Market crash-Part II: the RBI and government should join hands

In the previous article, the main problems facing the government and the RBI were listed –a falling rupee, slowing growth and rising inflation. What is needed at this stage is confidence-building measures rather than the fear-inducing steps taken, such as the one imposing capital controls. Foreign investors have been caught on the wrong foot in many countries, where they were prevented from taking their dollars out. They need to be reassured that option is not on the table. Instead, the government and the central bank will tackle the underlying problems.

The RBI and the government—including state governments—should come together. The government has many tools at its disposal, but the RBI’s tools are restricted to money—either controlling its flow or its cost. So it would seem only right that the government step up to the task first and then ask the RBI to play its part.

Tackle inflation: inflation in non-food manufactured products has receded but food inflation continues to be high. Some of the reasons behind this could be structural, but there are weaknesses in the market too, which may be preventing prices from falling despite good agricultural output.

The government should send a message out that it is serious about tackling food inflation and, here is where the state governments can play an important role. The states control the supply chain for food and their co-operation is essential to beat down food prices. The government can use its own buffer stocks and also import items in short supply to lower prices and also prohibit exports of the main food products in our consumption basket.

The governments should also convince large producers, suppliers and bulk users that they need to ensure prices remain low. Now, some may crib that farmers will get affected but, the government’s minimum support programme exists to provide them with price protection. The government needs to make its intention very clear – that food prices have to come down and it will not rest till they do. That should be enough warning for the hoarders (if there are indeed hoarders as some quarters suspect) to start unloading their stocks.

If food inflation comes down and stays there, then wage inflation will turn more gradual and even broad inflation will tend to come down. The benefits of this are not only to the RBI but the government as well. They need to talk as one on their firm desire to bring down inflation and any number of steps as needed should be taken to achieve this outcome. This is, of course, a long term strategy, but even initial signs that this strategy is working, and that the government knows what it is doing may convince the RBI that inflation will fall below its tolerance levels.

Slowing growth: if the government succeeds in demonstrating its seriousness in taming food inflation and retail inflation, the RBI should get enough leg-room to do several things to support growth, such as cutting interest rates and improving liquidity. That, in turn should energise growth, drive up consumption, drive up tax revenues and lower the fiscal deficit further, and in turn revive investment-led demand too. A better mood will prevail among investors, consumers and the industry.

This should result in better stock market valuations bringing back foreign portfolio inflows.

Strengthen the falling rupee: Improving portfolio flows will be a welcome sign as it can help the rupee stabilise. But the government and the RBI seem to have decided that gold is the softest possible target that they can attack to control a falling rupee. But, they can also tackle the underlying problems that have led to growing investment demand for gold—poor confidence in the economy, high inflation and falling stock market indices. If they tackle high inflation, as mentioned earlier, then one problem is taken care of.

What else can the government do to tackle a weak rupee? Stepping up exports growth is one option. This option is not getting enough attention because this cannot happen overnight and the global economy too is under pressure. That does not mean that India cannot take a higher share of the global trade pie. Also, if Indian companies are getting anywhere between 15%-20% more to a dollar, that should be adequate motivation for them to export more.

The government can give them some more encouragement. The commerce ministry has been meeting exporters and trying to resolve their procedural issues. But the finance ministry can step in too. The government has taken away export-related tax benefits, to move towards a zero exemption tax regime. Now may be the time to suspend that temporarily. The government can restore tax exemption on exports, with pre-conditions such as allowing exemption only on incremental exports and restricting it to companies of a certain size to avoid misuse.

The next step the government needs to take is to restore credibility in the policy and governance space. There are various aspects to this, including zero tolerance for corruption and cronyism and avoiding retrospective changes to policies. These can be divided into immediate, medium term and long-term changes. If the government can make good on the ones that can be immediately done, and lay out a roadmap for the medium-term and long-term policies, it would send the right signals.

The government has been consulting industry on freeing of FDI caps. But is has not taken up the liberalising of FDI in sectors such as education and real estate. Both are sectors where the entry of foreign competition should do wonders both for consumers and the growth of the industry. Next, it should get all ministries and state governments on board, to ensure that investments are not being held back other than for genuine reasons.

These measures put together should have a positive impact and set the rupee back on a more stable path.

Now, surely the government has enough talented advisors who could have told them about these and, perhaps, even better measures to pull the country out of this financial mess. Either the government does not want to listen, is not asking the right questions, or is fearful of the political fallout of these measures and their impact on its prospects in the forthcoming elections.

Now is the time for some firm actions from the government, irrespective of the political impact. The country is nowhere near an economic disaster as yet, but the situation can quickly turn bad if the government and the RBI do not play together as a team.

And yes, the opposition has complained that it is the government’s belligerence and arrogance that has forced them to adopt a disruptive approach in parliament. The government needs the opposition’s support in this task, whether it likes it or not. It needs to send a reconciliatory message and win the support of opposition parties.

The government should be able to convincingly tell people: “Yes, there are external problems we cannot do much about. But, internally we are doing all the right things possible to minimise damage to our economy and its growth prospects. That’s the best we can do given the circumstances.” That should be enough as India’s long term prospects are still bright. Even the most pessimistic of investors will agree to that statement.

But right now, nobody gets that feeling when they see the government and RBI blunder along, week after week. Whether voters will remember these issues is a different matter, when India goes to the polls in 2014. If investors are left holding a mess not of their making, India’s image as an attractive destination for investors will take a considerable beating.

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