India’s stock markets crashed by 769 points on August 16, as investors reacted to good news in the US and bad news at home. Stock markets fell and the rupee has crossed the Rs 62-mark, as the RBI’s capital control and gold import restriction measures appear to have caused panic.
Rather than take these measures seriously, in which case the rupee would have gained, the market appears to be thinking: “they seem to be panicking, so is the problem worse than we thought it was, and if so what’s the guarantee that more such measures will not be implemented?”
And there was bad news from abroad too. Economic data from the US suggests the odds are in favour of a scaling back of the US Federal Reserve’s quantitative easing sooner than later. Data on consumer inflation and initial jobless claims released on Thursday indicate that the US economy is on the mend and a QE taper may be around the corner. That raises the prospects of further outflows from emerging markets, putting more pressure on the rupee.
That is a tough position to be in. The RBI and the government needed to do something—they have made it tougher and more expensive to import gold and silver and they are now restricting dollar outflows. But putting capital controls seems like pressing the panic button. The RBI has capped the amount that Indians can freely remit abroad by 63% to $75,000 in a year, or cannot freely remit money to buy property abroad freely reeks of an era of micro-management by bureaucrats and not of a free democratic republic. They have even limited the overseas acquisition limits for companies from 400% of net worth to 100%. If even this does not strengthen the rupee, what will they do next? Will they prohibit foreigners from taking the money out?
All this seems very retrograde. Even if they did nothing, they would be criticised for letting things worsen. Can the outcome be different if they join forces, without letting one-upmanship and a blame game mar their common objectives—making financial markets strong once again and reviving animal spirits in the economy?
First, let us look at the key problems they are facing, a few of which the government and the central bank have tried to tackle, but not always in right earnest, and not always as a team.
Slowing growth: the government considers this a big problem as it means lower taxes, lower jobs and poor investor sentiment. The RBI, while being concerned too, is more interested in robust growth – meaning growth that does not come with sky-high inflation.
The falling rupee: a rising import bill and falling exports have meant that foreign dollar inflows are needed to bridge the gap. The Fed’s taper plans have seen portfolio outflows while slowing growth and the government’s poor policy-governance track record have hit FDI inflows. The RBI is more concerned about the currency situation than the government is.
High Inflation: This has been a bone of contention between the RBI and the government for ages. In the current governor D Subbarao’s early years, it was common to hear the finance minister and even the economist-turned Prime Minister, Manmohan Singh, say that some inflation is acceptable if it is accompanied by high growth.
That pressure from the government perhaps did see the RBI go slow on tackling inflation even while as soon as it crossed its tolerance limits. That proved to be an expensive mistake. Now that the RBI has decided to tackle inflation and even the rupee, it is hurting other macroeconomic variables.
This government and the RBI have not sufficiently tried to find common ground and win over the other side to their point of view. This has led to individual fire-fighting, sometimes resulting in causing a fire in the other’s camp. For example, the RBI’s tight monetary policy is affecting economic growth, in turn hitting the government’s revenue-raising targets.
Both the RBI and the finance ministry are manned by men of intellect and power. But, they do have great responsibility too. It is high time they realise that they need to put their differences aside and act in tandem. They need to publicly stop criticising each other’s policies; as even indirect criticism affects the credibility of one party’s actions in the eyes of the market.
Now is the time for non-partisanship, between the Centre and the Central Bank, and the Centre and the state governments. It is perhaps the Centre that should step up to the table and invite the others for a reconciliatory dialogue for a way out of this mess. Why state governments? If regional parties have acquired much more political power than earlier, their role in the economy too has become very important.
The RBI and the government can still join hands to send out a strong message to the world. Read about what they can do here in a separate article (will be uploaded shortly).
Read the RBI press release on capital controls here and on gold imports here.