The Reserve Bank of India is such a reliable institution. It is not stupid like much of the Central government; but it generally hides its intelligence well. It often has a message to convey; but it buries it effectively in piles of figures. It often takes a view that is independent of the government’s, but obfuscates it to conceal the differences.
So I was quite surprised to see its self-discipline coming under strain. The story develops over the last four quarters; but it will suffice to quote from the bank’s latest monetary policy statement. This is what it said: “The trade balance deteriorated despite the depreciation of the rupee in the quarter, due to the inelastic nature of some of India’s imports, as well as a slowdown in exports that reflected global uncertainty. The full year CAD for 2011-12 is likely to be substantial. Going forward, the CAD may still remain under pressure if import of oil and gold does not significantly moderate. Robust gold demand and continuing high crude oil prices, along with decelerating growth in EDEs may adversely affect India’s trade balance. A cautious approach with regard to trade and capital accounts is, therefore, required. Subdued global trends also adversely affected capital inflows to India in Q3, in line with the trend witnessed in some other EDEs. Even though capital inflows improved in Q4 of 2011-12, the continuation of the trend hinges on the pace of global and domestic economic recovery as well as policy reform initiatives. Risks to capital inflows exist from both global growth slowing down significantly as well as US growth rebounding substantially.”
Now, let me translate this into English. The excess of imports over exports increased even though the bank has been devaluing the rupee like mad to improve the balance of trade. That is because some imports such as those of oil do not go down with rupee depreciation; the government makes its oil companies subsidize them, so the price effect of devaluation is neutralized. And Indians continue to buy gold although its price has been shooting through the roof; these crazy guys are immune to economic policy. Growth of exports is also falling because our customers are feeling jittery about the future course of the world economy. Imports of goods and services in 2011-12 will be in enormous excess of exports; this payments deficit will continue to be high unless growth in imports of oil and gold slow down. Growth is also slowing down in poor economies that are our major customers; that will hurt our exports. So the prospects for India’s balance of payments are dim, so we favour measures to reduce imports and hinder investment abroad by Indian businesses. Investors in industrial countries are feeling insecure, so their investments in India came down in October-December 2011, together with their investments in other less developed countries. The investment flows revived in January-March 2012, but whether they continue to be substantial will depend on whether growth at home and abroad goes up as well as on whether the Indian government abandons such idiocies like the ban on foreign direct investment in retail. If growth slows down across the world, investment coming into India will fall. But it will also fall if the United States of America begins to grow faster and attract larger capital inflows.
That is where the RBI stops, but we can ask the question that worries it: if the balance of payments continues to be adverse, what is the worst we can expect? The payments deficit was $38 billion in 2009-10 and $46 billion in 2010-11; last year it must have been about $50-60 billion. If capital flows were to fall to zero, the reserves, which were $254 billion in the middle of last April, would finance the payments deficit for 4-5 years. But a paranoiac can always find something to worry about. The RBI might look at external debt, which was $335 billion at the end of 2011, and worry about all the creditors rushing to take their money out; it would then run out of foreign exchange and would have to go to the International Monetary Fund, cap in hand. The IMF would be delighted to have India borrow, though the RBI might consider it a shame. But even that fear is unfounded. Half of the debt is external commercial borrowings and deposits of non-resident Indians. The ECBs would get liquidated when importers pay for their imports, and NRIs will convert most of their deposits into rupees eventually. And as for foreign equity, its exit value will be much less than current value if foreign investors try to repatriate their investment. So the RBI’s worries are exaggerated.
What worries the RBI is not just the balance of payments, but the state of the economy — the inflation and the falling growth rate. The situation is uncannily similar to what it was in 1991, except for two things. First, as I said, the RBI has $254 billion in foreign exchange today, against $1.1 billion in 1991. And second, the government’s errors then were so big that the correction of just a few — the fiscal deficit, industrial licensing, import licensing, and the confiscatory taxes — was enough to turn the economy around. Today too, the errors are equally egregious, but they require a bit more research and reflection. But economic talent was a bit thin on the ground then; Rakesh Mohan and I were the only decent economists in the government, whereas today, economists are crawling all over the place. They should be able to work out solutions; it is not too difficult.
For instance, let me take the problem I have discussed above: the balance of payments. If I look at imports, I am struck by the following possibilities. We are importing a lot of palm oil from Malaysia; we could cut down its imports by producing more soyabean oil. We are importing a lot of fertilizer. Holland is prepared to send us millions of tons of cowdung free; all we have to do is to unload it and deliver it to farmers. Oil constitutes more than a quarter of our imports. After the oil crisis in the 1970s, we tried all kinds of substitutes; we could start by mixing 10-20 per cent vegetable oil, which is what Brazil has been doing for decades. And it would be easy to produce alloys that look like gold; if the government got out of its penchant for punishment and started promoting standardized gold substitutes, millions of poor Indians would substitute them for gold. We have lots of sun; all we need to do is to spread around solar panels. Solar power would need a subsidy, but less than what state governments are giving conventional electricity already.
Import substitution costs money; but it is called for by our current circumstances, and if we go about it economically, we can get a good return on the subsidy. All it needs is application of some economics; with the battalions of economists the government employs, it should be able to apply dollops of economics to our problems. Maybe the battalions need a few generals; but with a field marshal at the top, that should pose no problem.