Devaluing the reform process

The statement of Chief Economic Advisor Raghuram Rajan, when the rupee was nearing the Rs 60-mark to the dollar, that the government would step in at the appropriate time, was a clear indication that officialdom was not averse to the Indian currency finding a lower level. This is quite consistent with the official policy since the reform process began to allow the market to determine the general value of the rupee.

While the official agencies may have stepped in to ensure this process was not excessively volatile, there has been little effort to counter a trend where the rupee to dollar ratio has more than trebled from the Rs 18 to the dollar that existed in 1990-91. Each step in this process can be seen as just another necessary adjustment to world market conditions, but the resultant long-term trend of devaluation is a rather more critical evaluation of how the reform process has gone.

Impact on FDI

When the reform process was initiated, it was argued that open markets would result in greater domestic competition from imports. This competition would force domestic producers to become more efficient. More efficient producers would gain a greater share of the world market and thereby help strengthen the rupee. While an increase in efficiency may have happened in small pockets of the Indian economy, it was far from being the rule. The growth in exports was not quite able to keep pace with the growth in imports that liberalisation ensured.

The markets responded to these efficiency failures by pushing the rupee lower. Some of this downward pressure was warded off by the government’s success in attracting foreign investment into the stock markets. But the long-term declining trend in the value of the rupee indicates that either the inflows into the stock markets were not enough to protect the value of the rupee, or that the government thought it fit to allow the rupee to fall in order to help make Indian products competitive.

Whatever the reason for this sustained devaluation of the rupee, it has had consequences for the growth of the economy that must not be brushed under the carpet. The greatest impact has arguably been on Foreign Direct Investment. When foreign investors know that their investments will almost certainly lose value due to currency devaluation, they are less inclined to invest.

The US may officially complain against China keeping its currency steady against the dollar, but a steady currency provides greater comfort to Americans looking for long-term investments in China. Thus, while China has been able to attract long-term FDI, India has had to make do with foreign investment in its stock markets where each individual decision can be a short-term one.

Long-term devaluation has also had its impact on the cost of production within India. The higher cost of imported inputs created a direct upward pressure on the prices of the finished product. In addition, with imports becoming more expensive, local competitors saw little reason to keep their prices low. More often than not, domestic producers simply created a new market that offered products of a lower quality at prices that were only a little below import prices boosted by devaluation. One of the basic premises of liberalisation that global competition would force domestic producers to cut prices and improve quality did not always work out.

Sugar-coated packages

To make matters worse, the government has not been averse to an import-intensive infrastructure strategy. The search for world-class infrastructure has somewhere along the way been translated into a search for global brand names. In order to attract global brands the deals have to make up for, among other things, the long-term devaluation of the rupee. Central and State governments have been under pressure to find new ways of sugar-coating the packages to attract FDI. It has not been unusual to offer more land to the projects than is essential, so as to boost the real estate component of the deal. Indeed, the excessive use of this tool has contributed in no small way to the intensity of the protests against land acquisition.

And, land is not the only cost-enhancing concession that has been offered to attract foreign capital. Subsidies of hundreds of crores have been given for the construction of a new international airport at Bangalore. The foreign consortium investing in the same airport also demanded that an existing airport should be closed. And the government decided it was worthwhile to close down an existing single-runway airport in order to get another single runway airport.

The long-term devaluation that appears to have had official sanction right through the reform process has thus had consequences for the economy that go against what the reform process promised. Devaluation has belied the original expectation that a vast number of Indian producers would become cost effective and globally competitive. Devaluation has also been a cost-enhancing hurdle in the way of Indian products gaining a greater share of the world market. And with the Central and State governments leading the way with import-intensive infrastructure, the dream of India coming up with a host of products that would be globally competitive remains a distant one.

(The author is Professor, National Institute of Advanced Studies, Bangalore.)

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