Saturday, May 26, 2012

Eurozone impact on India

There is more than element of panic in the reaction to the fall of the rupee this month, methinks. India Inc has been howling ''crisis'' and it blames it on ''policy paralysis". These concerns are misplaced. The fall in the rupee is a natural response to the widening of the current account deficit beyond 4%, exacerbated by the flight of FII capital in the wake of the Eurozone crisis. The decline in the rupee is a natural stabiliser and should cause the CAD to fall this year. Remember, an important reason for the large CAD we are seeing now is huge gold imports. The fall in the rupee should help address this issue.

It may well be that Rs 56 is a bit of an excess but that is to be expected given overshooting in the currency markets. Some intervention may be required whenever there is too steep a fall because FIIs can start pulling out in an even bigger way if they suspect a free fall. The RBI is doing its bit and can be counted upon to do more if required. The government, for its part, is trying to address the fiscal deficit by raising the prices of petroleum products.

It is not at all clear that the flight of FII capital is on account of "policy paralysis". There was little movement on reforms in 2011 but that did not come in the way of nearly $10 bn of FII flows in the first three months of 2012. The present flight of FII flows is a  reaction to the Eurozone crisis and represents the preference for the safe haven of US treasuries in times of crisis. Those who think government inaction has led to foreign investment sentiment must explain why FDI rose significantly in 2011-12 over 2010-11.

I don't see the decline in the rupee as a harbinger of bad times to come. The Eurozone crisis that we are now faced with is no different from what we faced in late 2011. Since we managed growth of 7% then, we can be optimistic about touching 7% this year as well. You think that's bad? Think again. If we touch 7%, we will be the second fastest growing economy in 2012 in the world after China.

More in my ET column, Global recovery is two years away.

8 comments:

Vishal Kale said...

Solid Points! Read your column as well - and am in totsl agreement. Yes, the situation is drastic - but nowhere near the 1991 situation. And right again on Petroleum prices!

Anonymous said...

The current situation may not be a corollary of nonchalant called 'Policy Paralysis'. And the Technical Analysis evinced may be apt.

But that does not elude Government of its dithering attitude and lack of pace in the velocity. When you're second in terms of GDP, you can not live with the way reforms are initiated.

It won't be right to compare this with 1991 - Agree. But it won't be right even to compare it with what economists & government were rhetoric in 2008, when world confronted crises. It's not very bad, but its not good as well.

The conundrum is - can this become worse? If yes, what ought to be done to preclude the snowballing impact? Is the government on to those things?

srini said...

Are you going to revise your forecast after today's GDP report?

Anonymous said...

Something tells me you will have to swallow your words! By 2013 we will be on the threshold of a recession, the rupee will be flirting with 60 (there has to be ultimately a differential inflation adjusted parity) to the dollar etc.....

Anonymous said...

"Since we managed growth of 7% then, we can be optimistic about touching 7% this year as well. You think that's bad? Think again. If we touch 7%, we will be the second fastest growing economy in 2012 in the world after China. "

You should know something called the low base effect. Comparing emerging country growth with developed country growth is comparing apples to oranges. Why do smart people like you keep making this mistake?

Anonymous said...

I am also worried about the fact that Indian Economy cannot afford to contract. Even if Greece, UK or US economies contract it does not matter much because they have all facilities (i mean infrastructure, public health, education etc..) built for their nation. They probably have to halt for few years but then they will be fine after that. A contraction in Indian economy is disastrous as we have no facilities. No agriculture, No manufacturing and we solely rely on service industry. This is very unhealthy for an economy as we have huge population (UK can afford to be service oriented country as its entire population is less than Tamil Nadu's population). Infrastructure, public health, education etc. are deteriorating and secondly they are coming at a big prize (more taxes on middle class). How long do tax payers pay to Air India and Indian Airlines when their tickets are no less than other airlines. Hence it is for these reasons that I am pleading that we need immediate STRUCTURAL REFORMS to ease this situation. I dont mind if allow FDI into all fields. It's far better than being ruled by these ridiculous, corrupt, ignorant, irresponsible and unscrupulous politicians.

Anonymous said...

"Why do smart people like you keep making this mistake"

Why do illiterates like you feel compelled to comment on economics is beyond me

Anonymous said...

"Why do illiterates like you feel compelled to comment on economics is beyond me"

ok, I'm illiterate, certainly know nothing about economics, but would you care to also explain what was wrong with my point? Or, is it so obviously wrong, that there is no point in commenting on it?

Well, then how about commenting on the more palatable point made in the comment after mine - that post makes the point about developed vs developing economy growth, and in other words makes the same point about low base effect. Do you disagree with him/her? Why?