India’s vulnerability to global economic turmoil

it’s going to be a year severe economic unrest globally. It’s the perfect storm: the prolonged war in Ukraine; high and Rising inflation and public debt; currency war; trade tensions; commodity shortages; and increased uncertainty and volatility in asset prices that can lead to financial instability. Central banks are shifting their policy cycle from ultra-lax to tight, increasing the risk of recession. Dollar investments are being rolled back into the relative safety of the American financial system. Policy makers in low-risk economies compared to India are transparently communicating their struggles against the incredible complexities of these problems that have no easy solutions.

Is it 2013 once again?

Is India more or less vulnerable than it was at the time of the global economic turmoil of 2013, when the tremors of the ‘taper tantrum’ led to hasty liquidations? US Federal ReserveThe stimulus disrupted the currency and asset markets, and dollar investments were pulled out. emerging market economies like IndiaSending rupee in sharp decline?

it’s hard to say. But things are not as scary as New Delhi says. Some macroeconomic fundamentals are in the stress zone. The panic in the financial markets is evident from the wild fluctuations in exchange rates and government bonds. The sudden fall of the rupee partly reflects the mis-pricing of risk by the markets so far.

The fiscal deficit position is weaker than in 2013. The budget for this year (2022-23) was made before Russian troops invaded Ukraine. Nearly a quarter of the government’s expenditure was earmarked for paying interest on its previous borrowings, up from a fifth in the year ended March 31, 2022. The world has changed after the presentation of India’s budget on February 1.

rising borrowing costs

the inevitable result of Reserve Bank of India (RBI) tightened monetary policy on May 4 (repo rate hiked by 40 basis points), and an increase of 50 basis points in the cash reserve ratio) is that the government’s cost of borrowing is set to rise. Now almost half of the budget expenditure may have to go towards paying off debt and interest on it. How will India repay this debt? How much will the cost of repayment of the loan increase? These are the questions on which the sovereign rating of economies rests. Worrying about India’s current Sovereign Rating profile on this account will not be worrying. For public debt stability, the government’s target of reducing the debt-to-GDP ratio to 60% is a pipe-dream, and is likely to remain so for years.

In 2013, India was running a large current account deficit, which is not as wide as it is now, but is growing rapidly. It reached a nine-year high (2.7% of GDP) as of December 31, 2021. Anything above 2% is considered volatile for India. Rising US interest rates have made emerging markets like India relatively less attractive to investors. Foreign institutional investors have withdrawn over Rs 40,000 crore every month in 2022. As capital flows can no longer meet the trade deficit, the rupee has fallen lower than in 2013 when India was placed in the ‘Fragile Five’ economies. On Monday, it fell to ₹ 77.52 per dollar, which is its lowest level ever.

Forex reserves are in a much better position than in 2013 but are depleting rapidly. The RBI is spending around $10-11 billion a month to protect the rupee, with its forex reserves falling below $600 billion from an all-time high of $642 billion a few months ago.

weak growth trend

While the government talks about an ongoing recovery, India is entering the current episode of turmoil over a weak growth trend. GDP growth in the financial years 2011-12, 2012-13 and 2013-14 was 8.5 per cent, 5.2 per cent and 5.5 per cent. And it is estimated at 3.7%, (-) 6.6% and 8.9% for 2019-20, 2020-21 and 2021-22. Growth was anemic before the COVID-19 pandemic. Then there was a contraction – the first in decades – in the first COVID-19 year. When read with full figures for GDP and consumption expenditure in the economy, a statistically high growth projection for the next year (due to a lower base in the previous year) indicates that the economy is not out of the woods yet. (Advance estimates for 2021-22 will be updated later this month.)

Thus, macroeconomic fundamentals are not a source of much comfort. But the biggest threat to India may not be economic. The policy system’s poor capacity for timely and substantive policy response is risky. Monetary and fiscal policy has been less than properly and administrative chaos has shaken confidence.

The RBI turned to monetary tightening in an off-schedule meeting that shook the market. It is not needed. A well telegraphed frictionless transition was not difficult. This didn’t happen because the RBI made the world’s most powerful economies prepare to rein in inflation and instead focused on keeping the government’s borrowing costs low. The sudden change in its policy came less out of concern for growth-blocking inflation and more to protect the rupee. RBI timing was set by US Federal Reserve’s anticipation increase in interest rate. The noisy piece of gears is meant to prevent narrowing of the interest rate differential through the US, which will accelerate the dollar investment outflow, putting the rupee in free fall.

Central banks certainly have the option of making quick, sudden decisions. The big question is why did the RBI wait till the last minute when the US Fed was expected to hike rates? Knee-jerk, eleventh-hour decision making has become the norm – whether it’s a delayed reform of vaccine procurement and distribution policy last year or the recent cancellation of passenger trains to manage coal supplies.

financial challenge

The pro-rich bias in COVID-19 relief packages is not unexpected. The Finance Ministry deliberately decided to provide assistance to formal firms based on two arguments – both are fine under normal circumstances but are over-punctual in the midst of such a huge humanitarian crisis. Its first objective was to ensure that it could track remittances from the budget, and this could be done only if the recipients were organized sector firms; If the money is handed over to firms in the unorganized sector, there is no way for North Block to track the use of the money. Second, since the government has no mechanism to assess the genuineness of the beneficiaries, the task was entrusted to the banks as they have some capacity for due diligence of the beneficiaries. All this meant that government aid could only take the form of asking people to borrow, rather than putting up a safety net with wage protection, rent and other direct payments for those most affected by the pandemic.

It is now well recognized that the shock of the pandemic has disproportionately affected small firms as the government’s COVID-19 support package – mainly credit on easier terms – has not reached them. But the government has neither the fiscal space nor the administrative capacity to bail them out, a major reason why GDP recovery remains fragile.

missed opportunities

The government has spent too much time in office dragging its feet on reforms, firing experts and proactive institutions. Despite full knowledge of the extent of bad loans and other problems in the years 2014 to 2019, the financial system was not sufficiently strengthened. Similarly the pace of fiscal consolidation was very slow in high-growth years.

A global financial crisis, a pandemic, a war and other such black-swan events cannot be predicted. When they strike, policy and projections get derailed. Two things determine how the economy copes with the effects of the shock and then returns to the pre-shock economic trajectory: the ability to make sound policy and use the non-crisis years to strengthen policy, institutions and structural development. How well it was done. parameter. Failures on both these points have made India more vulnerable to external shocks in today’s global economic scenario than it needed to be.

Delhi-based journalist Pooja Mehra is the author of The Lost Decade (2008–18: How India’s Growth Story Developed into Growth Without a Story). She is now working on IG Patel biography