‘Rupee depreciation need not be fought at all times’

Formalisation involves bringing the informal units into the tax net and the regulatory net and this is definitely desirable. We don’t have reliable data on whether the pace has accelerated but it is a desirable structural change. However, we have to recognise that the process can be disruptive. Many units that thrive in the informal sector do so because they escape regulation — labour safety regulations, health regulations and also pollution control and of course taxes. If they are forced to comply fully, they will become uncompetitive and be squeezed out by those who can comply.

I can envisage the following type of structural change. Some units that are in the informal sector will definitely upgrade themselves to become formal and they should be helped to do so. These units, including some already in the formal sector, will expand and squeeze out other informal sector units that are unable to upgrade themselves. In fact, formalisation involves a cost and to be able to bear that cost you have to expand. This means there will be fewer units but of larger size. Some enterprises that were informal will get squeezed out. This is the bit that can be disruptive in the short run. In the medium term the economy will adjust.

I think formalisation is the way to go and that is positive. But we must also remember that if the livelihood of some people is affected we must do whatever we can to ease the pain of transition. They will have to find other ways of earning a living. This adjustment would be much easier if the economy were producing many more jobs. That is not happening and we should look to see how we could help create more jobs. That is not easy.

Yes, we do not have the data we need on employment, given the importance of the subject. And the data we have is extremely unreliable. For example, a large part of our labour force is engaged in self employment in the informal unorganised sector. They may be shown as employed in the surveys, but they are really ‘underemployed’ in the sense that they do not have a turnover that will give them a living wage. If you don’t have unemployment insurance, and people are too poor to stay out of employment, they will take up whatever job they can find and will be shown in the data as ‘employed’. But we can hardly take credit for this sort of employment.

We need to do a major revamp of our employment data situation . It is not easy for self employment but we should certainly be in a position to say what is happening to employment in the formal sector on a quarterly basis. The organised sector is currently very small - about 20 percent of the total but if we set targets about the growth of employment in this part of the economy we should at least be able to judge how we are performing on this front. If we could say with confidence that employment in the organised sector is growing as per target and wages are rising, we can be more sure that the overall employment situation is good.

You have raised a lot of issues so let me offer a few comments that will answer your question, even if in a round about way.

First, I do not think we should view a depreciation of the rupee as something to be fought at all times. Politicians have a natural desire to want a strong currency. If a country’s economy is strong — exports are booming, oil prices are low, the current account deficit (CAD) is low and FDI flows are strong — it is likely that the and the currency will be strong. Here the strength of the economy leads to a strong currency. But this does not mean that if the economy is not strong — i.e. export performance is weak, oil prices are rising, the CAD is widening and FDI flows are not as strong as you would like — then pushing the rupee to appreciate is not the right policy. Pushing for a strong currency when the economy is not strong will only weaken the economy further. In fact it will also weaken the currency, if markets get the impression that the government does not know what to do.

We should consider why the rupee has been under pressure and adopt policies on that basis. There are two possible reasons why the rupee could account for the pressure on the rupee. One is when the CAD widens beyond the level which can be financed by stable capital flows. In this situation you can either let the rupee depreciate or intervene by using reserves.

I think use of reserves in the face of a rising CAD is justified only if you think the problems are temporary and self-reversing. If they are not, then some depreciation is to be expected, and you must use other supportive policies to bring the CAD under control.

A second situation is where the CAD remains in the acceptable range, but there is a shift in capital flows out of the country. Again if the capital flow shift is temporary , there is a case for intervening by using reserves to cushion the effect, but if it is not, then the CAD should be made to adjust to what is a financeable level. Again a depreciation is not unreasonable in such cases, combined with other policies to reduce the CAD.

Today both factors are at work. The CAD has widened and is moving into uncomfortable territory (anything close to 3 per cent is uncomfortable). The prospects for oil prices and the weakness in exports does not suggest an early reversal capital flows are also moving away from emerging markets and therefore also India. And all this is happening at a time when the real effective exchange rate had been allowed to appreciate quite a bit in real terms in the last few years.

