For a stronger economy: We need economic reforms beyond liberalisation

Source: The post is based on an article “For a stronger economy: We need economic reforms beyond liberalisation” published in The Indian Express on 7^th September 2022.

Syllabus: GS 3 – Indian Economy – Liberalization

News: The Indian economy was expected to collapse due to the pandemic. Appropriate counter-cyclical policy enabled the recovery and it worked because reforms had reached a threshold of adequacy.

New reforms and measures are required to tackle current economic situation.

What new reforms are required from India?

Liberalization has reached a point of diminishing returns and new reforms are needed to overcome the current economic situation.

The focus should be on adopting the measures that currently favor India.

These include a) the digitization, where India has a comparative advantage, b) supply chain diversification, c) moving to a net zero economy and d) using green initiatives as a source of investment and innovation.

Attention should also be given to a) developing skills and capabilities, b) improving employability, c) improving infrastructure, d) reducing logistics and other business costs through better Centre-state coordination, e) enhancing the quality of governance and counter-cyclical regulation with good incentives, f) improve data use and privacy g) functioning of courts and police.

Why should banks not be privatized?

There is a recommendation to privatise most public sector banks (PSBs).

There is an argument that PSBs drain taxpayers’ money but this argument is based on the experience of last decade. PSBs were doing better than private banks in 2000s.

NPA rose because PSBs were pushed to lend to infrastructure where there are inherent asset liability mismatches.

However, after some recent measures, like improvements in governance of PSBs and risk-based lending profiles, NPA ratios have decreased. Even social schemes are now financed through direct subsidies by the government which has benefitted PSBs.

PSBs are trusted by people throughout out the country and it is evident from the opening of 1.7 trillion Jan Dhan accounts.

PSBs can gain advantage in low-cost deposit deposits through many co-lending opportunities and partnerships.

Private banks alone cannot increase credit when lending from PSBs has slowed.

PSBs should be allowed to compete and raise resources on their own and only those PSBs which are weak can be privatized.

Why rupee should not be made completely market determined?

There are recommendations that the rupee should be completely market-determined. Also, it should be allowed to sink under foreign outflows since this would benefit exporters.

However, the effect of exchange rate depreciation is reflected faster in Indian imports. Because, they are dominated by dollar-denominated commodities such as crude oil.

Indian exporters have little market power and they are forced to bear the cost of depreciation.

Studies show that exporters do not gain from currency volatility and the gain that is earned is usually temporary.

The fall in the exchange rate of the rupee from about Rs 8 in the 1990s to about Rs 80 currently has not brought about a sustained rise in exports.

Lower volatility in the real exchange rate helps both gainers and losers when there are changes in the value of the rupee. The positive and negative deviations from equilibrium real rates are harmful.

Only a fraction of the foreign portfolio flows (FPI) that look for trading benefits gain from volatility.

Some rupee volatility is good and encourages firms to hedge currency risks.