CHALLENGES IN INDIAN ECONOMY: DYNAMICS OF CURRENCY FLUCTATIONS AND

CURRENT ACCOUNT DEFICITS

PRANAB BANERJIPROFESSOR, INDIAN INSTITUTE OF

PUBLIC ADMINSITRATION

CURRENT UNCERTAINITY

• Is the current economic situation bleak enough for comparison with 1990-91?

• Between 2003-08, Indian economy grew at 8-10 percent, prompting prognostications of India’s emergence as an economic super power.

• From ‘India Unbound’ to ‘The Caged Phoenix’.

GROWTH TRENDS

• World Recession 2008 onwards.• India maintains high growth upto 2011.• Huge stimulus package (`1.86 trillion).• Monetary easing (Mo:21.5percent 2010-11).• Growth rates fall from 9.3 percent (2010-11)

to about 5 percent (2012-13).• Declining trend possible current fiscal

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014Q10

2

4

6

8

10

12

4.3

5.5

4

8.1

7

9.5 9.69.3

6.7

8.6

9.3

6.2

5

4.4

GDP gr rate

GDP gr rate

SECTORAL GROWTH

• Recent slowdown across sectors• Industrial slowdown• Even services sector shows decline: an

unprecedented development?• Decline in Domestic Saving Rate (from approx

37 in 2007-08 to 31 percent in 2011-12).

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014Q1

6.5

2.7

7.1

7.9

1010.7

12.7

10.3

4.7

9.59.9

3.5

2.1

0.20.3

5.5

-4.9

8.2

1.1

4.6 4.6

5.5

0.4

1.5

7.7

3.6

1.9

2.7

Sectoral Gr RatesIND AGR

1 2 3 4 1 2 3 4 12011-12 2012-13 2013-14

0

1

2

3

4

5

6

7

8

9

10

services

services

STIMULUS PHASE

• Growth rates maintained, but a cost.• Fiscal Deficit 2008-09: Actual double of target

(3%) 2009-10:6.5 percent.• M3 growth 2007-09: about 20%/yr.• Export Growth: 29, 13.6 and -3.5 (2007-10).• Current A/c Balance: -1.3, -2.3 and -2.8 (2007-

10).• Inflation (CPI): 6.2, 9.1 and 12.4 (2007-10).

THEREAFTER

• Fiscal Deficit: 5.7 and 5 (2011-13) (Lower than budget estimate)

• Central Govt expenditure: 15.8 percent of GDP (2009-10) to 13.1 percent (2012-13).

• M3 growth rates: 15.6 and 11.2 (2011-13).• Mo growth rates: 21.5 (2010-11) to 4.3 (Q3

growth 2012-13).• GDP growth rates: 6.2 and 5 percent.

1 2 3 4 5 60

5

10

15

20

25

M3Gross Fiscal Deficit

EMERGING PARADOXES

• Despite Demand Compression, current account deficit widens.

• In 2011-12 exports also grow by 21.3 percent, growth slows to 6.2 percent, yet CAD is -4.2 percent.

• Rises to -4.8 percent and the Trade Balance crosses 10 percent (2011-13).

• Inflation persists: 8.4 and 10 (2011-13).

1 2 3 4 5 6 7 8 9 10 11 12-2.7

3.4 6.314.1

-2.5-9.9 -9.6

-15.7

-27.9-38.2

-45.9

-78.2

-12.5 -11.6 -10.7 -13.7

-33.7

-51.9-61.8

-91.5

-119.5 -118.2

-130.6

-183.8-191

DEFICITSCurrent account$b Trade balance

1 2 3 4 5 6 7 8 9 10 11 12 13

-6

-5

-4

-3

-2

-1

0

1

2

3

Current account%

Current account%

POLICY PARADOX

• In 2012-13, all elements constituting aggregate demand slackened.

• PFCE growth halved: 8 percent to 4.1 percent.• Exports growth: 21.3 (2011-12) to -4.9 (2012-13).• Gross Fixed Capital Formation: 4.4 to 1.7 percent growth

during the years.• Government Final Consumption Expenditure: 8.6 to 3.9• When Aggregate Demand was slackening why was policy

not counter-cyclical?• Revenue Receipts Stagnant: effect accentuates.

MANAGING CAD

• Stagnancy in capital account inflows• After a peak in 2007-08 of $ 106.6b, inflows reduced

to $ 7.2 b the next year.• Thereafter, it crossed $ 60b since 2010-11.• Reserve have fallen from peak $ 305b (2010-11) to $

296 b (Dec. 2012), $ 275b (Sept. 2013).• Sustainable CAD- 2.3% GDP (Rangarajan & Mishra).

Assumes Net Capital Inflows $ 50-70b annually over next 5 yrs.

• Should be reduced to -2 percent ( R & M)

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-20

-10

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10

20

30

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50

FDIFPILOANS

THANK YOU !

Exchange Rate

• Sharp Rupee (vs $) depreciation: ` 44.2 (July, 2011), ` 55.8 (July, 2012) ` 68 (Aug. 2013).

• NEER depreciation less.• REER depreciation even less, if at all.• Volatility has sharply increased.• RBI monetary policy occasionally secondary to

exchange-rate policy.

EXCHANGE RATE POLICY EFFECTIVENESS

• Indi’s Exchange Rate Policy: Reduced Volatility and checking REER appreciation.

• Limits to the policy: sharp nominal exchange rate fluctuations, inflation, persistent and increasing CAD.

• Responsiveness of Exports to Exchange Rate:(-) 0.66 (Aziz & Chenoy 2012, insignificant)(-) 0.2 (L), -0.1 (s) (IMF, 2012).(-) 0.5 (Rangarajan & Patra 2013, insignificant)

• Responsiveness of Imports to Exchange Rate:0.47 (Datta, 2004)0.1 for net POL imports, insignificant for non-POL (RBI, 2012)

-contd-

-contd-

• “Estimates…show that changes in both overall trade balance as also in the non-oil trade balance are statistically insignificant to REER movements”. (RBI, 2012).

REASONS FOR PERSISTENT CAD

• Forty percent of imports: Energy & Fertilizers• Over ten percent: Gold & Silver• POL & Fertilizers import bill together almost equal

the trade deficit.• Price elasticity of imports low.• Exchange rate pass through imperfect.• According to Moody’s, fuel subsidies ` 1.6 lakh crore

(2012-13) or 60 percent of revenue account deficit.• Gold as safe inflation-hedge.