FDI: Shooting in the dark, while economy takes a nosedive

Presumably, the officialdom is pleased with the vote in Parliament on Foreign Direct Investment (FDI) in the retail sector.

The vote puts a stamp of legitimacy on the decision. Manmohan Singh’s government, displaying considerable firmness and determination, picked up the gauntlet thrown at it over the issue and has emerged victorious. Or so it seems. The outcome may be a political victory for the ruling establishment, but it hardly resolves – indeed aggravates – the issue about the medium and long term consequences of India’s dependence on capital inflows to meet trade and current account deficits.

The debate on FDI in retail has been centered around its potential impact on small and medium (SME) industries, which are usually family-owned and have traditionally dominated the sector.

This is no doubt an important issue. Another important, but largely neglected, dimension is about the macroeconomic philosophy underlying the FDI decision, especially considering the grit with which it was pushed by the UPA government. It is about the level of responsibility that informs policymaking and the choice made by New Delhi to promote continued reliance on capital inflows to fund current account deficits and unsustainable spending habits.

As I have been pointing out, the last 20 years of economic reform and globalisation have not made any meaningful difference to the external balances of India. Deficits in the trade account have continued and the government has been able to fund this through capital inflows – both direct investments and investments in the stock market.

Encouraging capital inflows into the country has been the cornerstone of government economic policy during the globalisation era. Little attention has been given either to making optimal use of the inflows or for promoting stability and sustainability in India’s engagement with the international economy, through efforts to bridge widening deficits in trade and current accounts.

With liberalised imports, private consumption and global business interests have acted together to favour unrestrained imports of petroleum, gold, automobile, and luxury goods, with little concern about how the dollars needed to pay for these imports would be generated.

According to latest reports, India’s trade deficit for the third quarter of 2012 increased to a record of over $ 49billion. Capital inflows have helped New Delhi avoid the kind of balance of payments crisis seen in 1991. Indeed, it is reported that Sonia Gandhi’s support for the FDI in retail was secured by warning her that a repeat of 1991 was inevitable if the decision was not implemented. This appears to be a fine example of dissembling.

While India has not seen a serious foreign exchange crisis after 1991, it is equally true that the rupee has lost value since then – and done so on an enormous scale. The exchange rate was Rs 17.50 for a US dollar in 1990, the year before the payment crisis.

Over the last 22 years, it has lost value thrice over and the rate is now in the Rs 54-55 range. With import bills burgeoning, the falling rupee breeds serious inflationary trends in the domestic economy. Recent policies offer a limited choice between episodic balance of payments crises and a steady decline in the value of the rupee.

Political instrument

BJP chose to treat the recent vote on FDI as a purely political instrument to weaken the Congress, if not topple the government. It did not raise the macroeconomic aspect of FDI in retail or the larger issues of the health and sustainability of India’s external balances.

The lone reference to use of FDI for deficit-funding has come from Sitaram Yechuri of CPM. It is doubtful if the prime minister or the Congress party will respond to the charge made by Yechuri.

Fiscal deficits, which lead to increased supply of rupees, are another factor that drives down rupee’s value in the international currency market. In the domestic economy, the increased money supply leads to inflation.

Fiscal deficits are in bad shape as well, with runaway increases in deficits and no serious effort to curb them. C Rangarajan, a member of PM’s Council of Economic Advisers, recently expressed concerns about rising deficits and this has since been followed up by the prime minister himself.

Regrettably, both Rangarajan and Manmohan Singh spoke like outsiders having no power to act. If at all something is to be done about fiscal imbalances, it is the PM and his advisers who must act. It does not help if they merely speak about it.

Macroeconomic stability apart, fiscal deficits also increase the financial powers of the government, that is a major factor in the other malady afflicting India – namely, corruption. To some extent, Manmohan’s focus on GDP growth ties his hands. Higher deficits lead to higher expenditure and this count for more GDP in the questionable economic framework Manmohan espouses. The result is an understandable reluctance to control the deficit.

Policy and decision makers are aware of the precarious foreign exchange situation and the vulnerability of rupee’s exchange rate. K C Chakraborty, deputy governor of Reserve Bank of India, recently questioned how the rupee can be strong or stable when fiscal and external deficits continue to rise. Such remarks apart, there is no evidence of action to correct the imbalances.

Equally regrettably, there is little public awareness or debate on the weaknesses in India’s economic fundamentals. With elections fast approaching, Congress is apparently staying the course by talking up the growth story and resorting to dubious practices like direct cash transfer to improve its chances.

There are no signs of willingness to face the challenges confronting India. It is not clear how far capital inflows can continue to support India living beyond its means.

(The writer is an assistant professor of Common Law at University of Ottawa, Canada)

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