Learn from Argentina
Without reform, India’s macroeconomic weaknesses persist
The travails of distant Argentina may provide a timely warning for Indian policymakers and politicians. The Argentinian peso has just hit a record low against the dollar, raising once again the spectre of destabilisation on the external account in a country that has already defaulted on its external obligations multiple times. Of course, India is not Argentina; it is neither a small economy nor a dollarised one, and its economic fundamentals are better than many of its peers. Besides, India is not in any danger of default, and has indeed been remarkably responsible in terms of its external borrowing throughout a history that has included numerous episodes of current-account instability. Argentina is nevertheless an important reminder that structural weaknesses on the external account never quite go away, and are always capable of reducing the set of policies available to decision makers. India faces a danger of losing control of its macroeconomic policy because of a past unwillingness to undertake structural reform.
When global conditions are positive, the Indian macro-fundamentals appear strong. This has been the case in the past few years. A global low-interest rate regime aided fund flows into the Indian economy, which financed the current account deficit; and low crude oil prices kept the trade deficit under control as well as moderated inflation and the fiscal deficit. However, both these favourable tailwinds have weakened recently. Just as the prospect of higher interest rates in the United States has pushed Argentina to the brink of another crisis, the new macroeconomic headwinds will expose the basic inadequacy of the Indian economy on the external account. India has more foreign exchange reserves than it had during the management of, say, the taper tantrum of 2013 — but even so, an episode of capital flight will drain reserves and stress the rupee. The Reserve Bank of India will not be able to manage the rupee, preserve foreign exchange reserves, and operate an independent monetary policy. Meanwhile, the government, too, will face reducing options: It will not be able to control inflation, reduce the fiscal deficit and keep the growth revival going all at the same time. India does not need to approach an Argentina-style crisis to discover the negative effects on its domestic economy of a failure to address underlying external weaknesses. Pessimism about these choices is widespread, as is obvious from the rout in bond markets where Indian government securities have seen a sharp increase in yields. The combination of returning inflation and the government’s loosening of its self-imposed fiscal consolidation targets is a harbinger of what may lie in store.
India is in this position because it has not taken the hard steps required to deal with a structural deficit on the current account. In other words, it has not prioritised exports. There is a limit to what import substitution can do, as economic history reveals so clearly. The only way forward to return stability to the external account and to restore the ability to conduct macroeconomic policy is to undertake the microeconomic reforms that make Indian products competitive. That will, of its own accord, cause a reduction in imports as well as an increase in exports, allowing India to survive the sort of adverse conditions that threaten today — and have already claimed Argentina as a victim.