I have written in the past about the relationship between the current account, capital account and budgetary deficits/surpluses and this is basic macro-economics. We all know, National Income - Nation Spending = Exports – Imports and National Spending = National Income - Private Savings - Taxes + Private Investment + Government Spending. If we re-arrange these two equations, we get the identity, Current Account Balance = Savings Surplus – Government Budget Deficit, which means the current account is essentially a function of private savings/investment balance and the government budget deficits. Since we are running current account & fiscal deficits means, the bulk of the adjustment had to be borne by Private Investment, which as the theory says took a hit in the last few years and it has come at the expense of growth, which has been slowing down. The only way we can get out of this self-inflicted wound is by cutting fiscal deficits. Public spending on infrastructure cannot be sacrificed as the country needs fixed asset investment as these add to the productive capacity of the economy but the painful adjustment has to come from cutting wasteful government expenditures like reducing our subsidy bill. The total fiscal deficits mean the federal deficits as well as the state government level deficits, which are unsustainably very high and all of this has an impact on inflationary dynamics in the country. In many countries like the US and German, local state governments are constitutionally mandated to run balance budgets and only the federal government is allowed to do deficit spending and as part of broader budgetary reform, we should bring in such a reform. Current account deficits essentially reflects excess domestic spending, which in our case is borne by two items; Oil Imports & Gold Imports. Gold though a store of investment value in an inflationary environment, in our case is a drag on external balance as we are importing though Gold has a Forex element to it and if we can find a mechanism to convert the idle gold into Foreign Exchange we would have solved some of the temporary problems and I have written about this in the past and not repeating the same before. RBI/Central Bank can do Gold Swap with global central banks if the Government can do a mop up of the idle gold sitting in the country, which will have FOREX value of more than Trillion Dollar at the current market price $1350. This gold value essentially represents the lost investment in the country, which would have increased the productive capacity of the economy. Couple of weeks back, there was an interesting piece on Yahoo Finance India about some of the measures RBI could take to shore up the rupee in the short term and it was repeated by some of my friends and posted on their Facebook pages, which is a combination of tightening liquidity and using reserves to support the currency etc. RBI can directly support Oil firms by providing Dollar liquidity to pay for Oil imports and buy Oil bonds from Oil companies. It can ask exporters convert dollar holdings within a stipulated period of their receipt of payments by their clients and any delay will incur penalty from the Central Bank etc. RBI can cut FOREX speculation by cutting net open position limits. It can also make Rupee liquidity tighter like raising SLR as well CRR. It can also reduce how much banks can borrow from RBI under the export re-finance scheme.
Posted on: Tue, 20 Aug 2013 06:50:44 +0000
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