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Shedding Crocodile Tears

The buzz among official eco-nomists these days is that India's Current Account Deficit (CAD) is getting dangerous. Reason : exports are less and imports are more and the gap is widening. So it is essential to attract more foreign investment to bridge the gap. It is forgotten though that more foreign investment necessarily means an increase in CAD.

The straightforward way to deal with increasing CAD is to devalue the rupee which would make Indian exports competitive and imports expensive. Such devaluation would happen in normal course whenever CAD increases. Increase in CAD means that demand for dollars for imports will be more than the supply of dollars from exports. The high demand for dollars would translate into an increase in price of the dollar, a corresponding decline in price of the rupee. This, in turn, would lead to an increase in exports. A balance between imports and exports would be reestablished at a new level. High demand for potatoes in the wholesale market leads to an increase in price and balance is soon reestablished between arrivals and sales. The shortage is wiped out. The same should happen in the forex market and CAD should be wiped out in normal course of business.

Why should Manmohan Singh and Chidambaram be worried about the CAD? The market will ensure that CAD is wiped out. One must be worried because the matter is intertwined with foreign investments and liquidity in the money market. Dollars come into forex market not only from exports but also from foreign investments. It is not necessary for the shortfall in export earnings to be met by an increase in exports. It can also be met from increased inflows of foreign investments. The simple formula is Exports + Foreign Investments = Imports. The above formula can be rewritten as Imports - Exports = CAD = Foreign Investments. This means that CAD is inevitable as long as the economy gets foreign investment inflows.

To go back to the potato example, it is not necessary that daily receipts of potatoes from the farmers be equal to daily sales. Stocks held in the cold storage can also be sold. In that case, the 'deficit' between daily receipts and sales will be equal to the withdrawals from the cold storage. It will not be possible to wipe out shortage in daily supplies as long as sales from cold storage take place. Similarly, the CAD arises only because there is inflow of Foreign Investments edging out export earnings.

If official economists are really concerned about increasing CAD, they should put the spanners in the inflow of foreign investments. Reduced inflow of dollars will lead to a decline in the price of rupee vis-a-vis the dollar. That will translate into increase in exports and wipe out the CAD. The interesting part is that official economists also want to maintain high inflows of foreign investments. Now, this is contradictory. Increase in Foreign Investments has to necessarily lead to an increase in CAD. One cannot have the cake and eat it too!

In truth they are only shedding crocodile tears on the increase in CAD. The truth appears to be quite different. They are actually happy with inflow of foreign investments and increase in CAD. They are mainly concerned about hiding the impact of increasing CAD on the domestic economy—exporters in particular. The consequence of increase in CAD in normal course of business is that the rupee will devalue. That would boost exports. This far is fine with them. Their problem is that a devaluation of the rupee will scare away the foreign investors. Say a foreign investor buys a share of Rs 55 in an Indian company and pays a dollar for this purchase at the current exchange rate of Rs 55. Now the rupee devalues to Rs 70. The sale of this share in the NSE will still fetch him Rs 55. But this will translate into only 80 cents because the rupee has devalued. The foreign investor will take a hit of 20 cents. Economists do not want this to happen because inflow of foreign investments increases the liquidity in the money markets and makes it possible for the government to borrow larger amounts at low interest rates. And the Government has recently increased the ceiling on amounts of government bonds that can be purchased by foreign investors.

Their main concern is to garner monies for supporting corruption and buying votes. They are actually following Charvaka's philosophy: "Take a loan and make merry." The ability of the Government to take loans at low interest rates is dependent upon inflows of foreign investments hence they are loath to let the rupee devalue. And, CAD has to necessarily be large if rupee is kept at an artificially high level. They are mighty happy with the increase in CAD. But they do not want the public to know of their intention because that will raise a hue and cry by the exporters. Hence they are shedding crocodile tears to befool the people of the country that they are 'worried' about CAD; while in reality they are quite happy about it. Analysts' assessment, including this writer's own, is that the correct value of the rupee today will be about Rs 70 to a dollar considering the differential rate of inflation in the USA and India. But official economists are trying to artificially keep the rupee high so as not to scare away foreign investors.
[contributed]

Frontier
Vol. 45, No. 48, June 9-15, 2013

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