FM’s crocodile tears over CAD
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Home General

FM’s crocodile tears over CAD

Archive Manager by WEB DESK
Apr 29, 2013, 12:00 am IST
in General
Jeay Sindh Freedom Movement chairman Sohail Abro

Jeay Sindh Freedom Movement chairman Sohail Abro

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Dr Bharat Jhunjhunwala

INDIA’S record Current Account Deficit (CAD) is “worrying,” said Finance Minister P Chidambaram. Indeed it is. CAD means that export earnings are less than import expenditures. But policies of the Finance Minister necessarily require that exports should be less than imports by a big margin.

The straightforward way to deal with increasing CAD is to devalue the rupee which would make our exports competitive and imports expensive. Such devaluation would happen in normal course whenever CAD increases. Increase in CAD means that demand for dollars for imports will be more than the supply of dollars from exports. The high demand for dollars would translate into an increase in price of the dollar, a corresponding decline in price of the rupee. This, in turn, would lead to an increase in exports. A balance between imports and exports would be re-established at a new level. High demand for potatoes in the wholesale market leads to an increase in price and balance is soon re-established between arrivals and sales. The shortage is wiped out. The same should happen in the forex market and CAD should be wiped out in normal course of business.

Pray, why should the FM then be worried about the CAD? The market will ensure that CAD is wiped out. The FM is worried because the matter is intertwined with foreign investments and liquidity in our money market. Dollars come into our forex market not only from exports but also from foreign investments. It is not necessary for the shortfall in export earnings to be met by an increase in exports. It can also be met from increased inflows of foreign investments. The simple formula is Exports + Foreign Investments = Imports. The above formula can be rewritten as Imports – Exports = CAD = Foreign Investments. This means that CAD is inevitable as long as we have foreign investment inflows.

To go back to the potato example, it is not necessary that daily receipts of potatoes from the farmers be equal to daily sale. Stocks held in the cold storage can also be sold. In that case, the ‘deficit’ between daily receipts and sale will be equal to the withdrawals from the cold storage. It will not be possible to wipe out shortage in daily supplies as long as sales from cold storage take place. Similarly, the CAD arises only because there is inflow of Foreign Investments edge out export earnings.

We must understand the FM’s concerns in this background. If he is really concerned about increasing CAD, the FM should put the spanners in the inflow of foreign investments. Reduced inflow of dollars will lead to a decline in the price of rupee vis-à-vis the dollar. That will translate into increase in exports and wipe out the CAD. The interesting part is that the FM is also wants to maintain high inflows of foreign investments. Now, this is contradictory for, as shown above, CAD = Foreign Investments. Increase in Foreign Investments has to necessarily lead to an increase in CAD. The FM cannot have his cake and eat it too!

It seems to me that the FM is only shedding crocodile tears on the increase in CAD. The truth appears to be quite different. The FM is actually happy with inflow of foreign investments and increase in CAD. He is mainly concerned about hiding the impact of increasing CAD on the domestic economy—exporters in particular. The consequence of increase in CAD in normal course of business is that the rupee will devalue. That would boost our exports. This far is fine with the FM. His problem is that a devaluation of the rupee will scare away the foreign investors. Say a foreign investor buys a share of Rs 55 in an Indian company and pays a dollar for this purchase at the current exchange rate of Rs 55. Now the rupee devalues to Rs 70. The sale of this share in the NSE will still fetch him Rs 55. But this will translate into only 80 cents because the rupee has devalued. The foreign investor will take a hit of 20 cents. The FM does not want this to happen because inflows of foreign investments increases the liquidity in the money markets and make it possible for the FM to borrow larger amounts at low interest rates. Note that the Government has recently increased the ceiling on amounts of government bonds that can be purchased by foreign investors.

The FM’s main concern is to garner monies for supporting corruption and buying votes. He is following Charvaka’s philosophy: “Take a loan and make merry.” The ability of the Government to take loans at low interest rates is dependent upon inflows of foreign investments hence the FM is loath to let the rupee devalue. And, CAD has to necessarily be large if rupee is kept at an artificially high level. It seems to me that the FM is mighty happy with the increase in CAD. He actually does not mind a large CAD. But he does not want the public to know of his this intention because that will raise a hue and cry by the exporters. Hence the FM is shedding crocodile tears to befool the people of the country that he is ‘worried’ about CAD; while actually he is quite happy about it. Analysts’ assessment, including my own, is that the correct value of the rupee today will be about Rs 70 to a dollar considering the differential rate of inflation in the USA and India. The FM is trying to artificially keep the rupee high so as not to scare away foreign investors.

There is no gainsaying that it is dangerous for the country to use money received from foreign investments for supporting corruption and purchase of votes. Foreign investments are capital receipts in form of a loan. These have to be repaid. This liability on the country will stand but the money would have gone in current consumption. This like taking a loan on one’s future incomes to splurge in a foreign vacation.

What should be done? The solution is to increase investments in infrastructure and research. Let us say we receive USD 10 billion of foreign investments. Let the Government make same amount of investments in infrastructure with imported capital goods. That will leave the balance between our exports and imports undisturbed. The capital receipts from foreign investments will be used to finance capital expenditures in infrastructure. But the FM is least concerned about incurring a debt and mortgaging future of the country. His eyes are totally focused on raising monies for enabling bleeding of the nation’s coffers through corruption and unproductive populist schemes. Thus he cries about the increasing CAD while actually enjoying every bit of it.

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