Time to use Foreign Reserves for India instead of America.

— MOHAN GURUSWAMY —

One of the few talking points of the Modi regime was that foreign reserves have scaled $590 billion. India is seventh in the global ranking. The biggest holder of cash as foreign reserves is China, now with $3 trillion, a trillion dollars down from the previous highpoint of $4 trillion in 2015. Japan holds $1.25 trillion and Switzerland has almost $800 billion, mostly due to other peoples money deposited in its banks. The other four ahead of India, Saudi Arabia, Taiwan, Russia and Hong Kong, are in the $400-500 billion range.

Despite this the Indian economy is not at a place where it wants to be. The Modi government now finds itself in a chakravyuh that it is unable to fight its way out. The government is just unable to make or attract the investment needed to make the economy buoyant again. India enjoyed a decade of unprecedented growth from 2004-14 that seemed to have lost steam in the last few years. For the skeptics, India’s average economic growth rose to 7.7 per cent in the 10-year regime of the UPA Government compared with 6.2 per cent recorded in the previous decade.

The slowdown of the last two UPA years was largely caused by a huge decline in the proportion of capital investment expenditure. Unfortunately that trend still continues in the Modi era. Growth in the Indian economy is still largely dependent on government investment. The decline in its investment is not because it lacks ideas, but because it lacks cash. The Modi regime has continued with the high subsidy UPA regime and has further been hit by a 23% increase (Rs.1.03 L crores ) in salaries after the Seventh Pay Commission recommendations were inflicted.

The promise of Modi was that he was expected to set right this trend and once again begin a new cycle with government led investment. He promised us a hundred new cities, a nationwide grid of high-speed rail networks, a national river-linking program and so many other major transformational projects. A hundred new cities have now become a hundred smart cities, which means little more than free wi-fi networks. The nationwide grid of fast trains has now become an exorbitant and apparently uneconomical single bullet train joining Ahmedabad and Bombay. Similarly all other feasible and exciting promises made are now mere caricatures of what were promised. All that was like his promise of Rs.15 lakhs for every Indian. Mere jumlas!

Consequently the picture continues to be bleak. Output of capital goods contracted 1% in July against growth of 8.8% a year ago. Production of consumer durable goods shrank 1.3% against a nominal increase of 0.2% a year earlier.

Then came the twin black swan events. Demonetization came as a body blow to the daily wage unorganized sector that makes up 40% of India’s GDP. The unorganized sector also accounts for 90% of the total employment of around 450 million. The loss of jobs due to the two events – demonetization and hasty implementation of GST- is still not empirically confirmed. Estimates vary. The construction and food retail sectors seem to have taken a massive hit and the ballpark estimation of loss of jobs is at about 20-30 million.

The hasty implementation of GST forced companies to reduce production in the run-up to its 1 July implementation as dealers reduced inventory. The announcement of rates was hasty and the many mismatches between input and output rates compounded the confusion. Of the Rs.95000 crores collected in the first month, as much as Rs.65000 is due to be refunded. The government doesn’t seem to have the cash to do so.

In a belated effort to reverse these trends the government was planning to loosen its fiscal deficit target of 3.2% of GDP to enable it to spend up to Rs. 50,000 crore. This is a piddly sum for an economy of about Rs.200 lakh crores now. Now that Coronavirus has crashed the economy, we need a huge injection of cash to revive the virtuous cycle of consumption- production- consumption. What we need is a huge cash infusion to boost investment. The option of meaningfully slashing subsidies, now does not appear politically feasible. He was just used up his political capital.

There is that old saying that when the going gets tough, the tough get going. Modi should now show toughness and imagination that is tempered with realism. He needs to revive the national mood and generate optimism over the economy. He now needs a plan to drive investment and consumption. He doesn’t have to go far to find the money to fund this plan.

The government is sitting with foreign reserves of over $490 billion with about $135 billion alone sitting in US banks earning next to nothing. These reserves are equal to about 80% of our foreign debt. Even after providing a quarter of the reserves to cover the expensive short-term hot money of NRI investors, each taking a pound of flesh for mostly foreign bank financed investment in their mother country, we will still have $300 billion in hand. How much money can be freed from the other $300 billion for investment is the big question now? Kaushik Basu of the World Bank has said that India’s foreign reserves need not be more than the current account deficit (CAD) or about $80 billion.

Just holding enough reserves to cover the CAD or exports for a few months would be about enough. This nonsense of holding reserves to at least cover six months imports is just plain arbitrary and concocted by the people who made the Washington Consensus. This “consensus” assures New York banks plenty of cheap money to finance American domestic consumption and extravagances. The Chinese have now realized the stupidity of financing the US cheaply with their reserves and have run it down by about $1trillion since.

Clearly running them down by around $100 or Rs.6.5L crores can be contemplated. The government could establish an India Infrastructure Investment Fund and start shifting meaningful fractions from the foreign reserves into this fund. Think of it as an Indian Sovereign Fund investing in India. A board of well-regarded experts, who can allocate investments on merits to prevent the usual leakages and political misuse, could administer the fund. The fund must also mandate the minimum level of local procurement and investment to boost Make in India. It is probably our best hope to revive the investment spirit to get the economy out of the hole it finds itself in. And Modi too.