Dangerous Drift


Prabhat Patnaik

A FANTASTIC scene is being enacted in the country. The rupee is sliding down, and is now considered the weakest of all the currencies of the “newly-emerging countries”. Because of this, the rupee price of imports, particularly oil, is rising everyday (over and beyond the trends in the world crude oil market). This rise in imported crude price is being passed on to consumers as higher diesel and petrol prices, which are on a daily climb and have reached unprecedented levels, levels that were unimaginable even a few weeks ago, just as the rupee’s new low against the dollar was unimaginable a few weeks ago. And yet the government sits tight, doing absolutely nothing, even as the burden on consumers, including on the poorest consumers who also suffer indirectly from higher petro-product prices, keeps increasing on a daily basis before everyone’s eyes.

No explanations are provided for this inactivity. But if one is to attribute some theory to the economic policy-makers in the government, it might be as follows: the slide in the rupee will automatically come to a stop when the exchange rate has reached an “equilibrium”, defined as a situation where the trade deficit has been reduced (because exports are encouraged and imports discouraged by the rupee’s depreciation) to a level where it can be financed through capital inflow (itself buoyed by the belief that the rupee’s slide has come to a stop).

The fact that the rupee is sliding at present only indicates, according to this view, that its value is above the equilibrium level; once it reaches that level the slide would stop, and it should be allowed to reach that level. Ergo, the government must just sit tight and allow this slide until equilibrium is reached.

This touching faith in the virtue of the market, namely, that it automatically reaches an equilibrium if allowed to function without any intervention, and that therefore such intervention must be eschewed, is absurd for several reasons. One, assuming that it does reach an equilibrium in the manner predicted, this could well happen at a price that imposes an intolerable burden on the people (which incidentally is the argument for foodgrain rationing).

In addition however, such an equilibrium may not exist at all. For the foreign exchange market, in particular, this is the case, whence it follows that the rupee’s slide may just go on and on until it has wreaked havoc on people’s lives through the inflation that it generates via the “passing on” of higher import prices.

The reason why such an equilibrium would not exist within reasonable bounds (in terms of people’s living conditions) is as follows. Inflation increases the prices of domestic goods and thereby reduces their competitiveness in the world market; hence even as the depreciation of the rupee increases the competitiveness of domestic goods in the world market (let us, for argument’s sake, assume this to be the case and also assume that this would raise exports eventually), the inflation generated by the very same depreciation reduces their competitiveness.

Since the impact of depreciation on the trade deficit, which we have assumed would be favourable, would nonetheless take considerable time to manifest itself, nothing materially improves the situation immediately as a consequence of such depreciation. On the other hand the inflation it gives rise to, creates the expectation that the rupee would have to depreciate still further. Speculators therefore move away from the rupee, causing its further depreciation, which in turn strengthens expectations about a further slide; and so on.

In other words when the rupee is sliding, nothing happens immediately to persuade speculators that the slide should be coming to a halt; on the other hand inflation persuades them to the contrary, and also the belief that other speculators would be driving down the rupee still further. The phenomenon of depreciation-cum-inflation therefore can go on and on, and that too within a very short span of time, without coming to an end.

Foreign exchange markets therefore necessarily require government intervention almost everywhere in the world (barring perhaps the US whose currency is generally perceived to be “as good as gold”). This is so especially in third world countries whose currencies in the past have been subject to a process of prolonged decline. Just three decades ago for instance the value of a US dollar was 13 rupees; now it exceeds 72 rupees. There is therefore no anchorage at which anyone can expect the rupee to settle. This fact causes huge drops in the exchange rate in the absence of government intervention.

There is also an additional factor. Several Indian companies have borrowed from world financial markets because of the low interest rates that have prevailed there owing to the cheap money policy of the US. The depreciation of the rupee has the effect of increasing their liabilities relative to their assets, and hence pushing them towards insolvency; and an anticipation of this very fact would make speculators move away from the rupee, further contributing to its fall.

The Modi government, by refusing to intervene both in the foreign exchange market and in the petro-product market, which has an impact as we have seen on the foreign exchange market as well, is therefore not just turning its backs upon the people, pushing them deeper into distress; it is also pushing the economy into such dire straits that it would ultimately run to the IMF and the international financial market, which would impose upon us draconian “conditionalities” and austerity measures reminiscent of what Greece has been facing.

While the Modi government’s inactivity has been widely condemned, the question immediately arises: what is the form that “activity” should take? The “activity” which any other bourgeois government would undertake is two-fold: a rise in the interest rate; and the use of foreign exchange reserves by the Reserve Bank to stabilise the rupee. In fact even Modi, when he does budge at all (if he does before feeling the need to run to the IMF), will do these very things.

But quite apart from the fact that the rise in the interest rate will have a recessionary effect, and particularly harm small producers, these measures will simply not be enough for stemming the slide of the rupee.

The basic problem here is that India has for long had a current account deficit which it did not worry about earlier because financial inflows within the neo-liberal regime were always adequate to finance it; and this was because India’s interest rate was higher compared to the advanced capitalist countries. But to believe that raising the interest rate will once again do the trick and prevent any strains on our balance of payments misses the fact that the neo-liberal regime itself has reached a dead-end the world over.

The dwindling social support for it within the advanced capitalist world is manifesting itself not only in a surge of right-wing parties, but also in the fact that where the right does come to power, such as in the US, it is forced to make adjustments to the neo-liberal regime. (Since this right is supported by finance capital it would never jettison the neo-liberal regime altogether).

This indeed is what Trump is doing: not preventing the free flow of finance, which is central to neo-liberalism, but putting some restrictions on outsourcing of activities from the US and on US firms locating plants abroad, and compensating the capitalists affected by such restrictions through huge tax-cuts. The fact that neo-liberalism has reached a dead-end, however, is clear even from Trump’s actions.

In the uncertainty that this has generated within financial circles, the tendency has been to bring finance from all over the world back to the US which is its home base. The appreciation of the dollar that has occurred vis-à-vis almost every other currency is an indication of this. In this context, a rise in the interest rate in India, apart from being recessionary, will not even bring in enough finance to cover the current account deficit and prevent the rupee’s slide.

But then, it may be asked, shouldn’t the recession generated by an interest rate hike itself curtail imports and improve the trade deficit to a point where the balance of payments becomes manageable? Even assuming for argument’s sake that this does happen, it is nonetheless an anti-people way of dealing with the trade deficit.

The trade deficit, which is the excess of our imports over our exports, can be written as (m.Y-X), where m refers to the import coefficient per unit of GDP, Y to the GDP and X to exports. An increase in the interest rate attempts to reduce the trade deficit by reducing Y (i.e., by causing a recession); in the process however it generates unemployment, distress and destitution.

A more effective and less anti- people way of reducing the trade deficit is by reducing m, the import coefficient. And this can be done through protection, by curbing imports selectively such that no adverse impact is felt on the people’s livelihood. In fact, now that Trump himself, the president of the leading capitalist country of the world, has introduced protection (and hence cannot preach to others on the benefits of “free trade”), there is no reason why India should not protect its own people against destitution, and its economy from becoming a mendicant before the IMF and world financial markets, by adopting direct measures to curb luxury or other unnecessary imports.


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