Rudimentary Policy Debates In India

*Ashmita Gupta

**Nasir Saboor

Introduction: The outcome of an economic policy lies not only in economist’s effort but
largely driven by its political affiliations. The rudimentary debates in macroeconomic policy in
India begin with demanding adequate poverty line deliberately avoiding high inflation. The
policy makers, apart from acknowledging stimulating factors to growth must also be equally
conscious of hazards dwindling under the appellations of nationalism and protectionism.
Monetary Policy of RBI is consistently at below par in determining the rate of interest and is
relatively indistinct and unclear in stance. Rest, any presage about the economic denouement is
certainly unprivileged due to underlying parallel actions of hidden factors.

With the starting of this decade Macroeconomic policy of India raises certain essential questions.
First, with debates over adequate poverty line for India, policymakers looked for an answer as to
what should be a suitable rate of economic growth that India can sustain without sparking off
high inflation? The answer is of prime importance because for an economy emerging out of the
aftershocks of 2008 financial crisis, policies for stimulation of the economy to get back on track
was important.

With a high consumer inflation, high current account deficit and a fall in the potential growth
rate of the economy (to as low as 6 percent, about 2..5 percentage points below what was in
2008) at the start of the decade, now at the onset of end of this decade, World Bank projected
India’s growth rate to hit 7.3 percent in 2018 and 7.5 percent in the next two years at the
backdrop of 6.7 percent growth in 2017.

*M.A Department of Economics, Faculty of Social Sciences, Banaras Hindu University-221005

(ashmitagupta184@gmail.com)

** M.A Department of Economics, Faculty of Social Sciences, Banaras Hindu University-

221005 (nasirsaboor@gmail.com)
FITCH Ratings also projected India’s medium term growth potential to be highest among large
emerging markets (EMs) as compared to China which has slowed since the late 2000s mainly
due to deteriorating demographic outlook, slow down in the rate of capital accumulation and fall
in investment rate. However, in case of India, despite the initial setbacks from GST and
Demonetization, placing high importance to demographic factors and investment rates place
India at the top of the list among the 10 largest emerging markets (EMs), FITCH said in a report.
Steps to materialize the potential in direction of boosting investment prospects, doing away with
huge non-performing assets (NPAs), improved labor market reforms, relaxing investment
bottlenecks, bank recapitalization along with huge potential with respect to secondary education
completion rate will help improve India’s prospects.

India along with Indonesia, Mexico, Turkey and Brazil are set to see continued robust growth in
the working age population in the next 5 years, bolstering GDP growth potential, FITCH said. In
contrast, Russia, Poland, China and Korea headwinds from deteriorating demographics which
will weigh on growth in future. India has a favorable demographic profile which is rarely seen in
other economies, thus, improving female labor force participation is going to be an important
aspect. India has an ambitious government undertaking comprehensive reforms and these
reforms are formidable in bringing out policy uncertainty.
The next important question which arises is why was the rupee losing value at the start of the
decade? The answer probably lies in high inflation, falling productivity growth, large trade
deficit and loss in export competitiveness during that stance. Increase in domestic prices led to
the fall in the domestic purchasing power which converted into fall in the international
purchasing power. Excess inflation in India as compared to its trading partners has led to a
decline in rupee in the past decade. The situation is a reversal of what we experienced at the
beginning of this millennium – a time when India has low inflation, rising productivity growth
along with the rise in rupee.

However, the current situation depicts somewhat a different picture. A higher exposure is bound
to impact currency and bond markets. Two important events in this regard are:

a) Donald Trump’s administration’s shift towards protectionism

b) India’s urge to narrow trade deficit with China

The dynamics shaping the global trade scenario is somewhat “dangerous” for some economies
with fears leading to a shift towards de-globalization (signs of slowing international trade) and
nationalism (to unfurl the “America First” flag by Trump administration).

In March 2018, US President Donald Trump has hiked import tariffs on two separate occasions.
At the advent of starting of March’18, the tariffs were hiked – 25% on steel and 10% on
aluminum imports, which would have a bearing on both India and China.

By the 3rd week of March, US struck another decisive blow on China by imposing new tariffs on
$60 billion worth of Chinese technology and consumer goods.

