ON SATURDAY morning August 17th India’s top policymakers gathered at a rather obscure event—the launch of an official history of the Reserve Bank of India (RBI), held in a room in the prime minister’s house in Delhi. Present were Manmohan Singh, the prime minister, and the past, present and future bosses of the central bank, among others. The day before there’d been a rout of India’s financial markets, as we described in a previous post. Here’s what I picked up at the event.
First, reality has bitten. There is a mood of distress, if not panic. This is a good thing. The economy faces “very difficult circumstances,” admits Mr Singh. While he and many of the others present held senior jobs during the previous balance-of-payments crisis, in 1990 and 1991, they have spent the past two years giving sugar-coated predictions even as the economy has slowed. Now though no one is disputing the fact that India is in trouble. Duvvuri Subbarao, the outgoing boss of the RBI, drummed in the message. “Does history repeat itself,” he asked, “as if we learn nothing from one crisis to another?”
Second, it is widely accepted that the capital controls announced on August 14th have backfired. The new rules limit the ability of Indian individuals and firms to take money out of the country and were put in place after clear signs of capital flight. However the changes have spooked foreign investors who worry that India might freeze their funds, too. The finance ministry has already tried to calm nerves. Although it probably won’t reverse the measures, the RBI is considering making it much clearer that more capital controls are not on the agenda. That would be helpful; people trust the bank more than the government.
Third, Raghuram Rajan, the incoming governor of the RBI, will assert himself sooner than expected and change the central bank’s tactics. On Friday, as markets tanked, he was in Singapore fulfilling an academic commitment that had been organised long before. He is due to take over formally on September 5th but he will be in Mumbai, where the RBI is headquartered, this week. He will try to end the impression of nervous hyperactivity that has built up in the past month. He will put his prestige on the line by trying to give a consistent and calming message to the markets: “We will not have a new policy every day.”
The rationale behind this new approach is as follows. The RBI’s existing measures might be enough to stabilise the rupee. (They include intervening in the money markets to jack up short-term interest rates, as well as the capital controls). Adjusted for higher productivity growth and higher inflation than the rest of the world, the rupee is theoretically worth, perhaps, somewhere between 55 and 60 to the dollar. So the market has already overshot a bit, offering more than 61 rupees per dollar at the weekend. And there are signs that exports are recovering, thanks to the devaluation and the recovery in the rich world. Exports grew by12% in July. India’s IT service companies, which generate foreign sales of about 4% of GDP, are expected to see an up-tick in business. A decisive improvement in the trade balance would make a world of difference.
Fourth, as the RBI calms down, the government will be expected to go into overdrive to narrow the trade deficit by fiat. By raising administered prices on imported fuel, demand could be contained. This will not be politically popular. Lower fuel subsidies will have the added benefit, though, of helping Palaniappan Chidambaram, the finance minister, hit his fiscal targets. The government will also try to end a blanket ban on iron-ore exports, which was imposed by the Supreme Court after a series of corruption scams. I’m sceptical this will work. Can the judges really be told what to do? I’ve just spoken to an expert who spent a week in July touring the mining belt in the states of Goa and Karnataka. His view is that it will take ages for the industry to crank production back up to its peak, when it was exporting ores worth $10 billion a year or so. Still, the central government will try.
Fifth, everyone wants to crack down further on gold imports—but is scared. India’s gold addiction is a nightmare; exclude gross bullion shipments into India and the reported current account deficit of 4.8% in the year to March 2013 would have been a far more manageable 2%. Accepted wisdom is that if you tighten the official rules, gold will still get into the country via smuggling, as was the case in the 1980s and early 1990s. But India’s demand for imported bullion has doubled since then, to 850 tonnes a year. It takes a lot of ingots hidden in suitcases to smuggle in that much. Taxes on gold imports have already been raised but there may be scope to raise them even further.
Sixth, the authorities are still missing a trick by ruling out the recapitalisation of India’s banks as a measure to restore confidence. Public-sector lenders that dominate the banking industry now have dodgy loans of 10-12% of the total. Almost 20% of infrastructure loans are in trouble. K.C. Chakrabarty, a deputy governor of the RBI, argues that most banks are state-backed and thus not at risk of failing. But they are viewed as radioactive zombies by investors and their rotten balance-sheets mean they are unable to lend, which might kick-start a recovery. America used its stress tests to force banks to get their houses in orderand to restore confidence in 2009. India should consider something similar. The tricky part is that the cost of recapitalising the banks might have to be borne by the government, which is already straining.
India has few good options, but the emerging plan could work. A big test will be whether the political leadership, which faces elections by May 2014, gets behind it. The urban middle class will be hurt most by the present crisis, but they are not the ones who decide elections in mainly rural India. Still, the wobbly economy may now become a bigger theme in the election campaign. That might focus minds and make it easier for the government to argue that its tough decisions are being made in the national interest.