The stock of reserves in itself is not a sufficient indicator, but the quality of such assets determine whether a country is vulnerable or not. Although RBI is sitting on a kitty of $400 billion, most of it is liability where the central bank is under obligation to repay when demanded and it’s not an asset which has been earned.
The country’s short-term external debt is at $196 billion and the long-term debt at $276 billion, which when the repayment time comes can exert strain on the currency if it coincides with some adverse global developments. Conventional metrics like ‘12 months of import cover are sufficient for a country’ may not hold true anymore as the movement of capital far outweighs the importance of trade and commerce.
“It is difficult to define the appropriate level since months of import cover, a traditional indicator, has become less relevant due to other liabilities,” says RBI’s former Governor YV Reddy. “The most important source of vulnerability for India in future would certainly be the magnitude of volatile capital flows and external debt, especially shortterm debt.”
When macro-economic worries appear, it is difficult to prevent currency slump even for countries with reserves built from exports rather than volatile capital flows. China had $4 trillion of reserves in 2015, but it lost $1.5 trillion in 13 months from capital outflows. And $1 trillion was used up in defending the currency, but it still crashed 10%.
IT’S THE MACRO, STUPID
Money is fungible. It chases assets that yield high returns and, at the same time, investors do want their money back, hence, one must keep an eye on how sound the balance sheet of a company or a country is.
The Indian economy is considered sound not because it possesses high foreign exchange reserves, but it was its promise of building a sound economy that resulted in such a high inflow.
In 2013, the nation was worried about a depreciating rupee when the RBI had to come up with a FCNR B deposit scheme with currency hedge. Now, the clamour is for RBI to prevent rupee appreciation. What turned the situation?
Since the 2013 currency crisis, India has come a long way in terms of economic management. Fiscal deficit, which was at 4.9% of GDP in 2012, is projected to shrink to 3% in 2018. Current account deficit, which was at 4.8% of the GDP in 2013, collapsed to 0.7% in fiscal 2017.
Consumer price inflation, the biggest mover behind currencies, has eased to 1.5% in the June quarter from 10.1% in FY13. The Modi government’s stubbornness in sticking to the fiscal deficit target enshrined in the Fiscal Responsibility and Budget Management Act and the adoption of inflation targeting have comforted investors that India was pursuing prudent policies. Fiscal profligacy is the root cause of most economic crises in emerging economies.
Government’s overspending crowds out private investment as it makes overall interest rates higher for the industry to borrow.
Spending by the state is always less efficient than spending by private entrepreneurs and whatever the economic benefit that it intends to achieve, if at all it materialises, it does take a few years than immediately.
Economic mangers conveniently blame factors beyond their control for any crisis. In 2013 ‘taper tantrum’ of Federal Reserve’s Ben Bernanke was blamed for the ills, and in 2008, it was Lehman Brothers.
Prior to that, in 1991 the political turmoil caused by the collapse of the Soviet Union and the Asian crisis in 1997. But on each of those occasions, it was India’s poor macros that caused more harm than the external factors.
“Till date, India has never had a fiscal stimulus that has not ended in tears,” says JPMorgan’s Aziz. “The 1982 crisis was created because of massive fiscal spending in 2-3 years before that.
The 1991-92 crisis was created by massive fiscal spending before that, the 2013 near-crisis was created because of the fiscal spending before that. India has never managed a fiscal stimulus till date.”
If history is any indication, efforts to stimulate the economy through fiscal stimulus may be a wasted bullet. What the government needs is to move in the direction it chose after the elections in creating a bullet-proof balance sheet.
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