India’s trade deficit with the US is much lower in contrast to its trade deficit with China. Largest
share of India’s exports goes to the US (16.13%) with 3.42% of the exports to China. The
imposition of tariffs on steel and aluminum by Trump administration has a tale depicting a
planned move- this is only because 5% of India’s exports to the US are metals out of which only
3% accounts for steel. However, there has been a sharp increase of 41.6% in India’s steel and
iron exports to the US during April 2017- January 2018 (Source: Ministry of Commerce). With
the hidden objective of moving towards protectionism, this tariff imposition is set to give a blow
to India’s low trade deficit with the US.

Thus, India is looking for an avenue to make its trade with China more favorable, attempting to
lower its widening trade deficit.
Installing levee in terms of protectionism by countries will not just affect trade between them but
also global trade and supply chains , the geo-political equations underlying the economic
relations (manufacturing, employment, output, cost, lost of government revenue and other
relating variables). At present, “America First” is a threat to the entire process of multilateral
trading system. A higher exposure to this degree is bound to impact currency and equity markets
– making it more vulnerable and volatile.

For instance, Korean won depreciated the most (1.5%) as aftermath of the US-Korea Free Trade
Agreement. Vietnam dong depreciated to the weakest level in 2017. The US currency too
suffered losses in global markets on intensifying trade war scenario. However, it later
strengthened against some currencies amid trade negotiations of US and China which eased fears
of trade wars. Dollar’s weakness against a basket of currencies supported our domestic currency
unit. Rupee strengthened against US $. With uncertainties still dwindling over the trade
negotiations, an import tariff would lead to inflation and the exchange rate movements- favorable
or unfavorable.

The third prime important question pertaining to policy is: What should be the level of interest
rates?

At the start of the decade, Café Economics has cited three studies that used Taylor’s rule
showing that policy rates in India have been lower than needed in the recent years- loose
monetary policy. Monetary Policy Committee (MPC) of RBI kept interest rate unchanged from
August 2017 at 6% p.a. – lowest in almost 7 years, on February 7, 2018 mirrored to market
expectations and fears of high inflation ranging all over.

Forecast of inflation (intermediate target of Monetary Policy), growth potential and desired real
interest rate are important unobservable variables around which India’s interest rate policy
centers.

Getting inflation forecast right is a major key variable. RBI is not alone in the list; most Central
Banks of other nations struggle to achieve this. It is important to look where inflation is one year
from now. Since, Monetary Policy works with a lag of 3-4 quarters, a decision taken today by the
Central Bank will effectively show results down the line in a year.

RBI went off guard in extrapolating the inflation situation probably camouflaged by the impact
of demonetization on prices. Expectations of future inflation added to the equilibrium real
interest rate gives an idea whether the interest rates are at the correct level or not. The debate on
India’s interest rate policy is fairly not optimal since inadequate attention to the unobserved
variable is given. However, the neutral stance on Monetary Policy implies that future policy
changes would be data- driven.

CONCLUSION: With signs of stabilizing impact of GST implementation, revival in investment

activity, large resource mobilization from primary capital market, provision for recapitalization
of Public sector banks – has projected a GVA (Gross Value Added) growth for 2018-19 at 7.2%
overall, balancing the risks evenly.

The objective of achieving multiple Monetary Policy targets, the unsettled debate of inflation vs.
growth (high growth with stable inflation), rapid transition and economic catch-up, calls for
adequate actions and correct future projections or forecast – for a stable, balanced and visionary
Monetary Policy. The ongoing macroeconomic policy needs to take into account empirical
evidence as well as underlying analytical base (feasibility). India in transition requires
contribution of ideas to development. Entrenched pessimism is bound to happen occur after years
of non-performance in India. However, India is regarded to have the best growth prospects
among Emerging Markets (EMs), much higher than Ems can hope for.
REFERNCES:

1. “Macroeconomic Policy for an India in Transition”, Ashima Goyal, EPW, Vol. 52, Issue
No. 47, November 25, 2017
2. “Three questions on India’s Economy” by Niranjan Rajadhyaksha, Mint, August 6, 2013
3. “India’s potential GDP growth rate at 6.7% over the next 5 years: Fitch Ratings”, Mint,
January 8, 2018
4. “US-China trade war: Which Asian countries’ exports are most vulnerable?”, Mint,
March 27, 2018
5. “Here Comes Trump’s Trade War” by Keith Johnson, Foreign Policy, March 1, 2018
6. “Risks of a US Trade War” by Michael Johnson, World Economic Forum, March 9, 2018
7. “Making sense of RBI’s Interest Rate Policy”, Mint, October 25,2017
8. “India leaves Monetary Policy unchanged”, Trading Economics