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Concepts & Tutorials

Keep the steroids, or else…

(I write the column “Acting Pricey”, on Pragati. Here’s the original.)

We are addicted. We are on steroids. We are now going to face the music.

A steroid reduces your immune response and thus the pain that it causes; the initial doses give you relief but after a while, your body forgets to protect itself and demands the drug instead. It reacts violently if you stop or forget a dose. Drugs like cocaine and even tobacco behave similarly – after some time, a single dose doesn’t feel great, but the lack of it causes serious withdrawal symptoms.

In a lot of ways, our economic system has been on steroids. You have to keep getting the drug, or you’ll collapse.

Case 1: The panic drop of the rupee

India’s been a net importer for the last twenty years, meaning, we export far less than we import. Last year, we were short by $190 billion. , which is 19 followed by way too many zeroes. We make up some of this through the export of software and from foreign remittances. We are still left with a big hole, called the Current Account Deficit (CAD) – $90 billion last year (or 5 percent of our GDP).

If this was the end of the story, we would see the rupee depreciate every single year, and that would eventually cause imports to drop and exports to rise and balance the equation. But it’s not the end of the story. Foreigners pump in money into our stocks and bonds, and that brings in dollars; the exchange rate remains the same.

For ten years between 2002 and 2012 foreign investors invested in India, keeping the exchange rate between Rs 40 and Rs 48 to a US Dollar. This was our steroid. Instead of using the incoming foreign exchange in to make better stuff that other countries might want, or building infrastructure that would make local goods more competitive compared to importing them or even making the rupee stronger as an international currency, we chose to fritter it all away and the import-export gap kept widening.

The first sign of a break down was in the second half of 2011, when foreign investors began to exit in the wake of scams and the lack of any progress on reforms. Within a few months, the dollar had appreciated by more than 20 percent. Luckily Some worldwide panic happened alongside and The western economies too decided to print massive amounts of their currencies, some of which flowed to India and given the relative sizes, even that little was enough to bring the dollar back up.

And then, 2013 happened. After a few months of massive inflows, the foreign investors stopped their buying. In a few days in the month of June, the rupee collapsed to an exchange rate of nearly Rs. 59. You didn’t need foreign investors to actually exit – you just needed them to stop investing further – that itself was enough to bring down the pack of cards.

The foreign dollar investment inflow was our steroid. We should have used it to make ourselves more competitive. Instead we kept relying on labour arbitrage (textiles, diamonds, outsourcing) rather than on climbing up the value chain and building high quality brands the world would have wanted. We did not need to improve: if Indians abroad kept sending packets of money back home, if foreign investors kept investing, why bother innovating? And then, It wasn’t that foreign investors pulled out. It was just that they stopped investing for one month; effectively, stopping the drug that kept our exchange rate stable.

Case 2: QE “Tapers”

The world is on steroids as well. The US is printing a ludicrous amount of money – $85 billion per month – to ensure that their economy stays put. Japan is doing the equivalent of $75 billion, to somehow introduce inflation. Yet, all that they managed to do – the third time for the US and the second for Japan – was to make the world feel good for a few months. It became so crazy that Markets would rejoice on bad news – knowing that more money printing would happen, and slump on bad news. And recently, as the US Federal Reserve announces it might ‘taper’ its purchases, markets took it on the chin.

The Japanese Nikkei hit a multi year high of 16,000 just a month back and it is down 20 percent. American bonds have rallied as they are losing a big player on the buy-side, the Fed. The fear is not that the money will stop coming – just that less of it will come every month.

We have created a system so much on tenterhooks that even the slightest hint of taking that steroid away will trigger a panic collapse.

Case 3: MNREGA

The Mahatma Gandhi National Rural Employment Guarantee Act gives rural workers at least Rs. 100 per day for just reporting to work. They aren’t allowed to use machines, or any form of productivity improvement measure – since that means lesser people will be needed to do work. At first this was a good idea in that it provided employment for the rural unemployed. But after some time, the results of low productivity became evident, in that we get hardly anything in return for the money spent, other than inflation. The problem is: who will bell the cat? It is political suicide to stop the “free money”, and it can only be stopped by politicians.

Case 4: Tax Cuts Without An End Date

While most tax cuts are expected to be permanent, many measures are taken temporarily to encourage an industry. You can invest in the stock market, and if you sell after a year, your gains are not taxed, a policy started about 10 years ago. Any attempt to reintroduce the equity capital gains tax will cause long term investors to liquidate before the tax begins to apply, which will lead to a stock market crash. Insurance payouts are not taxed, even for investment plans disguised as insurance policies; and any change in this policy will result in the industry losing customers in droves.

Foreign investors from Mauritius don’t pay capital gains taxes, and in the few times that the ministry has made attempts to curb abuse of this law by investors not actually residing in Mauritius, the stock markets have tanked and forced a rethink. (Taxes with specific end-dates work better, in that people are more informed and react early to the tax going away.)

We have a number of other examples – unqualified reservation in educational institutions for “backward” classes, a “no-firing” labour policy, free rice or wheat offered by politicians, extreme subsidies for solar or wind energy and so on. The receivers of the benefit get addicted to the ‘stimulus’ and any attempt to reverse the measure precipitates a crisis.

While we consider stimulus programs, we would do well to consider that at the end it will just be a steroid on which we become too dependent. The ‘exit’ policy of an action is quite as important, but at times of crisis when stimulus packages are created, the exit is thought of as unimportant. One problem with having very old people as our political bosses is that they don’t live long enough to see the consequences of their actions. It may be better for us to suffer a little today to make for a brighter tomorrow.

  • charles says:

    Totally agree with all the points. Indian corporates have grown purely on arbitrage and rent seeking behaviors. We risk losing our entire ability to innovate. The latest crisis is an opportunity to rectify that.

    • gaun says:

      People are really ignorant. There is incredible amount of arrogance everywhere and especially among Indian corporates. Somehow they seem to believe their rise is attributed to their smartness or hardwork and refuse to believe its just arbitrage. A bust is very much necessary to cleanse the system and a chance for passionate people to come up. Sadly its not going to happen any time soon as this failure of a system will be propped up until total collapse.

  • arun says:

    Thanks to your article i discovered a very edited magazine in pragati.

  • SMART Trader says:

    “If this was the end of the story, we would see the rupee depreciate every single year, and that would eventually cause imports to drop and exports to rise and balance the equation”
    IMHO this theory will not work.
    Once Rupee depreciates, the overseas trader will reduce the dollar price for our goods and the exporter will get less Dollars.Further the Dollar outgo for imports will go up. widening the CAD causing more depreciation for our currency.
    SMART Trader

  • Mohammad says:

    incredible analysis. I feel privileged, Deepak, to have access to your publication. thanks

  • Punit Gupta says:

    Nicely written article Deepak. Every time US went into recession they found a way to build some sort of a bubble. Wondering if this time its gonna be the stock market bubble or something else is brewing while we are looking at ever rising markets in US.

  • Anand Gadiyar says:

    “India’s been a net importer for the last twenty years, meaning, we export far less than we import. Last year, we were short by $190 billion” … “We make up some of this through the export of software and from foreign remittances.”
    Isn’t the $190 billion the deficit net of the software exports? When we’re short of 190 billion, that means “imports – exports = 190 billion”, right?

  • Sanjeev B says:

    Absolutely on the ball – few could have said this better, Deepak.
    “The ‘exit’ policy of an action is quite as important …” – never more true than with the Reservation policy that was supposed to end / taper in 1965, but didn’t.