Rough Ride Ahead for the Economy

The Reserve Bank of India (RBI) in its first quarter review of the monetary policy decided to keep the
policy rates unchanged. While the policy decision was on expected lines, the central bank has cut its
growth forecast for the current financial year to 5.5% from 5.7%. It also dubbed the external sector as
the biggest source of risk to macroeconomic outlook and refrained from laying out any timeline for
rolling back the measures it took in order to curb volatility in the currency market in July, which
effectively reversed the stance of the monetary policy.
The policy statements by RBI clearly suggest that there is more pain in store for the Indian economy.
Despite a lower base, the growth is not going to be significantly better than the last year. The only
saving grace for the economy at this stage seems to be good monsoon and agricultural growth. The
manufacturing growth has collapsed and there is virtually no sign of any revival in the sector. And with
tightening of credit conditions to defend the currency, scope of any revival has only diminished.
Further, the external situation has become extremely vulnerable which will have an impact on
economic growth and macroeconomic stability. Remember, the adjustment in the global financial
system which led to the outflow of foreign capital from the Indian market, resulting in a sharp fall in
rupee, was in anticipation of a possible roll-back of asset purchase by the US Federal Reserve. We do
not know for sure if that adjustment is over. There is a fair chance that when the Federal Reserve
actually begins to cut its asset purchase, there would be a similar reactionmaybe at a larger scale
making the management of the external account and currency extremely difficult for the central bank.
Therefore, it is highly unlikely that measures taken by the central bank to curb liquidity will be rolled
back anytime in the near future. Put differently, corporate and households should not expect interest
rate cuts in the foreseeable future.
To be fair, there is very little that the central bank can do at this stage. Cutting rates to support growth
could affect expectations in the currency market, though there is no guarantee that just tightening of
conditions in the money market will protect rupee for a very long. But keeping interest rates at higher
levels to protect currency will further damage the corporate balance sheet and affect growth
prospects. Clearly, RBI is caught between a rock and a hard place. The rupee once again breached the
60 mark against the dollar and fell 1.76% on the day of the policy announcement.
However, this situation could have been avoided. Apart from shifting goal posts for the monetary
policy from anchoring inflationary expectation to supporting growth to protecting currency, RBI also
allowed a huge build-up of the short-term foreign debt in the country. The total foreign debt has risen
from the level of $306 billion at the end of March 2011 to the level of $390 billion at end of March
2013. The composition of short-term debt during the same period has also gone up from 42% of the
reserves to 59%. Complicating matters further, the reserves as proportion of debt has fallen from
99.7% to 74.9% during the same period. Evidently, servicing external debt in the near term will be a
big challenge for the economy. It will only intensify the impact of a sudden stop or reversal.
Interestingly, all this while, RBI maintained that it does not need to interfere on the external account,
but the moment currency came under pressure and vulnerabilities on the external account started
getting exposed, currency became the guiding factor in shaping the monetary policy. If the build-up in
external debt was not allowed at this scale, the currency would have adjusted to the macroeconomic

weakness more gradually. It would have certainly put more pressure on the government to act in time
and address the structural weakness in the economy. However, what happened instead was that the
capital account was liberally used to hide the structural weakness and falling competitiveness in the
economy. As a consequence, we have now reached a situation where it is probably too late in the day
to restore confidence and make corrections in the internal dynamics of the economy without going
through the pain of slower economic growthwhich could have been avoidedwhile the external
account now purely depends on statements and action by the Federal Reserve. This is certainly not the
place that India deserved.
The Indian economy has reached a stage where no macroeconomic indicator is in favour. It has large
fiscal and current account deficits, a falling currency, slow growth and high inflation. To make matters
worse, there is no visibility as to how we will get out of this situation. The present situation and future
possibilities indicate a tough ride for the Indian economy ahead.
(Link:

http://www.livemint.com/Money/lSQZnfLfHgDatxBABCGjYI/Rough-ride-ahead-for-the-

economy.html)
http://www.journals.elsevier.com/futures/call-for-papers/india-2050-the-future-of-the-indian-economy/
http://www.niticentral.com/2013/06/01/the-eagle%E2%80%99s-view-of-the-indian-economy-84539.html
http://www.dnaindia.com/india/1863126/report-india-poll-2013-reveals-indians-are-optimistic-abouteconomy-see-pakistan-as-major-threat-and-think-corruption-is-holding-us-back

Meghe Dhaka tara link

http://www.youtube.com/watch?v=H4UQNSK_HVk