The Hindu : The downside of integration

Online edition of India's National Newspaper
Tuesday, Oct 28, 2003

Business

Business

The downside of integration

By Prem Shankar Jha

After three weeks of hectic buying by foreign institutional investors, who have come to India sniffing for a quick kill, it was inevitable that there would be a correction in the Sensex. But the fact that it was small and half was made up on the last day of trading before Diwali shows how strong confidence in the Indian economy is, both inside and outside the country.

But this confidence should not lull the Government into a false sense of complacency. What the buoyant share market is hiding is the extent to which the Indian economy is out of balance and the way in which the growing integration of India into the world economy, mandated by the WTO and other agreements India had signed, is steadily stripping the government of the powers that it needs to take short term corrective action.

The lack of balance is revealed by the balance of payments deficit recorded in the first quarter this year — the first in seven quarters. It has been caused by a fall in export growth to 8.8 per cent in April-August, while imports have soared by 22 per cent. Within this period the impact of the appreciation of the rupee is unmistakable. The growth of exports fell from 12.5 per cent in May to 4.1 per cent in August. Import growth, although much higher, reached a peak in June and slowed down somewhat in July and August, but this is deceptive, for it reflects a slowdown in the growth of oil imports, and a huge fall of 34 per cent in the import of gold and silver, neither of which are price sensitive.

The import of raw materials, components and consumer goods has been skyrocketing by 30 to 40 per cent. Most of this reflects the harvest and industrial recovery that is well under way. But a fair part reflects the 8 per cent appreciation of the rupee and the consequent cheapening of imports.

The external balance is not the only one being affected by the appreciation. The Government's tax revenues are its second victim. So far these have fallen short of the budget's expectations by about Rs. 1,600 crores, mainly because customs revenues have risen by only 7.8 percent (the target was 16 per cent) despite the 30 per cent plus increase in non-oil imports. A part of this is the direct result of the fall in rupee value of imports on which the duty is levied. This, however, is only half of the story. Customs officials under pressue to explain the slow growth have put the blame on a raft of export subsidies that they claim are costing the Exchequer Rs. 16,000 crores. This amounts to 6 per cent of the value of total exports.

After allowing for the need for some targeted tax reliefs designed to capture new markets, this suggests that the rupee was overvalued by about 4 per cent when the budget was framed. The appreciation since then has raised the overvaluation to 8 per cent.

It does not therefore take an economist to see that the rupee needs to be depreciated once more to around 48 to the dollar where it was a year ago. But that is where the downside of liberalisation kicks in.

For with a market determined exchange rate and increasing liberalisation of capital inflows there is now no way in which the Reserve Bank of India can push up the exchange rate. The only tool left in its hands is the interest rate.

Lowering it further could in theory discourage the inflow of money on the capital account. But first these have already been pushed down as far as they can go, and second, this will discourage NRI deposits the most and not the foreign institutional investors who are attracted by the soaring share market.

In short it may reduce inflows but at the cost of making India's reserves more volatile.

The truth is that international capital flows are now acting as a new kind of stabiliser — to keep the poor and punish the well managed NIC (newly industrialised countries) economies for daring to be well managed.

Printer friendly page
Send this article to Friends by E-Mail

Business