The elephant experts didn’t see

S. GURUMURTHY | Updated on September 20, 2013


Not gold and oil, but the huge import of capital goods in the UPA years has triggered the current account deficit and rupee crises.

Normally a new government faults the previous dispensation of another party for leaving behind a bad economy. But when the UPA government took over in 2004, it had some good words for its predecessor, the NDA.

In his Budget speech in July 2004, Finance Minister P. Chidambaram noted that “the economic fundamentals appear strong” and “the balance of payments robust”. Yes, the current account surplus of $22 billion for the three years 2002-04 had broken the unbroken run of current account deficits for almost a quarter century — despite the average oil prices having doubled.

This coincided with the world taking serious notice of India’s rise. But how come that India, which was seen as a rising hope for the world when the UPA assumed office, now finds itself in a hopeless situation — with its rupee almost halving in value in the last 20 months and still losing? What led to this fall?

Like six blind men

The national discourse on the present crisis is more like the story of the six blind men and the elephant. Most experts catch and hold out one aspect of the phenomenon as the cause of the crisis.

Everyone understands that the rupee fall has been caused by the galloping current account deficit since 2004. Many experts are blinded by the inevitable oil and unwanted gold imports as the culprits for the huge current account hole.

Some say the hole is so big because inadequate Indian reforms have dried up the flow of foreign capital. Some others hold global slowdown as the cause for India’s current account woes. Others say that because of poor reforms the growth is slow and, therefore, exports haven’t picked up. In the anarchic debate, the real cause of the current account hole and the consequent rupee fall — the elephant — is totally missed out.

Almost everyone is blind to the fact that more than oil and gold, it is the unprecedented import of capital goods which has torpedoed the balance of payments and dented the current account with a huge deficit of $339 billion during the nine-year UPA rule.

The capital goods imports in this period aggregated $587 billion, almost a third of India’s nominal GDP — the elephant which the experts have missed.

Actually, oil imports after off-setting exports ($279 billion) were less, at $515 billion, and gold imports (net of exports of gems and jewellery) were $161 billion. It is the gargantuan capital goods import that has blown the current account to pieces. It also has damaged the Indian economy from within.

Capital goods import

Here is the pathetic story. During NDA rule, the average annual capital goods import was $10 billion. But in the very first year of UPA rule (2004-05) it jumped by one-and-a-half times, to $25.5 billion.

Thereafter it galloped year after year — to $38 billion in the second year, $47 billion (third), $70 billion (fourth), $72 billion (fifth), $66 billion (sixth), $79 billion (seventh) $99 billion (eighth), and $91.5 billion (ninth). In the first four years, the capital goods import totalled $180 billion. In the next five years, the total vaulted to $407 billion.

In theory, capital goods import signals economic boom, promising rise in industrial production, in GDP. But here? Even as capital goods import rose by 79 per cent in the five years, the growth in index of industrial production fell by 56 per cent (from 11.5 per cent earlier to 5 per cent in the latter five years). And directly hit by the imported capital goods tsunami, domestic capital goods manufacture nosedived by one-tenth in 2011-13.

Even if India had had enough dollars to pay for the capital goods import without running a current account deficit, the huge import of capital goods would have devastated the national manufacture. The story does not stop here. The current account deficit also exported the growth away.

It is fundamental economics that exports add to national wealth (GDP) and imports cut into it. The current account deficit year after year has cut the GDP by 0.8 per cent in 2007-08, by 1.5 per cent (2008-09) by 2.1 per cent (2009-10) by 1.4 per cent (2010-11) by 2.6 per cent (2011-12) and by 3.9 per cent (2012-13).

But for the current account deficit, the nominal GDP of India could have been 16.9 per cent (not 16.1 per cent) in 2007-8, 14.4 per cent (not 12.9 per cent) in 2008-9, 17.2 per cent (not 15.1 per cent) in 2009-10, 21.7 per cent (not 20.3 per cent) in 2010-11, 17.7 per cent (not 15.1 per cent) and 15.6 per cent (not 11.7 per cent) in 2012-13.

