The defence of the rupee has caused damage. Time the government prioritised growth
The decline in the index of industrial production in June, by 2.2 per cent compared to last year, is a sign of extreme stress in the economy. The economy is no longer in the midst of a slowdown. It is witnessing a contraction. If the monsoons push up agricultural production, and good news comes in on the GDP front, that would be the doing of the rain gods. Meanwhile, the man-made disaster continues, in which we are unable to solve the problems that are hurting manufacturing, power and infrastructure. Clearly, the government’s response has been inadequate. Not only has it been unsuccessful in private project clearance, today its own activity, such as on new infrastructure projects, has collapsed. By now, prevarication and delay have weakened most companies and bank balance sheets.
Industrial contraction, persistent inflation and weak prospects for growth have reduced capital inflows, and created outflows in the form of purchase of gold and investment abroad, putting pressure on the rupee. The government has announced a number of steps to prevent further rupee depreciation. Some of these, such as increasing import duties on gold and silver, are aimed at reducing the current account deficit. Others, such as borrowing by PSUs, removing restrictions on NRI deposit interest rates and relaxation of ECBs, are aimed at increasing debt inflows on the capital account. At the same time, the RBI is continuing the interest rate defence of the rupee by selling government cash management bills every week. This would pull liquidity out of the system, making credit expensive.
There is a clear conflict between a policy of defending the rupee and one of promoting growth. The main question is: will the economy be better off with the rupee at 60, or with higher interest rates that risk hurting growth further through a tight money policy? The government is according priority to the rupee. But these short-term steps all move the country away from the path of reducing external debt, lowering import duties and building a profit maximising public sector. Indeed, these steps send out the signal that India’s commitment to reforms is fragile and the government is willing to move away from reforms on the flimsiest of pretexts. Raising rates and attracting dollar debt is not the solution to India’s problems, not even in the short term. Even if the