By Ian Fraser
Ben Bernanke is a convenient bogeyman for India’s unfolding economic woes. On May 22 this year, the 59-year-old Federal Reserve chairman unnerved global investors by suggesting that, if appropriate, the quantitative easing program that has helped prop up the US economy since early 2009 would be scaled back from next month. Bernanke’s “taper” talk, based on the premise that QE may have done the trick for the US, drove many investors to reassess their portfolios and withdraw funds from emerging markets.
The worst-affected currency has been the Indian rupee. As investors pulled “hot money” out of the subcontinent, the cracks in its economic model fell into sharp relief, specifically its dependence flighty international capital to fund its widening current account deficit. The rupee has shed 25% of its value since January, hitting record lows of 69 rupees to the US dollar on Wednesday, August 29.
This is driving up the cost of imports, including oil and other commodities, but has failed to trigger any concomitant surge in exports. Economic growth has slowed to 4–5%, down from 9.6% in 2010-11. The fall in the value of the rupee has wrongfooted the country’s bullion dealers, triggering an unprecedented discrepancy between the price of gold sold in local Indian markets and that traded on commodity futures exchanges like MCX. The current account deficit is widening, reaching 4.8% of GDP in the year to March, nearly double the 2.5% the Reserve Bank of India (RBI) sees as a sustainable level. This prompted Standard & Poor’s to warn that, as a large deficit country, India faces a rocky road.
Amid fears of a possible conflagration in Syria, the country’s S&P BSE Sensex stock market index plunged to 17,996.15 on August 29, though it rebounded to 18,401 the next day as the prospect of war subsided (the index seems volatile — it sank to 8,160.40 in March 2009 but soared to 21,004.96 in November 2010). Foreign investors dumped Indian stocks and bonds worth $3 billion in July alone.
Even though this equalled just 1.2% of foreign investors’ net holdings, there are fears of a more severe sell-off. The yield on India’s ten-year benchmark bond yields briefly rose above 9% on August 29, and inflation climbed to 5.79% in July. Some commentators, including the Guardian’s Larry Elliott, believe the situation is so dire, Delhi may be forced to call on the International Monetary Fund for a bailout.
India’s policymakers have been scrabbling around for ways of averting a currency crisis. Measures they have introduced so far include the blocking of the trading of currency swaps, restrictions on gold and silver imports, and demanding evidence from foreign investors that they’re not speculating on the rupee’s value. And on August 14, India tightened capital controls for locals, causing foreign investors to fear their funds would be frozen too. The Indian parliament’s approval of a $20 billion plan to provide cheap grain to the poor was seen as “unwelcome” by most overseas investors. Japanese brokerage Nomura said: “We see the bill as inflationary, because it creates a demand-supply mismatch, requires raising minimum support prices to encourage production, could create a shortage of non-grain food items and reduces the marketable surplus for the private sector.” An announcement from India’s finance minister, Palaniappan Chidambaram, that $28.4 billion of infrastructure investment got largely drowned out because of investors’ alarm over a possible balance of payments crisis, according to Reuters.
But who is really to blame? The Wall Street Journal’s Abheek Bhattacharya says: “India can only blame the Fed so much. It holds most of the answers to its troubles.” Jayati Ghosh, economics professor at Jawaharlal Nehru University in New Delhi, and an adviser to the Delhi government, agrees. In an interview with Spiegel, English Ghosh said most of India’s wounds are self-inflicted and the result of poor economic decision-making from successive governments:
“Our much vaunted economic boom was essentially a debt-driven consumption spree, financed by short-term capital inflows. Those who profited were mostly construction companies and the real estate sector. India's boom was also peculiar in that it did not generate any new jobs, but instead deepened the gap between rich and poor.”
She believes the country is now in a far more precarious position than China:
“[Unlike in China] a third of Indians still don’t have electricity. We fight against the legacy of a caste system which condones inequality and discrimination. India’s elites put up with conditions which are extremely damaging … The problem is the nature of our democracy, which developed on the basis of a strictly hierarchical society.”
Ghosh also chided Indian policymakers for their naïve assumption that the country could leapfrog industrialization and jump straight from an agrarian to a service-based economy. “Even now, the IT sector only employs around 2.5 million people in our country — compared to a working population of almost 500 million.” Those who see laissez-faire capitalism as the cure to all India's economic ills, such as The Economist, argue that India would benefit from fully opening its borders to multinational firms and fully liberalising the economy. But Ghosh argued that providing unfettered access to the likes of Wal-Mart and IKEA would spell disaster:
“These measures only destroy jobs. Everybody knows that retail multinationals employ much fewer people per product and per turnover than the small shops that dominate in India. Instead, we have to invest in the basics, in infrastructure: a road to every village. Water, electricity and housing for everyone. Access to bank credit for everyone—not just for rich entrepreneurs. We have to concentrate on things that create jobs. Then India’s economy will grow on its own.”
Ghosh warned that, unless India quickly introduces the necessary reforms, it faces “political and social chaos on a mass scale, and an increase in violence against women... we are sitting on a ticking time bomb.”
Given the country’s current predicament, there is no shortage of advice for Raghuram Rajan, the former professor of finance at Chicago University’s Booth School of Business who warned of the global financial crisis in August 2005, and who takes over as RBI governor on September 5. Some believe Rajan needs to dramatically hike Indian interest rates. And writing in Quartz, Matt Phillips says Rajan should play hardball with the currency speculators and do everything in his power to defend the currency’s value (Phillips outlined several measures the RBI could take, including a “diaspora bond”).
However, The Economist cautions against heavy-handed intervention. The magazine says Rajan should let the rupee find its own level. It argues Rajan should focus on controlling inflation, not on micromanaging what is one of the world’s most-traded currencies.