Macroeconomic Policy Challenges for IndiaBy

Dr. Shankar Acharya

Macroeconomic Policy Challenges for India

• Foreign Capital Surge of 1993/94• Asian Financial Crisis of 1997/98• Fifth Pay Commission• The Employment Challenge• Economic Growth: Past, Present

and Future.

Foreign Capital Surge of 1993/94

• Event: $12 billion (4% of GDP) added to foreign exchange reserve between sept.1993 and oct. 1994.

• 3 Major Policy Issues1. Should nominal exchanges rate be allowed to

appreciate (text book)?2. How to transform “problem” of capital surge into

opportunities for liberalizing external trade and payments.

3. If reserves were going up sharply, what could authorities do to limit impact on inflation?

• Policy Choices Mode1. Build-up RBI’s reserves and prevent nominal

appreciation of rupee2. Undertake number of payments liberalization

measures3. Undertake partial “Sterilization” of foreign asset

accumulation.

Asian Financial Crisis (1)

Lessons1. Avoid high levels of short-term external

debt2. Avoid sustained and substantial

appreciation of country’s real effective exchange rate (REER)

3. Avoid massive drawdown of foreign exchange reserves in vain attempt to defend unrealistic exchange rate

4. Strengthen domestic financial sector, especially banks (capital adequacy, prudential norms, etc)

5. Prudential limit for exposure of banks to speculative markets (stocks, real estates).

6. Keep current account deficit of BOP at manageable levels.

7. Cautious approach to Capital Account Convertibility.

Asian Financial Crisis (2)

What India Did

1. Short–term debt under tight control after 1991 crisis.

2. Market determined exchange rate managed judiciously in 1993-97. Rupee allowed to depreciate by 16% in “stress period” August-December 1997.

3. Some use of foreign exchange reserves to put brakes on depreciation,

4. Substantial banking reforms in period 1992-97.

5. Bank exposure to stock and real estate markets limited by norms.

6. Current account deficit contained after 1991 crisis.

7. Cautions approach to Capital Account Convertibility.

8. Monetary policy tightened in January 1998.

Fifth Pay Commission

Pay and Pensions of Employees of Central and State Governments 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/2000

Rs. Crores

Pay and Pensions 48323 54111 63710 73432 89748 111891 133381

(of which pensions) (8445) (9789) (12090) (14921) (18480) (26223) (36581)

As Percent of GDP

Pay and Pensions 5.6 5.3 5.4 5.4 5.9 6.4 6.9

(of which pensions) (1.0) (1.0) (1.0) (1.1) (1.2) (1.5) (1.9)

Revenue Deficit 4.3 3.7 3.2 3.6 4.1 6.3 6.3

Fiscal Deficit 8.3 7.1 6.5 6.4 7.3 8.9 9.5

Sources: Budget documents, CSO and RBI

Employment Challenges

Income, Growth and Population: Major States

Income, Growth and Population: Major States

(Contd………………)

Economic Growth: Past, Present and Future

Growth rate of GDP and Major Sectors 1951/52-1980/81 1981/82-1990/91 1992/93-1996/97 1997/98-2000/1 2001/2-2005/6

GDP 3.6 5.6 6.7 5.5 6.7

Agriculture 2.5 3.6 4.7 1.0 2.5

Industry 5.3 7.1 7.6 4.8 7.0

Services 4.5 6.7 7.6 8.5 8.5

Source: CSO; data for 1951/52 to 1999/2000 are at 1993/94 prices and for 2000/01 to 2005/06 at 1999/2000 prices

Growth: Recent and Outlook(%per annum)

Crystal Ball Gazing: A Possible Scenario