Similarly, long-term foreign investors have had reason to pause. This is not surprising, given the slowdown in consumption growth (car sales, for example, are suffering a prolonged decline). India has been left to finance its external deficit increasingly through short-term borrowing, the most capricious form of international capital.
As the late Massachusetts Institute of Technology economics professor Rudi Dornbusch once warned, a crisis takes longer than expected to arrive, but moves faster than anticipated when it does. India may be particularly vulnerable, because all players there have been complicit in a silent conspiracy of denial. An overvalued exchange rate strengthens repayment capacity, so international bankers cheer it on — until they cut and run. And the Indian government played a large part in fueling rupee appreciation by easing companies’ ability to borrow abroad.
Indeed, at a time when restricting access to short-term international funds has acquired intellectual respectability, the government’s reluctance to enforce curbs has been puzzling. The IMF, which now supports selective imposition of capital controls, seems unconcerned: the rupee, its annual review concludes, is fairly valued. This benign assessment is consistent with the IMF’s record of overlooking gathering crises.
With an overvalued rupee, there are no good policy choices. To avert a disorderly fall, short-term macroeconomic management requires officially engineered depreciation through administrative methods and restraints on external borrowing. A depreciated rupee should help revive Indian exports and lift growth. However, in the absence of complementary action, depreciation — whether engineered or market-driven — will make matters worse.
To dampen the additional inflationary pressures implied by a weaker rupee, more aggressive fiscal retrenchment is needed. Even so, a depreciated rupee will increase the burden of repaying foreign debt, and deepen the woes of domestic companies and banks.
To reclaim its promise, India must foster a new generation of productivity growth. The time for action is now. Unfortunately, a serious crisis may be required to initiate that response.
Ashoka Mody, a former mission chief for Germany and Ireland at the IMF, is currently a visiting professor of international economic policy at the Woodrow Wilson School of Public and International Affairs, Princeton University.
Copyright: Project Syndicate