Friday, August 23, 2013

What is ailing Indian economy and financial markets? – Part II

Current account deficit

Our policy makers, regulators, economic commentators and analysts have all expressed their grave concerns over the swelling current account deficit (CAD) of India. However, we have not seen any concrete steps to address the roots of the problem.

Theoretically, CAD arising from trade deficit is never a risk in itself. The excess of imports over exports essentially means that our economy is doing better than the other economies who import from us. The equilibrium is achieved through currency and interest rate adjustment. Currency depreciation should normally lead to demand for imported goods falling and exports becoming more competitive and hence bringing trade account to balance. Higher interest rates should attract more inflows, contain inflation, encourage savings and eventually lead to current account balance.

The CAD is concern if you do not allow market forces to operate freely, for socio-political concerns.
Substantial rise in social sector spending over past decade has led to unprecedented rise in consumption demand from lower socio-economic strata. Domestic supply has however not been able match the demand. Burgeoning middle class has also been demanding more phones, computers, luxury automobiles, textile, food etc. not produced locally, besides increasing the spend on leisure foreign travel. Young demography and rising aspirations have led to ever rising demand for global education and training as we have failed in constructing enough global standard institutions. These trends are not likely to change substantially even if our economic growth persists at current low levels.

The structure of our exports has changed in past decade in favor of engineering products and services from predominantly consumer goods earlier; meaning our exports are now highly correlated to global growth, which is not likely to improve substantially in near future.

This structural weakness in trade composition necessitates higher capital inflows so that at least balance of payment could be maintained; meaning we have to maintain our interest rates at relatively elevated level so as to attract higher foreign capital; meaning domestic investment will continue to suffer and supply constraints will persist for longer period.

Only serious structural reforms that attract significant foreign equity capital and other resources to augment domestic supply could resolve this conundrum. The current political structure does not seem to be conducive for such reforms.

Higher interest rate, larger convertibility for INR and unhindered FDI is inevitable, unless we choose to become a closed economy again. A large majority of our businesses are absolutely unprepared for this eventuality. So are our politicians who would not like to lose control over economy.

Consequently, notwithstanding small 2-4year period of exuberance in between, longer term structural imbalances should continue to prevail and so do CAD and weaker INR…..to continue on Monday

Also read:



Thought for the day

“Women and cats will do as they please, and men and dogs should relax and get used to the idea.”
- - Robert A. Heinlein (1907-1988)

Word of the day

Quincunx (n)
An arrangement of five objects in a square or rectangle, one at each corner and one in the middle.
(Source: Dictionary.com)

Shri Nārada Uvāca

Former PM Rajiv Gandhi discovered the huge (85%) leakage in social sector spending 27years ago. The government is claiming that it is making effort to plug it through DBT and touting this claim as big achievement.

Anyone expecting a faster action by government on anything else should relax and watch TV commercials.

No comments:

Post a Comment