FDI Liberalisation and RBI Governor’s Exit at What Cost?

The PMO has stated that the Indian economy is now the most open since FDI inflow has been liberalised further and restrictions in certain sectors have been reduced. The Opposition has linked the move to Dr Rajan’s announcement that he would not seek a second term as the RBI Governor. It is not that he has resigned. They argue that anticipating negative reaction in the markets, the government had to announce concessions to counter it. The two items of news are certainly connected as signals to lobbies in the BJP and international agencies.

Dr Rajan is going to be around till September 4 when his term comes to an end. He will still steer the economy through the uncertainty raised by Brexit and prepare the ground for the outflow of funds raised in 2013 when the rupee was rapidly depreciating. Further, a new Governor would be in place when Dr Rajan departs and why assume that she/he would not be able to handle the situation given the policy parameters already in place? It is possible that Dr Rajan may be able to handle things well but so could another person in his place, unless of course in a suicidal fit, the government appoints a cricketer to bat as the Governor. There is likely to be continuity in policy in the RBI given that bankers are sedate people not prone to sudden changes. Further, do the Rajan supporters feel that the policy-framework he put in place during his tenure is inadequate and only personal factors matter?

Personalities do matter and especially at the helm of affairs. Dr Rajan is said to know international investors, IMF mandarins and Central Bankers of other countries. It is said that he is highly respected and can easily convince them. But so could others. Investment depends on confidence and it is said that foreign investors’ confidence would decline due to Dr Rajan’s exit. But it is worth remembering that in the affairs of nations, personalities matter only so much. The US Congress heard Mr Modi and repeatedly applauded but when the next day it came to giving India a special status, nothing changed.

It is said that the autonomy of the RBI is important and Dr Rajan as an academic was taking an independent line. It is argued that the government did not like this and hence forced him to not seek a second term. How important is the Central Bank policy for an economy? It is no doubt important; but is it crucial?

Since 2008 the Federal Reserve tried to boost the US economy by resorting to Quantitative Easing (QE) without much of an impact. The EU Central Bank has also tried to do the same with little impact. Interest rates have been at record low levels (almost touching zero) and yet these economies did not respond. In technical jargon the economies are in a liquidity trap. In India too the RBI has made dozens of policy-announcements in the last five years with little impact.

In India, the food prices do not depend on the monetary policy but on what happens in agriculture. Here too speculation by trade is crucial—it often aggravates shortages by hoarding, as in the case of onions earlier and now tomato. As far as the other major commodities are concerned, their prices are internationally determined, given that the Indian economy has become a far more open economy. The recent fall in prices is a result of falling global prices, especially of petroleum goods. Thus, the fall in the inflation rate in the last two years has more to do with international prices than the RBI’s policies.

The rupee has depreciated substantially compared to the dollar since 2013. The present comfortable foreign exchange reserves of $ 360 billion are largely due to borrowings which today stand at around $ 450 billion. Thus, much of the reserves are borrowed funds and can leave Indian shores. Especially, its short-term variety can leave rather quickly. No wonder, every time there is a hint that the US may raise interest rates marginally, there is panic in the Indian stock markets that funds will start going out. In brief, the good news about inflation and foreign exchange reserves are fortuitous and not necessarily a result of the actions of the Reserve Bank.

As far as growth is concerned, the RBI has a limited role to play but by not lowering the interest rates more sharply, it did not help matters and this has been a bone of contention between the RBI and the government. The Governor was also one of the first officials (other analysts were quick to question it when the data was released) to question the sharp rise in the rate of growth shown by the new data series put out by the government last year. This did not go well with the government. But the problem is that the RBI did not put out its own estimates in spite of the autonomy that it has. Similarly, it did not present its own estimates of the true inflation since the WPI and CPI are rather inadequate as target variables given that they do not reflect inflation in services which now account for 60 per cent of the economy.

It is well accepted that growth is propelled by investment and that is where the country has faced difficulties. The investment rate has fallen from a peak of 38 per cent in 2007-08 to the current level of about 30 per cent. It is known that the private sector investment has slowed down because of spare capacity which is a reflection of lack of adequate demand. The public sector was also not investing enough till recently because of the cut-back in Plan expenditures. Added to all this is a crisis in the infrastructure sector which has borrowed heavily and is unable to repay the banks resulting in NPAs and the banking crisis. Due to the public outcry on the writing off of debt and growing NPAs, the banks have now become cautious and that is not helping investments. The RBI’s rush to get the banks to clean up their balance-sheets of all bad loans has created an environment of over-caution. There is no doubt that cleaning up was a necessary step but the path needed to be tread more carefully.

In such a situation, is foreign investment the route to raise investments in the economy? One needs to ask: would foreign investment enter in a big way to boost the investment rate of the economy? At present, net foreign investment into India is about $ 60 billion (annually) or about 10 per cent of the total investment into the economy. Even if it jumps by, say, 50 per cent, it would not solve the problem of the decline in the investment rate in the economy. Would it generate jobs in the economy and give a boost to manufacturing?

Clearly, foreign investment in the sectors that have now been liberalised, will be largely capital-intensive rather than labour-intensive and would generate few jobs. Further, if the Indian companies, who may fear the deep pockets of the MNCs, exit or slow down their investment, then that would set back output and employment. Take the example of the competition between Amazon and Flipcart, with the latter facing multiple problems as Amazon expands in India. In the case of airlines where there is spare capacity, Indian investors may slow down their investment. Such decisions will aggravate the demand problem since MNC investment would take time while in the meanwhile Indian investment may decline. For instance, investment by IKEA and Walmart has been talked about for quite some time but it has yet to take place.

What if imports are replaced by local manufacture in India like, in the case of defence equipment, which we import in billions of dollars? It is likely that only that defence equipment would be manufactured in India which the military orders. Big orders take years, if not decades, for example, the Rafael deal or the Fifth Generation Fighter Aircraft (FGFA) or the import of guns, etc. Thus, such manufacturing capacities will take conside-rable time. As the Rafael deal shows, France is not very keen to set up facilities here while also demanding a high price. Similarly, for the FGFA negotiations with the Russians. How much technology transfer could take place is also unclear given issues of sovereignty, secrecy and dual-use technologies. We have been producing the MIG and Sukhoi for long but upgrades have taken place in Russia even though they have transferred more technology than the West has done.

In brief, which problem does the NDA hope to solve by liberalising FDI—investment, employ-ment, growth, import substitution or technology upgradation? There is little certainty about any of them. So, is liberalisation a knee-jerk reaction to Dr Rajan not applying for a second term? If yes, did the government want him to go at this cost? Did it have to liberalise to show the international agencies that Rajan’s going is not a swadeshi move? The swadeshi lobby in the NDA, which wanted to see Dr Rajan’s back has got the worst of all worlds, because Dr Rajan’s replacement will be someone with a similar economic philosophy.

A retired Professor of Economics, Jawaharlal Nehru University, New Delhi, the author has penned the book, Indian Economy since Independence: Persisting Colonial Disruption, Vision Books.