By RP Gupta
India’s foreign exchange reserves have increased from $642 billion on September 3, 2021 to $580 billion on July 8, 2022 and the current account deficit (CAD) could exceed 3.0% of GDP over the next financial year 2022-23. External debt (private and sovereign) of approximately $267 billion will mature within the next 12 months; this could cause a big hit on foreign exchange reserves. So far, foreign exchange reserves of 580 billion dollars, or about 19% of GDP, reassure India. But given the rising CAD trend, depleting foreign exchange reserves and falling rupiah, India should not be complacent.
The pandemic followed by the Russian-Ukrainian war has caused upheaval in the world economy. Even the United States and other Western countries face its heat. But the emerging economy like India must be more cautious on the external sector which is more sensitive compared to the domestic economy. However, the two are linked to a large extent.
The CAD is more detrimental than the budget deficit. Typically, the CAD is funded by global investors through external debt (private and sovereign) and equity investments. Therefore, foreign exchange reserves are built up through the expansion of “international liabilities”. However, India’s budget deficit is mainly financed by domestic debt liabilities. The government’s external debt alone is less than 5% of GDP and comforts India compared to many other countries.
The falling Rupee against the US Dollar is a major deterrent to retaining global investment in India and as a result, foreign exchange reserves are depleting. The process is somewhat cumulative. Recently, the RBI has taken some good measures to stop this phenomenon, but these are not enough. In such global turmoil, India must quickly come up with a “strategic plan” to mitigate any likely external risk instead of leaving the matter to RBI alone.
Such a plan should essentially include “structural reforms” to improve “global competitiveness”, boost exports and reduce or replace imports. Global competitiveness does not only depend on producers, but on the multitude of policies and regulations. Relaxation of trade and tax laws should supersede all reforms.
All types of taxation on “intermediate goods” such as energy and minerals should be reduced, which has a multiplier effect on the cost of producing entire goods and services. Even, the calibrated export incentives, along with the sunset clause, can be offered on additional exports of a few select items. This will boost both exports and GDP growth.
Central government fiscal debt of less than 60% of GDP is within the manageable limit compared to many major economies. Therefore, the government should not hesitate to choose the proposed fiscal expansion to mitigate the likely external risk. The DAC resolution must take priority over the budget deficit by all means.
Vast export potential for services, processed foods, textiles and handicrafts needs to be unleashed. Remittances of around $85 billion from Indians working abroad must be safeguarded as a priority; which is equivalent to “the export of services”. MSME reforms are lagging behind; they will stimulate exports in addition to creating enormous jobs. This should also be a priority.
India must gradually develop its self-sufficiency in energy, fertilizers, food, medicines, microchips and rare minerals. The import of thermal coal must be replaced by national production. New exploration for oil and gas must be done aggressively.
The railway needs to increase its share of freight traffic to reduce diesel consumption and logistics costs. Public transport should largely replace private vehicles to save fuel. Power outages should be shortened to save diesel consumption in generators and pumps. Similarly, a series of reforms are needed that have a common impact on external sector stability and GDP growth. The two are linked to a large extent.
Gold imports are to be drastically reduced over the next 3-4 years using an innovative modified gold system as recommended by the author in his book, Turn around India-2020. This alone will supplement foreign exchange reserves by approximately $450 billion over the next 5 years. Remarkably, this will be done without increasing international liability and therefore the rupiah will stabilize. This could, in fact, be a game-changer.
Considering that the total assets of global financial institutions exceed 400% of global GDP, the share of global investment in India’s debt and equity is too small relative to the size of its economy. A vibrant capital market will certainly attract global investors and facilitate producers for new investments. For this, facilitation must coexist with regulation.
Such a strategic plan, accompanied by an implementation timetable, can be made public to inspire confidence in global investors, the capital market, producers and exporters of goods and services, etc.
The current global turmoil can be seen as an opportune time to enact sweeping reforms. This will not only mitigate the likelihood of external risk, but put the Indian economy back on its growth path. India must act quickly and emerge as a strong economy with a stable rupee and comfortable foreign exchange reserves exceeding international commitments.
(The writer is an economist and the author of the book “Turn Around India-2020”. Opinions are personal.)