In the circumstances I think the RBI has done the right thing. They have let the rupee depreciate and they have also used reserves, about $30 billion or so, just to let the market know that they are not sleeping. The depreciation will help Indian business competing against cheap imports in the same way as import duties do. Relying on depreciation is much better than raising import duties because it also helps exporters. Import duties do nothing for exports and to the extent that they raise the cost structure of the economy exports are actually hurt.

However, having let the rupee depreciate we should do something to bring down the CAD. We cant do anything about oil prices., But we can do something about exports. The depreciation will help but we need a thorough revamp of our ease of doing policies towards exports.

I would put it a little differently. Good economics works for everybody in the medium run. Sometimes good economics may not produce positive results in the short run, at least for some people, and that is the big challenge for politicians. How to persuade people that it is the medium term they should focus on.

On the fiscal deficit there is general agreement that good economics requires a sustainable fiscal deficit. Two factors are relevant in determining what is a good fiscal deficit. First, is our fiscal deficit much higher than other comparable countries? The answer is yes. Our combined fiscal deficit (Centre and States combined) is more than twice that of other emerging market countries. Another consideration is what is the total debt to GDP ratio? India’s debt-GDP ratio is also much higher than the rest of the emerging market countries. Since the fiscal deficit is the yearly increase in the net debt, if we want to reduce the debt to GDP ratio we have to keep the fiscal deficit in check. If we want to look good to financial analysts and attract long-term capital, we should bring our fiscal deficit down to a reasonable trajectory.

Chinese government debt-to-GDP ratio is not very high, but the Chinese banking system does all the lending. There is a great deal of opaqueness in China because we are not sure how much of public debt is hidden in the form of bank debt to public sector organisations.

I don’t think the objective circumstances justify a departure for the fiscal deficit targets. Exports are doing badly and investments have not yet recovered but we should not use these as an excuse for increasing fiscal deficit. We should instead focus on what can be done to promote these sources of aggregate demand. The Finance Minister has said he will meet the fiscal deficit target of 3.3 per cent of GDP. That has sent a good signal but if we keep changing the targets everyday, people are going to say the government of India is not serious about managing the fiscal deficit. A little bit of fiscal fundamentalism becomes inevitable to maintain credibility. That is why I have advocated a shift to the concept of a ‘structural deficit’ where the size of the deficit can be adjusted on the basis of objective circumstances that are verifiable. But we haven’t done that.

Of course in practice people will make allowances for temporary disruptions. Take for example, GST. It is a major reform, and in the medium term it will have a big impact on the economy. However there seems to be a shortfall in tax realisations. If there is a slippage which is entirely because of GST shortfalls observers may be willing to make some allowances. But the fiscal trajectory must look credible.

Actually, each of these issues has come up because there is a problem, and the question is are we addressing the problem? The depreciation is the right thing to do, but the real question is are we doing enough to bring the CAD under control? Are we doing enough to help exports? And are we doing enough to revive investment?

On the fiscal deficit, if we achieve the 3.3 per cent target in a credible manner that will be good but I don’t know what the underlying situation is. There are said to be tax shortfalls and the disinvestment target is unlikely to be met. If oil prices rise, the subsidy on LPG will go up. So, the jury is out on that one. We will get a better idea of the situation when the mid-year fiscal assessment is presented.

Also, the fiscal issue relates to the combined deficit of the Centre and the States and there are question marks on the States. All these loan write-offs — none of the States can afford the loan write-offs that they are doing. Will a loan write off mean a deviation from the fiscal deficit target? And if not, does it mean other programmes will be cut? We have to ask the State governments these questions. Many State governments are acting in a manner that doesn’t, in my view, reflect good economics.

I think we need to energise much more intellectual activity focussing on the quality of policy making at the State level. We have a lot of intellectual inputs into policy making at the national level, but hardly any at the State level. And yet in many areas, especially in implementation, it is the States that are the key players. I wish chief ministers would appoint State-level economic advisory councils which make their reports public.

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