JOIN USThe update to the World Economic Outlook by the International Monetary Fund (IMF) presents a dismal picture with global output expected to be lower in 2013, than originally expected in forecasts made last April.
The projected underperformance is mainly because of lower growth in emerging markets, continuation of a recession in the eurozone area, and a slower US expansion. The eurozone area continues to suffer from low demand, depressed confidence, financial market fragmentation, weak balance sheets, and fiscal consolidation. In emerging markets, weaker prospects reflect infrastructure bottlenecks and other capacity constraints, lower export growth, lower commodity prices, financial stability concerns, and, in some cases, weak monetary policy support.
The growth estimates for majority of advanced, emerging and developing countries, including India, have been scaled down. A few exceptions are Canada, Japan, Spain, and the UK. Amongst Brazil, Russia, India, China and South Africa (BRICS), growth rate in India will be higher than most others, but lower than that of China, the only solace being the narrowing margin between the two countries.
In the global economy, while old risks have not dissipated, new ones have emerged. The volatility in markets due to hints of unwinding of the unanticipated monetary easing policy, increase in interest rates in advanced countries and asset price volatility have hit emerging markets hard. In addition, weakness in domestic activity led to capital outflows, equity price declines, rising local yields, and currency depreciation in emerging markets.
If volatility persists, emerging markets are expected to suffer more setbacks. The IMF has advised all countries to make efforts to address these challenges and restore growth.
On the external front, global trade volumes are not very encouraging for India. Imports by advanced countries are expected to record a negative growth of 0.8 per cent in 2013 while exports by emerging countries are expected to decline by 0.5 per cent. And herein lies a challenge for India – to maintain its export market share despite the shrinking pie.
The overall situation for Indian economy is rather grim and careful navigation is needed. The economy has already slowed down substantially, investments are low and interest rates are high.
In addition, the domestic currency has been depreciating rather rapidly for which many in the markets were not prepared, and hence seeking the Reserve Bank of India (RBI) intervention to restore the rupee in the range of Rs 54-56 vis-a-vis the US dollar. This level is difficult to justify by economic logic.
In determining the exchange rate, inflation differential between the two countries is an important factor in the long run. Illustratively, average annual inflation rate in India has been 6.0 per cent during 1993-94 to 2011-12 compared with 2.4 per cent in the US over the similar period. The average exchange rate of the rupee against the US dollar was Rs.31.4 in 1994 and adjusting for the inflation differential of 3.6 per cent per annum would require an adjustment of the rupee. Economic logic, like, the law of gravity, cannot be defied.
The RBI would unnecessarily be sinking the country’s hard-earned foreign exchange reserves to stabilize the rupee at a level where it does not belong. Further, the import cover of foreign exchange reserves is already low and should be preserved especially when short-term external debt is high.
While the RBI is attempting to contain ‘so-called’ volatility in exchange rates, the correction was long overdue and should be allowed to carry through, at least now, though it is a late adjustment of yesteryears. Who knows, how much of exports India has already lost, because of an appreciated exchange rate? Also, in sharp contrast to strategic ‘beggar-thy-neighbour’ policies pursued by our neighbours, should India always pursue ‘enrich-thy-neighbour’ policy by maintaining an appreciated exchange rate?
The depreciating value of currency should not hinder the RBI in considering the easing of monetary policy, as these are two different issues. The exchange rate is finding its natural long-term but delayed balance, as argued above, while lower interest rates would encourage investment, employment and growth.
A booming economy, and not artificially high interest rates, attract foreign direct investment. And in uncertain times, India does not need to attract fair-weather friends – foreign portfolio investment - by insisting on high interest rates, detrimental to domestic growth. In this period of crisis, when growth rates are slowing, the IMF is advising countries to undertake structural and other reforms to restore growth.
This advice seems rather difficult to implement as the areas identified for such reforms are wide ranging. Also, as the fiscal space is highly constrained now than was in 2008, policy makers would find the challenge rather daunting. The IMF under Madame Lagarde, could probably, lead a joint effort, as it did under Strauss-Kahn in 2008 to ease the pain.
(The author is Reserve Bank of India Chair Professor at Indian Institute of Management, Bangalore. Views expressed here are personal)