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Hidden dangers in our pursuit of growth

S S TARAPORE | Updated on January 22, 2018 Published on November 26, 2015

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Low interest rates have widened the savings-investment gap, while an overvalued rupee has undermined domestic industry

The Indian economy is poised at a crucial point. It could either enter into a phase of a reasonably long period of sustained growth, or in endeavouring to achieve unsustainably high growth rates could face severe dislocation, resulting in a downturn of growth. It is in this context that it is important to avoid major macroeconomic pitfalls.

Ensuring sustainable growth

Sounding a note of caution on sustainable growth is often misconstrued as a denial of an opportunity to the Indian economy to grow at a faster rate.

There is no pre-set ceiling for the growth of the Indian economy, but there are real dangers in trying to grow at an unsustainable rate.

With a given level of capital we can improve the growth rate by revving up capacity utilisation, but individual sectors can very quickly reach the limits to growth. Again, in an increasingly integrated global economy, sluggish global growth can also dampen prospects for growth of the Indian economy.

India is, at the present time, in a sweet spot of having the highest growth rate in the world. With an expected growth rate of 7.2-7.5 per cent in 2015-16, powerful cheer squads from the sidelines would understandably press for a higher growth rate of 8 per cent, getting within striking range of the much cherished, but much elusive double digit growth.

Consumption-saving conflict

We no longer want to save sufficient amounts before buying housing properties and even most durable goods are bought on the ‘never never’ hire purchase system. The instant consumption results in a drop in savings which in turn puts a lid on growth. All this is dismissed as old fashioned economics.

The fashion of the hour is to produce more at lower and lower interest rates and, as interest rates are lowered, there is an inexorable drop in financial savings, thereby widening the investment-savings gap which has to be filled by running a much larger balance of payments current account deficit.

In the initial stages, foreign capital inflows continue but, as foreign investors get restive, large outflow of capital takes place.

There is also the viewpoint, articulated, by the much respected Jagdish Bhagwati, that foreign direct investment should be allowed into any and every sector even if it be rouge and lipstick.

It is argued that instead of India saving for others, others would save for India. The resolution is not so simple for two reasons. First, investment income outflows could rise to stratospheric levels.

In the mid 1960s, a Reserve Bank of India (RBI) study showed that a mere foreign equity investment of ₹12,000 enabled the company to become a sizably large company today remitting out each year millions of dollars.

This is not to say that Foreign Direct Investment (FDI) is undesirable; all that is stressed is that there is no free lunch.

Secondly, it is axiomatic that the pattern of investment determines the pattern of distribution of income. If investment is oriented to consumption of goods by the upper income group, income will get channelled to those income groups — a basic lesson taught by the great master Jan Tinbergen. It is no surprise that the world over, there has been increase in inequality of incomes.

The right exchange rate

We in India, like a number of other countries, are reluctant to let the exchange rate depreciate as we consider it a reflection of poor macroeconomic management.

Now, if the Indian inflation rate is much higher than in key currency countries, an exchange rate depreciation is unavoidable but we stoutly resist such depreciation.

The RBI’s 36 country model shows a real effective exchange rate (REER) appreciation of 13 per cent while the 6-country model shows an appreciation of 24 per cent.

True, we would be told about esoteric productivity gains and all that but the ground reality is that a large number of Indian exports are becoming uncompetitive in world markets.

What is even more alarming is that imports from other countries are swamping Indian domestic industry. Reflecting all this is the 3 percentage point interest rate subsidy on rupee export credit.

India has periodically resorted to this instrument but it is a clumsy one. The appropriate measure is to gently depreciate the rupee so that Indian exports remain competitive and Indian domestic industry is not crushed by imports.

While policymakers get uptight when commentators talk about the appropriate rate being around ₹70-72 per US dollar, we are hurting ourselves by not doing so.

It is gratifying to note that the articulate chief economic adviser, ministry of finance, Arvind Subramanian, recently enunciated that to have a competitive industry you must have competitive exchange rates.

One fervently hopes that this is a precursor to a more competitive exchange rate.

End to lower interest rates?

Having punished the saver enough, one hopes that the government does not make strong noises for lower interest rates. Depositors, who account for the bulk of household savings, if punished further, will resort to imprudent savings.

In the long-term interests of the economy one hopes that the government would not make clarion calls for lower interest rates.

Such calls make good copybook but damage the economy. One prays that government lets the RBI decide interest rate policy.

The writer is a Mumbai-based economist

Published on November 26, 2015
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