R. S. Rajan – Managing the Macroeconomy. Monetary and Exchange Rate Issues in India

Автор: R. S. Rajan
Название книги: Managing the Macroeconomy. Monetary and Exchange Rate Issues in India
Формат: PDF
Жанр: Бизнес
Качество: Изначально компьютерное, E-book

Since the liberalisation of the Indian economy in 1991, the country
has experienced sustained current account deficits (CADs), with
domestic investment rates outpacing the growing savings rates.
These deficits were serviced by a massive influx of capital inflows
which was made possible by the gradual removal of, or reduction in,
restrictions on foreign investments since 1991. These inflows also
often generated significant net demand for the Indian rupee (INR),
which in turn applied upward pressures on the currency. A natural
consequence of such currency appreciation would have been a loss
of export competitiveness and a widening of the country’s trade
deficit but for the active foreign exchange intervention of India’s
central bank – the Reserve Bank of India (RBI). The resultant buildup
of India’s foreign exchange reserves created excess liquidity in
the system which was subsequently absorbed by the RBI (so-called
monetary sterilisation) in order to prevent the rise of inflationary
pressures in the economy. This absorption of excess liquidity
continued up until the Global Financial Crisis (GFC) of 2008–09,
when there was a sudden reversal of capital flows and a slump in the
Indian economy.
Considering the relative lack of US toxic assets on Indian corporate
and bank balance sheets, coupled with India’s primary reliance
on domestic demand for its economic growth, it was initially
assumed that the impact of the GFC on India would not be severe.
However, things changed with the collapse of the Lehman Brothers
in September 2008. India, which did not face as severe an impact
during the Asian Financial Crisis (AFC), was hit more during the GFC
due to the increased level of trade and financial integration with the
rest of the world. The freezing of the global credit markets hurt the
Indian corporate sector which was reliant on cheap credit from the
international markets to fund their expansion. The financial sector
troubles spilled over into the trade sector, which, along with reduced
demand and supply of goods and increased cost of credit, negatively
affected industrial production and exports, eventually resulting in a
growth slowdown (Kapur and Mohan, 2014).
The reduced global demand for India’s exports led to a rise in
the country’s CADs which was further aggravated by a slowdown
in capital inflows. Further, the simultaneous increase in capital
outflows – due to investors rebalancing their portfolios – caused India
to experience the lowest capital account surplus since the 1990s. This
consequently led to a marked deterioration in the country’s balance
of payments (BoP). The RBI tackled the CAD and the slowdown in
inflows by intervening heavily in the foreign exchange market to
defend the INR. Since the GFC, the bilateral exchange rate vis-à-vis
US dollar depreciated from ì 39 in January 2008 to reach a low of
ì 68.85 in August 2013, before bouncing back slightly and hovering
at around ì 60 for much of 2014.
As with the advanced economies, the Indian government and the
RBI took steps to lessen the impact of the crisis by providing stimulus
to ensure the safety of bank deposits and stability of the banking
and financial system as a whole. Even though net capital inflows
increased in the immediate period after the GFC due to the lower
interest rate environment in the advanced economies, they did not
reach the pre-crisis levels. A combination of factors – including the
announcement of the tapering of US monetary policy, premature
withdrawal of monetary and fiscal stimulus and domestic structural
constraints and policy bottlenecks – contributed to the sharp
decline in capital inflows. At the same time, India’s CAD widened to
5 per cent during the GFC. The reduced capital inflows along with
widening CAD worked in tandem to apply downward pressures on
the INR. Simultaneously, inflationary pressures remained at elevated
levels since 2010, largely due to supply-side bottlenecks in general
and those specifically in the agricultural sector.
While a growth slowdown coupled with a deterioration of the
current account was expected during the GFC, the extent of the negative
spillovers to India was striking nonetheless. Though there was
a resurgence in capital flows into India since September 2013, there
remain ongoing concerns about the impact of eventual normalisation
of monetary policy in the United States and other developed economies.
