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Article rank 20 Nov 2018 mint ePaper

V. Anantha Nageswaran is the dean of the IFMR Business School. These are his personal views. Read Anantha’s Mint columns at
www.livemint.com/baretalk. Comments are welcome at views@livemint.com BARE TALK V. ANANTHA NAGESWARAN

S. Gurumurthy’s hit and misses

Social media is busy analysing S. Gurumurthy’s speech at the Vivekananda International Foundation on 15 November. He
is a government nominee on the board of directors of the Reserve Bank of India (RBI). The board is meeting on 19 November,
hence, the extraordinary interest in and reactions to his speech. It was an impressive speech and one that is thoughtful and
thoughtprovoking, as always.
In principle, the idea that a country that faces a twin-balance sheet problem—in the corporate and in the banking sector—
should have the option to consider a central bank-funded government expenditure programme is not that outlandish. It is
conceptually correct. Problems arise in translating it into reality.
The developed world has always preached one thing to developing countries and done something else under similar
circumstances. Faced with a balance sheet squeeze, America, the Eurozone, Japan and the UK engaged in monetization of
government debt, even if it was not quite the monetization described in textbooks. But the all-important fact to note here is
that financial markets allow them to do so. Financial markets do not extend the same courtesy to developing economies. It is
partly unfair and partly with good reason.
It is unfair because financial markets constrict sovereign policy choices for developing economies. It is with good reason
because it takes time for emerging economies to win credibility and the trust of investors. Once they are established, countries
can and do abuse them and get away with it. However, it takes a long time for financial markets to revisit the risk premiums
they attach to assets of developed and developing countries. For better or worse, India is wired into international financial
markets.
Even if India wants to raise walls for capital inflows and outflows, it cannot do so because it runs a current account deficit.
It needs to be funded. It is one thing to say that India welcomes foreign direct investment (FDI), but it is another thing to find
foreigners willing to supply all the external funding needs as FDI. India also does not want it to be all equity flows because
ownership is a sensitive matter, but debt money funded external deficits are not ideal because they are not stable, but fickle
flows. So, conceptually, Gurumurthy’s idea is correct, but practically it is impossible.
Hard-currency countries could get away with deficit financing which is what quantitative easing (QE) was about. Emerging
economies cannot. There will be a heavy price to pay. That is the market reality. In other words, Gurumurthy ignores the
counterfactual—the costs of pursuing such a policy for a developing country. QE was in the context of a Great Recession. But
India has been claiming that it is the fastest-growing large economy in the world. Therefore, the government has failed to
make the case for such a remedy in India.
Gurumurthy has zeroed in on an important fact of modern exchange rate regimes around the globe when he stated the
following: “The Indian rupee gets expanded only when dollar comes in India and when the RBI acquires the dollar, it prints
Indian rupees and gives it to the banking system. There is no other way the Indian rupee gets generated today.”
To be clear, India does not run a currency board system with the US. India is free to estimate its money supply needs and
print Indian rupees accordingly. But emerging economies, in particular, regardless of whether they are in a fixed exchange rate
regime with the US dollar, do expand their money supply when US money supply expands and contracts their supply when US
money shrinks. It is because the US consumer is the market for many economies.
Second, when US monetary policy is expansive, the US dollar tends to weaken and emerging economies experience foreign
capital inflows. Global confidence and risk appetite are usually high when the US dollar is weakening. So central banks in
developing economies tend to run expansive monetary policy then, to prevent their currencies from strengthening excessively
against the US dollar as capital floods in. When the US runs a restrictive money supply, risk appetite turns south, dollar
borrowing obligations begin to bite and emerging economies raise rates to prevent their currencies depreciating too much, too
fast. Sometimes they succeed and sometimes they don’t.
So, the developing world, in particular, is still operating as though it is in a fixed exchange rate regime with the US dollar.
It is partially true for India despite the fact that it has a large domestic consumption share of gross domestic product. It is hard
to get away from this reality as long as the US is the world’s dominant consumer market, as long as India runs current account
deficits and as long as India has to keep an eye on its external debt repayment obligations in any given year.
In short, while there is much conceptual merit in Gurumurthy’s speech, India is not in a position to embrace his ideas in
practice because its economy is far from being strong. It has to raise its head slowly before striking out on its own. There
might have been a time when India and China dominated the world, but that was when economies were labour-intensive and
not capital-intensive. The Great Plague came and the world became capital-intensive. Economies rich in labour endowment
have not figured out since then as to how to grow and regain their lost glories, Gurumurthy’s latest speech notwithstanding.
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