Millennium Post

Rajan makes firm moves

Never since the economic crisis of 1991, had India undertaken so many economic policy reforms and moves as initiated in the last one week. The policy moves were an afterthought in the wake of continuously rapid slide in the rupee’s exchange rate. There were fears of losing grip over external
payments and rising import and repayments bills. Some felt we were in for a similar deep crisis as 1991.

Maybe, one can take a look back at the moves and try a quick assessment of what these can achieve and what they cannot. But then, what are these measures and what impact these can have on the rupee and how exactly? A raft of measures was announced as Raghuram Rajan took over the governorship of the Reserve Bank of India. These are leaving an impact on the rupee exchange rate and one can expect that the worst is over for the rupee for the time being. Almost the first move of the Reserve Bank was to partially reverse its earlier decision to restrict outward investments by Indian companies. The RBI had in mid-August brought down the level of outward investment from 400 per cent of net worth of a company to 100 per cent. This created a scare among foreign companies – including FIIs — that if capital controls could be imposed on Indian companies it might be extended to foreign companies as well. That resulted in quick sales and withdrawal which pushed the rupee down. Now the RBI has somewhat restored the outward investment limit, giving the impression that India is not distressed.   

On the other hand to shore up confidence and allow more dollars to flow in, RBI liberalised external commercial borrowing guidelines to permit companies to use foreign currency loans from overseas shareholders to be used for corporate general purposes. That is, excepting on-lending to other group companies, it should be possible now to use borrowings from foreign shareholders to tide over funds requirements. The same day, on 5 September, parliament passed the pensions bill to allow 26 per cent foreign investment in Indian pension funds. The bill further promised that if the foreign investment limit was raised for the insurance sector then the higher limit should be applicable to pension funds was well. This was a critical proposal which was hanging fire for a long time and passage of the bill created a positive vive for India as a global investment destination.

Additionally, governor Rajan gave fresh incentives to banks to bring in more deposits from non-resident Indians. He allowed banks to give their NRI deposits to the RBI and earn a decent interest rate over their costs. This should bring more exchange resources to the central bank. He also permitted banks to raise foreign exchange loans up to 100 per cent of their unimpaired capital. These are liberalisation of rules which should enhance flow of dollars from overseas. However, whether these measures bring immediate flow of funds from overseas or not, these moves gave the impression that the central bank is in the grip of things. It is capable of driving action, rather being driven about by e3vents. These moves had some impact op0n the financial markets, though admittedly some drift was witnessed despite these mainly because at best the policy moves taken were byt and large technical in nature. These were not major breakthroughs. Following these measures, the rupee exchange rate had rolled back to 66 to the dollar level and the volatility level had been somewhat contained. Thus, many who had predicted that the rupee would slide to a level of 70 to a dollar shortly were stalled in the track.

But a move which has been taken subsequently and announced at the close of the day on Friday can have the power to turn the tide. Following their talks on the sidelines of the G20 Summit in St Petersburg, India and Japan declared a currency swap deal of $50 billion, which should give a boost to sentiment about the rupee. Under this scheme, in case either Bank of Japan or RBI faces a crunch in foreign exchange resources, it could borrow from the other to the tune of $50 billion. This is a large enough war chest for the RBI to exigencies and once the market knows that a deep chest is available it will be more cautious about beating down the currency. It will be important to watch the overseas non-deliverable forward contracts in Singapore, Dubai or London how they view the totality of these measures. In the end, with these measures augmenting RBI resources, it can be a little more risky to bet on rupee losing value in future.

Having said that, it must be admitted that these are only short term measures which can help tide over the current crisis. These even in their totality are not a solution to the problem that India is staring at. The solution lies in two permanent improvements. India has got addicted to chronic deficits in its external; payments. The trade deficit last financial year was as large as $191 billion. We were hoping that enough funds should keep flowing from overseas and help us bridge that howling gap. The US quantitative easing had come in handy for funding the trade gap. But the yawning gap was so large that any amount of spill over from QE could not help, let alone when these were set to flow out. Thus, unless the trade deficit is controlled, external volatility would continue to plague India.

Funds flow from overseas would not depend on policy liberalisation alone. A liberalised policy framework is just an enabling provision. Funds would flow only when the real economy functions well. If Indian economy is growing and its own investment rate high, overseas funds could come in. This calls for domestic reforms of the way we do handle business. These are process reforms.
These involve reforms of governance as well. India could not open a single new major greenfield project for years. No new coal mines could add to coal production capacity. No new steel plant to add to steel production. Industrial units could not be opened as land disputes plagued every single proposal. Even infrastructure projects are held up on ground of environmental or other clearances.

These need to be streamlined. It is only when these two inter-linked issues are addressed and settled, India growth story could be resumed. It is only then that we could hope to see flow of investment from overseas. Domestic growth will also lead to avoiding imports for meeting every shortage – be it of coal or gas or ores or manufactured products. IPA

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