Until a few weeks ago, the government insisted that it was not overly concerned about the fall in value of the rupee, the worst performing Asian currency at a time when all emerging markets are facing the heat. Economic Affairs Secretary Subhash Garg even claimed, last month, that the rupee – which has hit lifetime lows of Rs 72 to a dollar – could fall to Rs 80 without it being a “serious thing.” Despite these reassurances, on Friday, Garg said that the government will do “everything to ensure that the rupee does not slide to unreasonable levels.”
The government announced a series of measures to check both the fall in the rupee and the subsequent widening of the current account deficit, which is the difference between the value of exports and the value of imports. The moves, such as diluting requirements for dollar hedging on infrastructure bonds, exempting withholding tax for “masala”, rupee-denominated bonds sold abroad and removing limits on investment that can enter India, are all aimed at reducing pressure on the rupee and attracting more dollars to the country.
Additionally, Finance Minister Arun Jaitley promised a review of “non-essential imports” and considering policy measures that would boost exports. These are directly aimed at preventing the current account deficit, which is already at its widest in five years, from growing any further.
There is nothing like a crisis to evaluate the government’s policy and temperament.
The current situation is nowhere close to as dire as the one that India dealt with in the aftermath of the economic crash a decade ago. Yet the reaction to it tells us plenty about a government that had the fortune of tremendously favourable oil prices through much of its tenure, with the effect of keeping inflation and the deficit well in check in those years. Suddenly, less than a year before elections are due, the government is facing an economic and reputational headache that could do great damage to both the country and the Bharatiya Janata Party’s political prospects if handled badly.
So, what has the government chosen to do? Some of its measures are an attempt to attract more dollars into India, or at the very least bring them in earlier than they might have been expected, while also reducing pressure on the rupee. Trying to make masala bonds more attractive by exempting them from withholding taxes and removing some limits on foreign investment will not really alter the deficit in the long run, but it might change sentiments for now.
However, analysts, and the markets on Monday, didn’t seem to think so. The rupee continued to weaken on the first full day of trade after the announcements, with the Sensex also dropping. “Given the build-up of expectations into the weekend meeting (with some talk of non-resident Indian bonds and rate hikes not being ruled out), the policy response will likely disappoint market expectations”, Nomura Research said in a note to its investors.
Build the wall
Other moves, such as promising a curtailing of “non-essential imports” amount to the erecting of walls around the economy. Despite Prime Minister Narendra Modi’s attack on protectionism at the start of the year, his government’s budget this year brought back the import substitution approach from the 1960s and 1970s, earning criticism from even some ardent supporters, like economist Arvind Panagariya.
Using the same tactic to prevent currency from leaving the country, and prevent the current account deficit from growing larger, has prompted similar criticism. Take Swarajya’s R Jagannathan: “It is irrational to pretend that import curbs and export boosters will solve the problem; import curbs will only disrupt businesses that are currently in revival mode, and could also indirectly impact exports negatively.”
Sanjeev Ahluwalia, an advisor at the Observer Research Foundation, made a similar argument: “The measures announced to reduce the underlying CAD (Current Account Deficit) were very regressive and paltry. Consider – controlling unnecessary imports – what is that? High end German, British and Japanese cars – but what about the linked exports? Aircraft fuel? Gucci handbags? Are we seriously keen to slip back so casually into the ‘license raj’ again?”
Going into the festive season, when Indians usually loosen the purse-strings and buy much more, the promise of import curbs has left a number of industries shaken. Expectations of higher gold import duties also serve as a reminder of the Congress-led United Progressive Alliance years when the government would keep trying to limit gold buying, only to see smuggling rise instead. And of course, many of these measures that are supposed to act as a salve in the short-term could end up leaving India more vulnerable over time.
Underlying all of this are a series of failures from the government. It is true that India’s macroeconomic fundamentals are much better today than they were in 2013, the last time the rupee caused panic. Much of that is due to smarter policies from the Reserve Bank of India, and the windfall that came from low oil prices. But the fundamental reason for India to have a current account deficit in the first place has not been addressed – the fact that the country imports nearly all of its energy needs and has not yet been able to broaden or deepen its export base. Make in India has not worked.
And so the government is forced into stop-gap moves. Easing up capital controls here, raising barriers against movement of currency there, all the while attempting to juggle panic in the markets while also weathering political attacks on the weakened rupee and high oil prices. From insisting nothing has gone wrong to stepping in, little coordination with the Reserve Bank of India and, of course, the wider failure that this crisis represents, the last few weeks have spoken volumes about the performance of Modi’s bumbling economic team. It is almost disturbing to imagine what might have happened if the government had not had remarkably favourable oil prices for most of its tenure.