Can there be a Magic Wand for Indian Economy?

Posted in Finance Articles, Total Reads: 803 , Published on 20 January 2014

In the uncertain story of Indian economy, the day Raghuram Rajan spoiled the party by increasing the repo rate, market painted him as a new villain. The change in opinions about him from being a messiah to a devil is a result of market expectations not being met. When market expectations are not fulfilled, tongues start wagging and people turn vengeful. The RBI governor is caught in a classic “impossible trinity” - low growth, high inflation and depreciation in the value of currency.

The Indian economy grew 4.4 percent in quarter ended June 30 well below the expectations of 4.8 percent. Indian rupee has fallen the fastest of any emerging market currency in the last month, down 8.1 percent. All of us acknowledge that these are not easy times and the Indian economy faces challenges. The downfall of rupee, increasing fiscal deficit and soaring inflation have emerged as some of the prime concerns for nation. Amid all this market and nation wants RBI to be a torch bearer for India’s economic development and stability; demanding an immediate solution for all the problems.

Image Courtesy:, digitalart

There has been dismay about the ferocity of rupee depreciation; and much of it has been attributed to the ‘tapering’ of its ultra easy monetary policy by the US Fed. However such a diagnosis is misleading. Our economy can go astray both in diagnosis and remedy if the role of domestic structural factors in this problem is not acknowledged. At its root, the problem is that for last three consecutive years the current account deficit (CAD) has been higher than the sustainable limit , and possibly will remain high for a fourth time this year. The government claims to bring down CAD to $70 billion, which is termed more than optimistic by analysts. In previous years the CAD was financed because of the easy liquidity in the global system. The breathing time which this financing gave was not used to address the structural factors and bring the CAD down to its sustainable level. Had this been done Indian economy would have withstood the ‘taper’. Since CAD was not contained it made economy vulnerable to sudden stop and exit of capital flows driven by global sentiment; the eventual cost of adjustment too went up sharply.

RBI and Government took a series of measures to heal the ailing economy and drag it back to the growth trajectory. RBI opened a forex swap window for OMCs to calm volatile market. Opening forex swap window for oil companies enabled them to face the double whammy of depreciating rupee and increasing crude oil prices. This move of RBI to address volatility in forex markets helped ease battered rupee.RBI took several measures to curb the demand for gold and tighten the gold import norms, which is one of the main reasons for widening of the current account deficit. The existing norm to make 20 percent of every lot of imported gold exclusively available for the purpose of exports was revised to exclude supplies of the metal to special economic zones (SEZs) as exports to qualify for further purchases from overseas. The import tax on gold has been increased from 8% to 10%. To stall currency from falling, RBI has prohibited purchase of real estate by Indians in markets abroad; bank has also lowered the upper limit on outward transmittal from $200,000 to $75,000 a year. To drain cash from the financial system in a bid to address volatility in August 2013, RBI auctioned 220 billion rupees of government cash management bills.

In this debut speech on 4th September, the newly appointed RBI Governor Mr. Raghuram Rajan stressed on additional tools to generate growth – accelerating financial development and inclusion as well as financial stability. To ensure the same he talked about bringing in free bank branching for domestic scheduled commercial banks in every part of the country, subjecting banks to variety of priority sector lending requirements, joining hands with SEBI to steadily but surely liberalize our financial markets, rupee internationalization through steady liberalization, improving the financial infrastructure by strengthening the payment and settlement system in the country. Following this speech in the first quarterly monetary policy review by the governor showed that he has his ears on ground and he is willing to walk the tight rope against the market pressure and expectation, even if it has to be done alone.

Although the measures of RBI did show short term positive impacts but the only lasting solution to external sector problem is to bring the current account deficit below a sustainable level and to finance the reduced deficit through revenues from growing sectors rather than by borrowing from international financial markets. It will bring in stability in long term. Reducing the current account deficit requires ground level policy and infrastructure solutions - RBI does not have mandate or authority in terms of policy making, needed to provide such solutions. Only the government is empowered to deliver required policy changes. Even after favouring policies are brought in place by government structural adjustment will take time.

“Finance thrives when financial infrastructure is strong, but most of this cannot be done overnight” Market, analyst, critics always look forward to a “magic wand” solution to economic crisis, but in reality it hardly exists.

This article has been authored by Abhishek Raghupungav & Tanu Bindra from TAPMI



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