In 2014, there has been an unprecedented surge in investment by foreign institutional investors (FII) with a total of over US$ 20 billion having already come in during January-June. But, RBI governor Raghuram Rajan has sounded a note of caution advising government to be circumspect in spending money.
Rajan’s warning is based on the premise that ‘FIIs who bring in money can also take it back’. He observed that apart from continuing wind down of QE (quantitative easing), US Federal Reserve may also increase interest rates triggering reverse flow of funds.
As custodian of balance of payments (BoP), governor’s caution is understandable. However, to aver that there could be flight of capital is bit of an exaggeration! This may even affect sentiment at a time when the economy has just started to recover from 3-year slump and needs further push to a higher growth path.
In middle of last year when Fed Bank gave a mere indication of wind down of QE 3, it led to panic and within 3 months around US$ 12 billion of FII funds moved out. Then, underlying fundamentals of economy were weak as GDP growth during first quarter was only 4.6% on top of 5% registered in 2012-13.
The current account deficit (CAD) during first quarter was US$ 21.8 billion or 4.8 % of GDP. Inflation was high and fiscal deficit unsustainable. Even worse, then UPA government was suffering from policy paralysis and confidence in its ability to implement reforms was at its lowest.
Today, scenario is much better. During first quarter of 2014-15, growth has rebounded to 5.7% and CAD down to US$ 7.8 billion or 1.7% of GDP. With NDA having got an overwhelming mandate to govern, we have a ‘stable’ and ‘decisive’ government under Modi whose motto is good governance and development.
Steps have been taken to rejuvenate governance structures and improve administration. Procedures are being streamlined to cut red-tape and increase efficiency. Emphasis is on removing regulatory hurdles and expediting approvals. Openness and transparency is hallmark of decision making under new dispensation.
As a consequence, projects involving tens of thousands of crores – stuck in red-tape for several years, even decades – have been cleared and many more are on way to being un-clogged. Introduction of e-based system for environment and forest approvals will impart momentum to the process.
These together with policy reforms like increase in FDI cap in defense, opening up investment in railways, commitment to avoid retrospective amendment in tax laws etc has generated a tsunami of interest among foreign investors. They want to come in droves and stay invested for the long-term.
When, there are opportunities galore and definite expectation of generating good returns over a long-term horizon, it does not really matter whether funds come in vide FDI route or even portfolio investment (FII). This precisely explains the surge thus far and momentum will sustain due to bulging confidence in India’s long-term high growth story.
Modi’s clarion call for ‘make in India’ and his follow-up initiatives both on the domestic and international fronts has served as proverbial icing on the cake. This has reinforced conviction in India’s ability to move on an accelerated growth trajectory even as analysts are anticipating double digit growth.
India’s has received a tumultuous response with Japan committing US$ 35 billion over 5 years and China has signed deals worth US$ 20 billion during visit of President, Xi Jinping. They will be investing in smart cities, railway modernization and up gradation, high speed and bullet trains, power and other infrastructure.
USA too is unlikely to forgo opportunities and will make requisite investment to maintain its share in the cake. During forthcoming visit of Modi to USA later this month – where Obama is all geared to extend a red carpet welcome – India can expect commitments to exceed combined flows from Japan and China.
With such a momentum building up – propelled by top leadership in USA that serves its geo-strategic interest as well – even after Federal Reserve increases interest rates and wind-down of QE continues as planned (leading to full exit in June, 2015), reverse flow of dollars is unlikely. Rajan’s apprehension does not hold water.
Yet, why is he being so circumspect in regard to spending? Why is he not willing to reduce interest rate [despite consumer price index (CPI) going below 8% benchmark set by apex bank to guide movement in policy rate]? Why would RBI not like to be an active partner in reviving growth impulses?
Perhaps, Rajan’s mindset is still conditioned by fiscal profligacy of previous government spending indiscriminately on subsidies and welfare schemes and lot of that money never reached the beneficiaries. That era has gone.
The sole focus of current dispensation is on productive spend, building infrastructure and creation of assets. It is even restructuring MGNREGA to create assets in agriculture and rural areas and restrict coverage only to low income states.
NDA-government is wedded to restricting subsidy only to poor and transferring money directly to their bank account. A fool proof financial architecture under PM Jan Dhan Yojna is being created for making this happen and ensure there is no pilferage.
To rein in inflation, it is addressing supply side constraints – through steps like release of food grain from central pool, de-listing fruit & vegetables from APMC (agriculture produce market committee) act, action against hoarders etc. This will also ensure that inflationary expectations are nipped in the bud.
With such an approach that combines growth with fiscal consolidation and low inflation, Indian economy will be robust and resilient. It will be far less vulnerable to external shocks be it reduction in exports or increase in interest rate in USA or wind down of QE.
In this backdrop, it is high time RBI sheds its conservatism and becomes a proactive partner in India’s growth story through a supportive monetary and credit policy.
Hope, the Governor will start batting on the front foot!