Raghuram Rajan, the new governor of RBI, believes that the economic mess that the country finds herself in is not structural and can be fixed in incremental steps

While admitting that the Indian economy has serious problems to overcome, Raghuram Rajan, the new governor of Reserve Bank of India (RBI) believes that the very problems that India finds herself in, namely the current account deficit and balance of payment crises are not structural in nature, and can be fixed by incremental reforms.
 

“For the most part, India’s current growth slowdown and its fiscal and current-account deficits are not structural problems. They can all be fixed by means of modest reforms,” wrote Rajan in Project Syndicate, an economic think-tank. He added, “Indeed, despite its shortcomings, India’s GDP will probably grow by 5%-5.5% this year – not great, but certainly not bad for what is likely to be a low point in economic performance.”
 

Rajan believes that the key to India’s recovery is to take incremental steps, not necessarily major structural reforms, like clearing projects, fixing subsidies and easing financing flows. “The immediate tasks are more mundane, but they are also more feasible: clearing projects, reducing poorly targeted subsidies, and finding more ways to narrow the current-account deficit and ease its financing. Over the last year, the government has been pursuing this agenda, which is already showing some early results. For example, the external deficit is narrowing sharply on the back of higher exports and lower imports,” writes Rajan in Project Syndicate.
 

Why were most of the projects not cleared earlier? The main reason was the conservative mindset adopted by the Indian government amidst a series of scams and corruption charges. They put all the projects on hold. “India’s investigative agencies, judiciary, and press began examining allegations of large-scale corruption. As bureaucratic decision-making became more risk-averse, many large projects ground to a halt,” Rajan explains.
 

Rajan believes that the Indian public are depressed and are often critical of the government, which have hampered the pace of reforms, though he feels that the government should have acted quicker. Rajan writes: “...while the government certainly should have acted faster and earlier, the public mood is turning to depression amid a cacophony of criticism and self-doubt that has obscured the forward movement.”
 

Due to paralysis and self-doubt, the current account deficit widened as government shut down mines and banned iron ore exports. Rajan states: “..as large mining projects stalled, India had to resort to higher imports of coal and scrap iron, while its exports of iron ore dwindled. An increase in gold imports placed further pressure on the current-account balance. Newly rich consumers in rural areas increasingly put their savings into gold, a familiar store of value, while wealthy urban consumers, worried about inflation, also turned to buying gold.”
 

In addition to corruption and decision paralysis by the government, Rajan traced India’s problems to the accommodative monetary policies (i.e. quantitative easing of US) of developed countries which were targeted at avoiding recession in the West. However, according to Rajan, the recession never happened while India continued to have high relative interest rates, which constrained credit to businesses and investment.
 

Quoting figures to state the case for India, Rajan said that most of the India’s macroeconomic numbers are far better than other emerging markets, and that the situation is not as bad as most people think. He writes, “India’s public finances are stronger than they are in most emerging-market countries, let alone emerging-market countries in crisis. India’s overall public debt/GDP ratio has been on a declining trend, from 73.2% in 2006-07 to 66% in 2012-13 (and the central government’s debt/GDP ratio is only 46%). Moreover, the debt is denominated in rupees and has an average maturity of more than nine years. India’s external debt burden is even more favorable, at only 21.2% of GDP (much of it owed by the private sector), while short-term external debt is only 5.2% of GDP. India’s foreign-exchange reserves stand at $278 billion (about 15% of GDP), enough to finance the entire current-account deficit for several years.”
 

He concludes with an optimistic tone: “India can do better – much better. The path to a more open, competitive, efficient and humane economy will surely be bumpy in the years to come. But, in the short term, there is much low-hanging fruit to be plucked. Stripping out both the euphoria and the despair from what is said about India – and from what we Indians say about ourselves – will probably bring us closer to the truth.”