year between 1981 and 2010, and income inequalities have widened sharply. Even this fall underestimates the much slower growth of the real economy over the last 30 years compared to the previous 35 years because in the last three decades, the financial sector has grown much faster than the real economy, and has consequently accounted for an increasing proportion of GDP. Do we need to be so anxious to forget our priorities to please an aging superpower whose economy is in a mess, where the majority party in the lower house of Congress is constrained by the agenda of the Tea Party, which would like nothing better than to wind the clock back to the 19th century era of laissez-faire capitalism? (In fact, the so-called Ryan Plan to correct the fiscal deficit would achieve exactly this.) Do we have a penchant for adopting policies that implode soon — Russian socialism in 1960s and 1970s and finance capitalism now?
Instead of learning from the policies of the world’s fastest growing economy of the last 30 years, if not in global economic history, our objective seems to be to spite it on exchange rates, on the issue of the yuan in the SDR basket and so on. One example is that, as reported by The Economic Times, April 29, “India will support only an easily and freely convertible currency for inclusion in the International Monetary Fund’s special drawing rights, or SDRs.” The virtues or otherwise of full convertibility apart, we have obviously forgotten that when the SDR basket was introduced in 1973, no currency in it, other than the US dollar, was fully convertible. Even the mighty German mark was protected against undue appreciation by controls on capital inflows.
