4 Anticipate and manage external risks prudently: The UPA-2 seems to have a schizoid view of external turmoil — sometimes using it to explain away domestic problems like inflation and sometimes believing that India would not be badly affected by external problems like the difficulties of the Eurozone. The growing loss of confidence in the India growth story and the sharp increase in the perceived risk of staying invested in India that led to the outflow of foreign institutional investors from mid-2011 could have been anticipated.
The uncertainties in Eurozone are perhaps the most important short-term risk factor for India. A large amount of corporate borrowing abroad in the form of convertible bonds or syndicated borrowings is coming up for repayment over the next year. Much of this debt was a consequence of the wide gap in interest rates opened up by the RBI’s interest rate hikes. European banks may well be reluctant to refinance this partly because of the perceived increase in the riskiness of Indian corporates and partly because of the need for liquidity against further sovereign default risks in Europe. Another risk factor is the large amount of short-term borrowings whose share in our external debt has increased from 4.5 percent at end-March 2003 to 21.2 percent at end-March 2011. This requires prudence in the use of our foreign exchange reserves, which have to be conserved against the eventuality of large repayments of corporate borrowings and a sudden outflow of volatile short-term borrowings.
The decline in the international value of the rupee has to be seen in a longer context. If one looks at the difference in the rate of inflation in India and in the US than a 15 percent or so decline in the rupee over 2011 would just about maintain an equivalence in purchasing power at the rate prevailing at the start. The decline was arrested by the inflow of foreign investment funds in the first half of the year and when that flow was reversed, the change in the exchange rate was swift and dramatic. There is little that one can do to fight this except to play a little on expectations and tighten the restrictions on speculative activity. Using reserves to counter a change in the rupee’s real value would be futile and unwise given the need to conserve reserves for a potential increase in outflows when borrowings become due for repayment and are not refinanced.
5 Shift the focus of inclusive growth from handouts to productivity enhancement:Largely for political reasons the government now spends Rs 1.8 trillion on programmes for inclusive growth, two-thirds of this on beneficiary oriented and social service schemes and one-third on physical investments to raise productivity. The Food Security Bill will add even more to this cornucopia of handouts. The actual impact of these schemes in raising the long-term earning potential of poor households is open to question. The government must use the argument of fiscal prudence, which will be justifiable politically in a crisis year, to shift the weight of inclusive growth schemes away from handouts towards measures that improve the productivity of poor households with training asset improvement and last-mile infrastructure.
This must become part of a longer term strategic goal of broadening the geography of rapid growth in India to bring rain-fed areas, hill areas and tribal-belt districts into the highgrowth economy. One important part of the broadening is to connect the North and the East of the country into the more prosperous and faster growing West and South. In fact, the long-term potential for rapid growth depends on the demographic dividend of a rising proportion of young working persons in the population and this will arise largely in the northern states. Bihar and UP have grown rapidly in recent years and this, more than the employment guarantee scheme that has sometimes been blamed, may be responsible for the sharp reduction in the seasonal labour migration that sustained Punjab and Haryana agriculture. The Central government must rise above narrow political concerns to provide resources for logistical investments, labour training, industrial promotion and credit development in these Opposition-run states.
One does not know how much time Manmohan Singh has before he decides to step down or on what he will choose to stake his limited political capital. As a person of sterling honesty, he may want to make anti-graft moves his parting gift. But the political class may not support this with any real enthusiasm. He could, on the other hand, go all out to get the political class to accept the tough decisions needed to protect the economy in early 2012 so that it moves onto the path of rapid and inclusive promised in the Twelfth Plan. It would be a fitting finale to a career in high politics that began 20 years ago when he did something similar to rescue the near bankrupt economy and ushered in the era of liberalised market-oriented growth.
Nitin Desai is a leading economist, a policy maker in sustainable development and was the Under-Secretary for Economic and Social Affairs at the UN.