|Should we worry?|
|Monday, 16 April 2012 01:31|
Forex reserves biggest mitigating factor vis-a-vis 1991
RBI Governor Duvvuri Subbarao made an important point when he said, at the launch of the updated festschrift for Prime Minister Minister Manmohan Singh, the macro situation was nowhere as severe as it was in 1991, a comparison being increasingly made today in policy circles. Subbarao pointed to the central fiscal deficit being 7.8% of GDP in 1990-91 as compared to 5.9% today though the current account deficit was higher (the short-term component of debt, he said, was higher now as compared to 1991). Though Subbarao chose to use more favourable fiscal comparisons, the combined central and states deficit is roughly the same at 9.5% of GDP and, if you include the 1.5-2% or so of petroleum under-recoveries, even the central fiscal deficit is comparable—the real differentiator is the level of forex reserves. At 8.5 months of import cover, they’re more than three times the (2.5 months) level of 1991 and, in terms of debt, forex reserves are around 95% of external debt as compared to just 7% in 1990-91. Even in terms of the short-term debt, the cover today is several times higher than what it was in 1990-91 when India had to ship gold to the IMF.
So should we be worried? Having said the 1990-91 comparison was alarmist, Subbarao admitted the macro-situation today was worrying, a point reiterated by Raghuram Rajan, Chicago university professor and honorary advisor to the PM, when he said that given the huge current account deficit, the last thing India could afford right now was to upset foreign investors with policy measures like retrospective taxation and GAAR. If the fiscal situation today is nearly as bad as it was in 1991 (or worse, depending on which definition you use), think of what will happen if, as many believe, the government introduces the Food Security Bill, in the next budget, closer to the elections—according to estimates made by CACP chief Ashok Gulati, the costs could be around 2% of GDP each year for the first three years the Bill is rolled out. Given the 4.3% current account deficit in Q3 (and likely 4% for the full year), the rupee is likely to remain under pressure, so if RBI decides to defend the rupee, the forex cover will look that much less impressive (it drew down $20 bn between September 2011 and January 2012 for this purpose). In other words, India may not be as vulnerable as it was in 1990-91, but the unacceptably high twin deficits have left little room to manoeuvre, making India vulnerable to oil price shocks and even any moderate-sized FII outflows.