The
Panic that did Not cause a Crash
The rupee has not collapsed. There
has been no capital flight. Stock markets have not plunged. Credit ratings
have not deteriorated. Inspite of radioactive war clouds over our region,
there has been no repeat of the 1990/91 financial crisis. Why? Because
of Manmohanomics that laid the foundations of an outstanding management
of India’s external accounts over the past decade. In addition, the
RBI’s innovations in domestic financial markets (like abolishing the
automatic monetisation of the government’s deficits) and in monetary
policy instruments have strengthened the external sector.
First, today India has over $ 55 billion of foreign exchange reserves,
sufficient for almost a year of imports. These reserves have been built
up without a significant escalation in the country’s external debt and
without boosting inflation. Reserves are never enough but today they
are high enough that very few fear a sudden loss of dollars. Under the
broadest definition and in the worst case scenario, just about $ 20
billion of the reserves is “hot” money.
Second, India’s much-maligned capital controls regime has its virtues.
Short-term capital inflows are discouraged and there are restrictions
on capital outflows. Short-term debt now constitutes less less than
a tenth of forex reserves, down from almost 150% as at end-March 1991.
Overseas borrowings have been very prudent.
Third, the RBI’s record of managing the exchange rate is commendable.
The over-valuation of the rupee, that killed us in 1990/91, is now very
marginal with respect to a basket of five leading currencies. During
a systemic crisis, residents are the first to move their money out.
But in India, ordinary citizens are prohibited from doing so. They can
convert rupees into dollars for genuine purposes like education and
travel but not for making overseas investments and for exporting their
savings or capital gains.
Fourth, the current account deficit is extraordinarily safe. This is
made up of the trade deficit (imports minus exports of merchandise goods)
and earnings from trade in “invisibles”, like software exports and remittances
of workers from overseas. The current account deficit is secure because
of the very impressive growth in invisibles earnings in which liberalisation
of gold imports in 1996 has played a key role. But the deficit is low
also because domestic investment is not booming-a cause for great worry.
Fifth, with the proliferation of the internet and after a decade of
reforms, both the NRIs and the FIIs (foreign institutional investors)
are better informed and seem to have adopted a bit of the Indian blas�
attitude towards impending disasters. Reserves would have been about
$ 10 billion lower had we not borrowed from NRIs in the last three years.
Some FIIs have exited but most are comfortable. 96% of the approximately
$ 15 billion of FII investment in India is in equities. The fear that
any substantial liquidation would lead to a sharp fall in market values
works, in Montek Ahluwalia’s words, as an automatic stabiliser. It also
helps that the FII community has a large proportion of young Indian-born
or Indian-American professionals. Further, many Indian companies are
attractive investments. India is no longer seen monolithically but as
a conglomeration of states, some of which are well-performing.
It would, however, be unwise to be smug. India is not exploding externally
but is imploding internally because of the appalling state of its public
finances which is stymieing increased investment and faster growth.
India’s country risk premium has increased and there is uncertainty
in areas like IT and tourism. Corporate India must, therefore, push
for confidence-building treaties with Pakistan to reduce the risk of
nuclear and missile conflict. More than that, buoyant domestic economic
performance with strong external linkages is the only way to increase
our global leverage and minimise strategic costs.
