Karela Fry

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Is the economy tanking?

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IBN Live adds to the daily chorus of hand-wringers over the state of the Indian currency:

Indian stocks on Tuesday dropped for the first time in five days with S&P BSE benchmark Sensex plunging over 651 points, its biggest fall in over a fortnight, on massive selling as the rupee breached 68-mark versus the US dollar on fresh signs of trouble in Syria.

That bastion of right-wing thought, the Economist has this to say:

If the rupee still looks vulnerable, India has three options, none very palatable. One is to let the currency fall further. In most countries a cheaper currency would boost exports and help close the current-account deficit. But India’s manufacturing industry is too small and too bound in red tape to ramp up quickly. So a turn-around in the balance of payments may take time during which investors could panic. Meanwhile the weaker currency may destabilise the domestic economy by adding to inflation and increasing the government’s subsidies on fuel and thus its borrowing.

The second option is to do the opposite and increase interest rates to attract more foreign money in, following the path of Indonesia and Brazil. But this would further hammer Indian industry, which is already in poor shape, and probably increase bad debts at banks too. If the economy slowed further as a result, equity investors might begin to worry about corporate earnings declining and pull out their roughly $200 billion of investments in listed shares. Inducing a credit crunch in India might make things even worse.

The last option is to lower government borrowing. It is running at 7% of GDP (including India’s states) and has stoked excess demand in the last few years, widening the current-account deficit.

The article nails the issue: the government is caught between an industry which thrives on imports and government sops, and a populace which would (and does) starve without government subsidy. Since I am bang in the middle, I would prefer the second option: increase interest rates to at least match inflation.

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Written by Arhopala Bazaloides

September 3, 2013 at 12:25 pm

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