Perhaps India could have been ahead of China. More. The UPA’s nine years saw the aggregate import of manufactured goods jump to $50 billion – up 20 times.

The surge in import of capital goods and manufactured goods put Indian manufacturing in the ICU. And note. Gold imports dent the current account yes; but they do not kill local manufacture. But capital and manufactured goods imports have achieved both!

And shockingly it is the Government that incentivises the huge capital goods import with a red carpet of tax waivers costing lakhs of crores of rupees. The Government cut the customs and excise tariffs in 2008 as fiscal stimulus to the economy in view of the global meltdown. For mega power plants the tariff was made ‘Nil’. The stimulus caused additional revenue loss of Rs 2.6 lakh crore each year. The result was the capital goods import tsunami, which rose by almost 80 per cent since 2008.

Lost tax revenue

The total tax revenue lost by tax cuts in four years from 2008-09 to 2011-12 was Rs 22.6 lakh crore. The ratio of customs duty to imports halved from 15.6 per cent in 2004-5 to 7 per cent — even as the imports rose six times from Rs 3.6 lakh crore to Rs 23.5 lakh crore — reducing the effective import-weighted tariff to almost one-eighth of its 2004 levels.

As far back as in January 2005, Prime Minister Manmohan Singh and Finance Minister P. Chidambaram had sworn in public to reduce the unnecessary tax waivers as the tax rates were reasonable.

Yet not a single rupee of tax waiver was rolled back in the 2005 Budget or in 2006 or in 2007 or in 2008. On the contrary, tax waivers were doubled from Rs 2.6 lakh crore to Rs 5.2 lakh crore a year, and year after year, from 2008-09 as the red-carpet welcome for the capital goods tsunami.

And capital goods imports stimulated by tax cuts, which trebled the fiscal deficit, rose by 79 per cent to $407 billion. But for the tax cuts, with the global meltdown in 2008, there would have been no great propensity to invest. Clearly, the huge rise in capital goods import is the direct effect of the tax stimulus — a case of tax-cut induced, not demand-led, investment.

Had capital goods import not been tax-incentivised to rise (by a whopping 79 per cent) the current account deficit over the nine-year period of UPA rule ($339 billion) could have been less, perhaps by $182 billion — namely just $157 billion, had the imports been on the pre-stimulus levels. And consequently the forex reserves would have been more by $182 billion.

Don’t go that far. Imagine the capital goods import and therefore the current account had been less by just $100 billion. There would have been no crisis. Isn’t it stupid to invite the huge current account deficit via capital goods import by incurring huge fiscal deficits via tax cuts?

Real culprit ignored

The stupidity did not end there. The tax cuts were intended to be passed on by the corporates to consumers so that their buying power was not eroded and the economy did not get into recession.

But the corporates did not pass on the stimulus tax cuts to the consumer. This is evident from the rise in the ratio of corporate profits to GDP from 11 per cent in 2004-5 to 12.5 per cent after the stimulus. The current account deficit directly pulled down the rupee value. And the fiscal deficit incurred to invite the current account deficit indirectly knocked down the Indian rupee.

Yet the real culprit — the tax-cut induced capital goods import — is virtually unnoticed in the national discourse. Ignoring (suppressing?) the real cause, the Government is applying the usual ointment of soliciting external commercial borrowing and stock market investments as cure for the cancerous growth in current account deficits.

On top of it, the UPA is proposing an additional Rs 1.50 lakh crore spend on the Food Security Bill to buy votes. A government interested in the nation and the rupee would have deferred the Bill to better times. Why then will the rupee not fall, and continue to fall?

Saying that the intrinsic value of the rupee is three times its market value, The Economist magazine ([January 2013) lists the rupee as the most undervalued currency in the world.

Yet it is getting valued less and less. It does not need a seer to say that reckless management of the external sector is the real reason for the rupee fall. Will the establishment thinkers realise the truth — which is the precondition for remedy?

( The author is a commentator on political and economic affairs, and a corporate advisor.)

(This article has been corrected for errors.)

Published on September 05, 2013

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