Dr Ashwani Mahajan
In its recent report, International Monetary Fund (IMF) has warned that Indian economy has started receding after reaching a high rate of economic growth, in the same way as it happened in Latin American and South East Asian countries. The phenomenon has been termed as Middle income trap, which means that there is a tendency for developing countries to remain developing (and not reach developed state), as they get trapped in low and middle growth again. It is notable that countries like Thailand, Malaysia, Philippines, Indonesia, Taiwan, South Korea, Hong Kong etc. had reached a high rate of growth of 10 to 12 percent in 1980’s. These economies were then termed as emerging economies due to their high per capita income and high rate of growth of GDP. Sometimes they were also termed as ‘Asian Tigers’. These economies were attracting good amount of foreign investment. Multinational companies were opening their production centers in these countries and production system of these countries was looking more developed.
These countries were also receiving lot of foreign exchange from rising exports and foreign investment. Sense of development was pushing the prices of real estate to increase manifold. However, something happened suddenly and prices of real estate started declining fast. Balance of Payment on current account (CAD) not only turned negative, that in fact became intolerable. Foreign investment was flying back and result was foreign exchange crisis. Flight of capital and bursting of real estate bubble resulted is decline in demand and production both. Real wages were going down (and living standards started falling obviously).
These countries started raising short-term loans from international markets to fill the Current Account Deficit (CAD), and the obvious result was increasing share of short-term debt with maturity of less than one year. These loans with maturity of less than one year as percent of total foreign debt reached 62 percent in Indonesia, 68 percent in South Korea, 80 Percent in Philippines, 65 percent in Thailand and 84 percent in Taiwan. In a single year (1997-98), $100 billion of foreign exchange flew away, which was 5 percent of their GDP. These countries were forced to devalue their domestic currencies to combat this problem. In South Korea, real wages went down by 155 percent and real wages in other countries were similarly affected.
In India, after reaching a consistent high growth (8 percent average) in the last 10 years, the estimated rate of growth has come down to only 5 percent in 2012-13. Many analyses are being made in India, and internationally, about the significance and causes of this decline. IMF has warned that decline in rate of growth in India and China, is indicating at looming dangers for these economies. IMF is trying to link this downfall with slowing down of technological development. IMF has said that declining Gross Factor Productivity, which is an indicator of technological development, is the cause of this slowdown.
IMF’s report clearly indicates that India is also getting trapped into the similar trap in which first Latin American countries were trapped and later South East Asian countries, which they call Middle Income Trap. It is notable that South East Asian crisis was mainly foreign exchange crisis, which forced these countries to devalue their currencies heavily. Bursting of real estate bubble added fuel to fire, and when real estate prices declined, banks felt the heat and employment opportunities also declined. Many Indian, who were working in these countries, had to pack their baggage. They even lost their accumulated savings. India could also have been affected by this crisis, but we were eventually unaffected and saved. Rather our growth started accelerating since 1998 and our growth reached 8 percent in ten years preceding 2011-12.
How was India Saved
India was saved despite South East Asian crisis, because rupee was not convertible on capital account. That the government was making all efforts to make rupee convertible on capital account, is known to all. Rather decision had almost been taken at official level. However, due to pressure from the many organisations and warning by different international agencies, this decision was postponed. The reason why foreign investors could take their investment back was the fact that currencies of most of the South East Asian countries were convertible on capital account. This facilitated the flight of capital from these countries. However, rupee was not convertible on capital account and is still not convertible. The second major reason, how India was saved, was the fact that though exchange rate of rupee was largely market determined but Reserve Bank of India was having significant control on exchange rate. Thirdly, our economy was not export based and fast rising domestic demand was making our industry grow very fast. Fourthly, our foreign debt-GDP ratio was very low. It may be noted that our foreign debt was almost $100 billion at that point of time. All these factors could help save our economy from crisis. India was insulated even from US crisis of 2008, as it was not much dependent on rest of the world. Huge domestic demand, large foreign exchange reserves, high rate of growth of industries and the economy, all helped India to overcome even the worst US crisis, since 1930s.
Now Danger is Severe
A few years ago, our foreign exchange reserves, which were sufficient for 3 years of imports, are not sufficient for even 6 months imports now. Declining rate of growth of exports and fast increasing imports, and rising foreign debt are deteriorating the situation further. In 2009, our foreign debt was $225 billion, which increased to $374 billion in December 2012 and this is rising fast. Current Account Deficit (CAD) has reached 6.7 percent of GDP. Trade Deficit has reached 12.5 percent of GDP. Foreign Debt-GDP ratio has been rising persistently and today nation is getting fast dependent on foreign investment (both FDI and FII) and external commercial borrowings. Outgo on interests, profits, dividends, royalties etc. has been rising and reached $26 billion in 2011-12. It is the responsibility of the government to control the situation and restrict the import, especially project goods, telecom and power equipments from China. Gold and silver imports also need to be restricted, to keep in check the Current Account Deficit. We need to attract NRIs to invest and deposit in India. But we must hurry up; this is the need of the hour.
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