Is the solution to excess foreign debt more debt? Does the answer to the rupee crisis lie in increasing dependence on dollar financing? Is giving hot money the red carpet treatment the right way to reduce vulnerability to hot money flows? Can the problem of falling domestic savings rates be solved by cutting domestic interest rates and paying foreigners and non-residents better interest rates? Can you have low interest rates with high inflation?
Commonsense should tell us that the answers to all these questions are a clear no. But this is precisely what the government of India thinks is the right solution. It has been opting for non-solutions, in fact “solutions” that will compound the problem instead of solving it, driven by short-term political calculations.
Over the last two years the government has encouraged foreigners to invest in domestic debt and equity. The sharp fall in the rupee is because some of this money is leaving India, as interest rates in the US look better. But the government has not learnt its lessons. Since foreigners are leaving, it wants Indians living abroad to plug the gap with their dollars. The government is also considering the issue of quasi-sovereign bonds abroad – issued not by itself but by public sector entities – to raise dollars.
Does this make sense? According to this Times of India report, banks are offering significantly higher interest rates both for non-resident rupee and dollar deposits. The divergence ranges from 0.25 percent to 0.75 percent for varying tenures.
Let’s leave the dollar rates alone, for the moment. If you want rupees, why pay the NRI a higher rate than the RI – the resident Indian?
There is, of course, some logic to this: NRIs deposit dollars and denominate their savings in rupees. So the higher rate is really for getting more dollars in at higher rates. Makes sense? Actually not.
Consider the problem that is really cropping up: India’s core macroeconomic issue is that we have a falling domestic savings rate and a still elevated investment rate. In 2011-12, we had a gross savings rate of 30.81 percent, down 6 percent from 2007-08.
The investment rate fell less sharply, from 38.03 percent in 2007-08 to 35.70 percent.
The gap between savings and investment is thus 35.70 minus 30.81 – nearly 5 percent.
Now let us consider how this is connected with the current account deficit (CAD) – a key cause of our rupee crisis.
The CAD is not only the excess of our foreign spending over our external earnings and remittances; it is also the gap between the domestic savings rate and the domestic investment rate. If we don’t save enough at home, we have to import the capital. Is it any surprise that the near 5 percent gap between the savings and investment rate is being financed by a near identical CAD gap of 5 percent?
And when the climate for capital import is worsening – as it is now – we should be focused on raising the domestic savings rate, not seeking to import more capital on more unfavourable terms, as the difference in the NRI deposit rate alone shows.
Then there is the economic and ethical argument. Why should rupee savings have two different rates – one for NRIs, and another for locals? Is this not an open invite to Indians to send their rupees abroad and then bring it back as NRI deposits? Not that this is easy, but this is what is being incentivised. Are we not distorting the market for deposits this way?
Next, why should the government borrow more cheaply that you or me?
Recently, the Reserve Bank tightened short-term rates and this caused a sharp rise in yields on bonds (meaning, their market prices fell), which damaged the returns on debt funds. But when the rise in yields started impacting the prices of government bonds, the RBI suddenly decided it can’t afford to raise rates for the government. So it decided to buy short-term bonds and sell longer-dated ones so that rates for government bond issues don’t go up too much.
Once again, we have two classes of borrowers: when I take a home loan, I borrow 10- and 15-year money at 10.5 percent (or more). My loan creates demand for houses and jobs in the real estate segment; the government can borrow at lower rates, but substantially wastes this money in corruption and leakages?
The explanation for the divergence could be that I may not repay, but the government always repays. But is this the case? Governments often repay by printing notes, which creates inflation. Ordinary people repay by earning more and improving their own productivity (in a new job, or by showing improved performance at work).
In short, government repays by a form of financial repression where it lowers its actual interest costs by stoking inflation – surely an anti-social move.
The right answers to the rupee/CAD/fiscal deficit is staring us in the face: it is to free the rupee (if it goes down, it will curb imports and improve exports; if it goes up, it will curb inflation); free interest rates (if rates rise, they will improve domestic savings rates, and reduce the need for foreign flows; if rates fall they will boost domestic investment and supplies and hence inflation); and real reforms to boost domestic sentiment and investment (free agriculture, ease labour and land laws). Growth will happen when businessmen see prospects of making money, and not just because rates have fallen artificially.
Lastly, the business of government is governance. Its first duty is to protect the borders and enforce law and order. Next, it must facilitate the creation of social and physical infrastructure (schools, hospitals, roads, etc), and also create a transparent and simple system of law and regulation where business knows the rules and is convinced that the field is not tilted against it. Even if you are ideologically against free markets, you can’t oppose the fundamentals of governance.
We know that government – at centre and states – has not done these basic things. China can come and go from our territory with impunity; illegal immigration from Bangladesh continues (thus, our borders are not safe). Law and order is largely a myth – our cities are not safe, as the brutal rapes of the recent past and surging crime rates attest. Business success depends on who you know in government, not how to satisfy customer needs.
India’s nirvana lies in governments getting back to basics. They should not try to take on new responsibilities (food security, giving free laptops) without first reforming governance.