While offering many growth-enhancing opportunities, India’s
ever-increasing integration with the world economy has given rise
to a host of new challenges in managing the economy, particularly
given the absence of any type of global policy coordination (Rajan,
2014).
Chapter 1 provides an overview of India’s broader macroeconomic
environment and policies with a focus on the macro growth story
since 1991 along with the dynamics of its balance of payments and
inflation trends. As will be emphasised, the Indian economy faces
some serious challenges, including stabilising and moderating inflation
rates which have at times reached double digits, reviving the
investment and overall growth outlook, as well as managing some
key imbalances (most notably fiscal deficits and CADs).
An important issue facing India under current conditions is the
lack of fiscal space to stabilise aggregate demand and manage inflation.
This in turn underlines the importance of monetary policy to
bring about these changes. To that end, there is a need to understand
the channels through which monetary transmission takes place to
improve its effectiveness in stabilising the economy. Chapter 2 estimates
the interest rate pass-through from policy rates to the money
market rates and then to the retail lending rates to understand the
effectiveness of monetary policy in India for the period 2001–10. The
chapter also identifies factors affecting the interest rate pass-through
in the country.
Chapter 3 focuses on exchange rate and reserve management in
India. Even though India is classified as a flexible regime by the
International Monetary Fund (IMF), the RBI intervenes heavily in
the foreign exchange market to “manage” this flexibility. This has
implications for macroeconomic management of the country. While
India has been moving towards greater exchange rate flexibility, the
RBI appears to have intervened to manage exchange rate movements
and has accumulated international reserves in the process. More to
the point, India’s reserves increased from US$ 5.6 billion in 1990 to
US$ 300 billion by 2010 and have remained more or less at that level
until 2013. What are the drivers behind this reserve build-up and are
they adequate in the event of a future economic shock? These are the
questions addressed in this chapter.
Exchange rate movements in emerging economies like India can
have significant impacts on domestic prices and the real economy.
For instance, a depreciation of the exchange rate has implications for
inflationary pressures in the economy through imported inflation.
The notable absence of inflation hedges and inflation indexation in
India has made the society quite sensitive to inflationary pressures.
Chapter 4 computes the exchange rate pass-through (ERPT) into
import prices of India at the aggregate and disaggregated sectoral
levels for the period 2003–13 using both trade-weighted and bilateral
USD exchange rates to estimate the impact on imported inflation.
It also examines the existence of asymmetry and non-linearity in
ERPT at the aggregate level in India.
While a currency depreciation can only have long-lasting effects
on the impact by changing the sectoral allocation of resources (from
the non-tradables to tradables), in the short-to-medium runs it ought
to lead to an improvement in the trade balance, albeit with a lag.
More specifically, the so-called J-curve effect suggests that a depreciation
of a country’s currency leads to a worsening of the trade
balance in the short run and an eventual improvement in the long
run. Chapter 5 examines the J-curve effect for India – both at the
aggregate as well as the disaggregate level – for bilateral and sectoral
trade for the period between 2001 and 2013.
Chapter 6 shifts focus slightly to the sources and relative stability
of external financing in India with particular reference to foreign
direct investment (FDI) inflows. Understanding the sources of
external financing is important, given India’s persistent current
account deficits, while understanding their relative stability is critical
as booms and busts in capital flows have been the main drivers
of exchange rate and reserves volatility in India (as it has in many
other emerging economies) and has concomitantly complicated
monetary policy. FDI inflows into India have been rising steadily in
importance since the early 2000s. The conventional wisdom about
FDI has been that it is a relatively stable source of external financing
compared to other types of capital flows such as portfolio investments
or bank flows. Therefore, policymakers are generally keen on
encouraging FDI inflows both from the perspective of macroeconomic
management as well as from a development perspective. This
chapter examines the available data on Indian FDI inflows in some
detail.
Overall, the chapters in this book tackle important macroeconomic
policy issues pertaining to India, informed by analytical frameworks,
data and empirics. While the chapters in this volume have
been written in a manner that can stand up to academic scrutiny,
they are also meant to be accessible to researchers, graduate students
policymakers and practitioners interested in India’s monetary and
external management