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UPA's FDI semantics will not fix India's current account woes and strengthen the rupee sustainably

Saurav Jha @SJha1618

Updated: July 10, 2013, 2:41 PM IST
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The depreciation of the Indian rupee is once again leading to calls for 'reforms' to shore it up. And naturally these reforms are all in the realm of neo-liberal semantics which somehow believe that further 'opening up' certain tertiary sectors of the Indian economy to foreign direct investment (FDI) will miraculously generate long term demand for its currency. Unfortunately, the truth is quite the contrary. Not only is this model, if it could be called one, of attracting foreign capital flows to mitigate current account woes essentially an unsustainable proposition, the price that the UPA may be willing to pay for them is quite likely to create new balance of payment problems in the not too distant future.

The narrative being built up by the UPA at the moment is quite simple. India's current account deficit is at unsustainable levels and therefore the capital account must register larger surpluses to prevent the Indian rupee from further depreciation. If only life were that simple. India's current account deficit(CAD) stands at around five percent of GDP. Just balancing that out with capital flows for even a year means attracting new flows to the tune of 90-100 billion dollars (if I assume that the Indian economy is currently in the 1.8-2.0 trillion dollar range). I wonder how 'open' India has to become to bring in 'stable' inflows of even half that amount in the present context over even a three year period. Do remember that India's CAD is structural and will persist unless addressed directly through greater exports and lesser imports of certain commodities. Of course, the UPA will say that they are looking at FDI only for the very short term and that it is only one part of their strategy to fix India's balance of payment problems. However the kind of FDI they are trying to attract does not hold up to the reasoning given for it.

Countries usually bring in FDI as an add-on to domestic investment and for sourcing technology. And it is usually done in sectors that will actually contribute to new export earnings such as automobiles for instance or to substitute high levels of import (say in electronics) and save foreign exchange. FDI for expertise is often brought in for difficult infrastructure projects. But the sectors that the UPA is now looking to open up all belong to the so called Finance, Insurance, Real Estate (FIRE) component and other tertiary activities such as telecom. Now foreign investment in these sectors will certainly not boost export revenue nor are they really required to make India's domestic FIRE sector "reduce costs" through efficiency. India's telecom sector for instance has long boasted some of the lowest domestic call rates in the world. After all the real reason for the draught in domestic investments is high interest rates due the overspending of the UPA on populist schemes and not because our FIRE sector is not deep enough or cannot allocate funds efficiently. Truth be told, these flows will merely result in greater foreign ownership of Indian assets which will simply look to partake India's current levels of consumption besides boosting it through greater extension of consumer credit
What is more, given India's current standing in the geo-economic space and the general lack of confidence of the investor community, any investments are likely to come only with strings attached. Take the case of FDI in retail for instance. After much fanfare about FDI in retail apparently fixing everything from India's middlemen to wastage issues, one finds that neither Walmart nor Tesco are currently that keen to step in.

Concurrently you have all the various pink papers carrying noises from the Commerce Ministry that the conditionalities that were so grandly announced while allowing 51 per cent FDI in retail may be diluted. Unsurprisingly the one conditionality that all foreign retailers really want removed is the 30 per cent local sourcing clause. So essentially for 'some FDI' which will generate 'some demand' for the rupee for 'some time', the UPA has to agree to create a new domestic sink for imports. Thus FDI in retail if it has to happen in any measure that could offset our current account deficit for the time being may actually lead to much greater CADs later and thereby put greater pressure on the rupee in the future! Make no mistake; the rise of Big retail and the rise of China are joined at the hip. While 'big box retail' seems rather attractive for all those who live in suburban condos and drive vehicles it has the very real potential without the local sourcing clause of foreclosing future employment opportunities in labour intensive manufacturing for a bulging rural youth population. And I am talking about the next ten years when India's demographic dividend will come into its own. For all those who think that by default low cost manufacturing will come to India and big retail will source domestically I have a bridge to sell to you over the Mandakini. Needless to say FDI in retail will certainly also destroy many small retail jobs, not to mention the many other not so happy implications for the urban food and energy balance that may come in its wake.

Big box retail will only mean more consumption not just of imported goods, but also of our number one import - oil. More mamas and papas will drive into large retail outlets for weekend shopping or more. Huge retail establishments whether you like it or not are themselves massive energy guzzlers, quite likely to impact your electricity bill. What is worse, thanks to your domestic coal exploration policies, more and more coal is being imported from overseas putting greater pressure on the CAD. Of course, you could argue that with our current coal governance that would happen anyway.

The foreign sourcing issue also holds for FDI in the telecom sector. FDI in telecom may be accompanied by calls to allow greater equipment to be sourced from China. Now if dilution on this front indeed happens, it will be yet another instance of the UPA pulling in different directions. Since currently one of the UPA's apparent 'action' agendas is to reduce India's dependence on electronic imports which is well on its way to displace energy as India's number one import by 2020 this could become yet another policy contradiction in terms.

And by the way, local sourcing clauses are now being adopted the world over most notably by the US itself in the solar power industry. So while the West becomes more protectionist, India is being told to adopt the old discredited Friedmanite prescription. And for what - To remedy its current account woes?

This constant reference to FDI being a 'long term investment' is grossly simplistic. FDI is often a one-time investment that leads to net outflows through profit repatriation. Indeed what the UPA is not telling you is that it now has to compete with the likes of Nigeria for FDI which has announced a 100 per cent profit repatriation policy. Inter-temporarily without appropriate taxation FDI can actually end up putting greater pressure on balance of payments as companies 'take home' their investment earnings. And we all know what happened when Pranab Mukherjee as Finance Minister tried to get foreign companies to comply with tax norms that would help the Indian exchequer.

Had India been ruled by a government that was not seen as being riddled with scams which lead to frequent licence award reversals, I would wager that India would be the prime destination for FDI of all kinds even with a minority stake cap in many sectors without any conditions. If India had a government that would actually build the necessary physical infrastructure we would have seen FDI following domestic investment into various manufacturing units both boosting exports as well substituting traditional goods imports. With its still rural river basins India should be looking towards greater sustainable penetration of low cost manufacturing to take the pressure off agriculture. And it doesn't even have to be on a scale where India's environment falls into jeopardy. It can be enough to improve India current account situation though. But the UPA is not even managing that.

The government should aim to build business sentiment through governance, not pander to specific business interests under the aegis of a 'crisis' doctrine. As a growing country which will probably continue to import energy, we have to ensure that those energy imports are put to good use by boosting employment and exports. They should not just end up being consumed. But for that the lip service has to stop and implementation has to begin. Moreover populism has to be curtailed. For instance by not raising fuel prices gradually, the UPA regime probably ended up making our national auto energy bill greater than it could be. And what happened at the end of it? A significant one time hike had to be made that has probably resulted in somewhat of an energy shock for the Indian economy with growth down to 5 per cent levels at the moment.

So this move to liberalise new sectors is very much in keeping with the UPA's double whammy of left-right economics where on one end of spectrum you have extremely dirigiste groups wanting the government to destroy its fiscal stability through overspending and on the other hand you have neo-liberal aficionados pushing policies that would certainly make Friedman, Hayek and Thatcher proud. Neither will fix India's CAD-like economics state.

The author tweets at @SJha1618
First Published: July 10, 2013, 2:41 PM IST

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