Rollback to forward
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- PM Modi arrives in Belgium to attend India-EU summit
- Uttarakhand crisis: Centre moves HC challenging its order for floor test
Slamming the brakes on budget proposals may stave off crisis, restore confidence
While introducing the finance bill, Finance Minister Pranab Mukherjee postponed the General Anti-Avoidance Rules (GAAR) and promised not to introduce tax policy changes retrospectively. Proposals to give arbitrary powers to taxmen and numerous retrospective tax changes were incredibly bad policy and the government should never have introduced them. But with the country running a large current account deficit, even if the government believes that these policy changes are important, India cannot afford to turn foreign investment away at the moment. A greater dependence on foreign loans to finance the deficit can weaken fundamentals further. The rollback of budget proposals will help reduce the risk of a balance of payments crisis.
The rupee has been under pressure to depreciate in recent days. As foreign investors turned away, the RBI not only stepped in to intervene, it took measures to ease foreign debt inflows that may stabilise the rupee for some time. But in case of a crisis this move could create an even bigger contractionary effect. Capital account liberalisation is good for a country, but can be a source of risk. Especially when an emerging economy chooses to finance a large current account deficit by borrowing abroad.
The recent pressure on the rupee is not due to a one-off temporary shock, say, a hike in US interest rates or a nuclear test by India. It is the result of a slow deterioration in macroeconomic fundamentals of the Indian economy. With the government on a spending spree, fiscal deficits are rising and the country as a whole is spending more than it is producing. This profligacy is visible in net imports. India imports more than it exports by 4 per cent of the GDP today.
The identity of the current account deficit on the one hand and expenditure minus production on the other is often forgotten or ignored in policy circles when they attempt to address the symptoms rather than the disease. In recent months, the first level of response by Indian policymakers was to address the demand and supply of foreign exchange by selling foreign exchange reserves to prevent rupee depreciation. This could not solve the fundamental problem of overspending.
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