Time to brace yourself for a hard landing

September 2, 2013

(Any opinions expressed here are those of the author and not of Thomson Reuters)

In his speech to parliament last week, Prime Minister Manmohan Singh said: “The depreciation of the rupee and rise in dollar prices of petroleum products will no doubt lead to some further upward pressure on prices. The Reserve Bank of India will therefore continue to focus on bringing down inflation.”

By saying this, the economist in Singh seems to have won against the politician. This has also been a vindication of sorts for outgoing RBI Governor Duvvuri Subbarao.

In his latest speech, Manmohan Singh merely reiterated what the governor has been saying for so long.

It is difficult not to admire Subbarao for his courage in holding out against so much pressure and doing the right thing.

Could it be possible that what looked like a battle between the RBI and the finance ministry was really a battle between politicians and economists in the government?

I would say it’s good that the RBI governor was around to do the right thing.

We cannot close our eyes to the withdrawal of excess liquidity by the United States. Quantitative easing will be taken away when it suits them. No one should kid themselves into believing that the U.S. will put the interests of Asian economies over their own – and why should they?

When it happens, we are bound to see some serious outflows from FII portfolios – debt and equity. Capital inflows will also get tighter at least till the global economy settles to a new equilibrium.

The only way to save India from a full-blown currency crisis will be to make the most of whatever we can in the next 12 months.

A currency reserve of five months of imports may not be adequate. Considering that we are a net importing country, rupee depreciation will not only lead to oil inflation but also increase the cost of manufacturing. Our exports will have to outpace the impact of the rupee depreciation on inflation.

Given that exports also depend on markets overseas, we need to pray for a swift recovery in the United States and the EU.

Prime Minister Singh rightly said there will be no capital controls. However, measures to severely contain foreign currency borrowing to buy businesses overseas and the import of luxury goods are surely called for when the country is on the threshold of a currency crisis.

Surely, with the inflation outlook and pressure on the rupee, it is unlikely that there can be any further rate cuts. On the contrary, it would be well advised to keep the real interest at least neutral, if not positive.

Negative interest will only drive away household savings, leading to a dearth of private investment.

The finance minister has his to-do list – contain fiscal deficit at 4.8 percent of GDP; revive manufacturing, contain the current account deficit by reviving exports, increase investment through PSU expenditure, sort out the environmental challenges coming in the way of coal production, and so on.

All the right things but is there someone who will make them happen? No matter what suffering is forced on the Indian economy, it seems we will continue with fiscal profligacy with an eye on elections due next year.

It is unlikely that elections will be announced early because it takes time for financial giveaways to reach potential voters. It seems the Indian economy is destined to suffer more pain.

Still, it is difficult to appreciate the prime minister’s call for political consensus and support from the opposition.

In a democracy, a government is presumed to be in a majority and should have the ability to get its policies through.

How can the opposition stall any progress? Unless, of course, the ruling coalition is not acting in unison.

In such a case, it would be best to go back to the people for a fresh mandate. Otherwise, India’s economy is likely to continue bleeding and investors better brace for a hard landing.

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