Are Khullar’s warnings coming true?

When the Finance Ministry burps, be it ever so softly, everyone takes notice. When other ministries yell themselves hoarse, no one gives a damn.

If anyone, it is the PMO that is to be blamed for this state of affairs. Not just the current one but all its predecessors too. Successive PMOs have been so busy playing politics that they have tended to neglect all other issues until it is too late.

This trend was set by Indira Gandhi. With some minor tweaks, her modus operandi — of making the PMO an instrument of politics rather than governance — has become the template for her successors.

Result: Crises build up and burst with monotonous regularity. Not just economic crises but all sorts of other crises — in foreign policy and domestic policy.

You can make your own list. It will be long, very long.

The crisis that is building up now and could burst by the end of this year is in respect of India’s balance of payments. As during 1988-90, the PMO cannot say it was not warned.

The warning came two years ago in February 2011 in the Commerce Ministry's dire analysis called “Strategy Paper for Doubling Exports in the Next Three Years”. It went unsung into the night. But it can be found at http://commerce.nic.in/WhatsNew

/StrategyPaper.pdf.

It had been put together by one of the finest economists in the Government, Rahul Khullar, who was the Commerce Secretary then. Khullar had identified all the things that the other ministries must do.

He had even explained it all to the PM who agreed fully. But this office did nothing because it was busy with politics and foreign policy.

The warning

The Report had pointed out, very presciently that: “...the proportion of merchandise trade to GDP is expected to increase from close to 35 per cent to nearly 48 per cent in 2013-14.... However, the BOT deficit is projected to increase from 7.2 per cent of GDP in 2010-11 to nearly 13 per cent of GDP in 2013-14.

“There is no hard and fast rule to determine the numerical size of a sustainable Balance of Trade (BoT) deficit. For economies with large remittance earnings and positive net services earnings plus large invisible flows, even a 10 per cent deficit on the merchandise account can be managed.

“Equally, however, economies with lower invisible earnings, including net services and smaller remittances may not be in a position to even sustain a 5 per cent BoT deficit. The real point is that sustainability is best gauged with respect to the Current Account Deficit (CAD).

“The projected BoT deficit on merchandise account of 13 per cent is clearly cause for serious concern because it can lead to an unsustainable CAD. Services earnings will most certainly grow over the next few years. However, it is unlikely that even their growth can sustain a ballooning of the BoT deficit to the size of 13 per cent of GDP.”

It made some sector-specific recommendations for increasing exports. For the most part, they were ignored, most importantly by the Finance Ministry.

Two years on, the Finance Mministry is trembling in its boots that India will run into a balance of payments crisis by the end of this year. The current account deficit (CAD) is around 5 per cent of GDP and exports are simply not growing fast enough. The global credit rating agencies have taken note. They are quietly warning global investors to be cautious.

The price of neglect

Except for the Reserve Bank of India (RBI) which is under no illusions, everyone else thinks that since the foreign exchange reserves are high, they will be enough to stave off a crisis, should it come. But it is only the RBI which knows how quickly these could melt. That’s why its Governor has ruled out any further cuts in interest rates. FICCI, CII and Assocham may grate on and on about the need to cut rates but do they understand that any increase in aggregate demand will lead to higher imports which, if unsupported by enough exports, will result in a payments crisis?

The Finance Ministry knows this. That’s why it is straining hard to offset the warnings put out by credit rating agencies. It is trying hard to shore up capital inflows.

It is the old story being replayed: If you can’t earn and spend, borrow and spend. Strong capital inflows — not FDI but FII money — are our only hope in 2013. The Budget will therefore hand out many lollipops to foreign lenders.

But look at the irony. The rupee could appreciate as a result of large dollar inflows and exports become even more uncompetitive. Not just that. A cheaper dollar could increase imports leading to an even more pressing need for even higher capital inflows.

In short, there is trouble ahead. That’s an important reason why businessmen should batten their hatches and wait for the gathering storm clouds to pass.

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