India’s structural opportunity in a new age of financial repression

News: This article discusses the changes going on in the global monetary system and how India can attract capital in this scenario.

How the global monetary system is changing?

To handle huge levels of debt, the developed world and China need to inflate away their debts. The developed world has discovered it’s new normal in inflating away debts, but India continues with its existing monetary system.

Also, the investors are realizing that inflating away debt is done to keep interest rates low while inflation is high. For investors, the only easy way to preserve the purchasing power of savings during repression is that capital should leave the repressive system.

How India can be a key investment destination?

First, due to changes in the global monetary system, low-risk investments are turned high-risk, and vice versa. Hence, capital is likely to flee due to growing risk of decline in the purchasing power of savings in both the developed world and China.

Second, advanced economies have a total non-financial debt-to-GDP ratio of 300%. However, for India, it’s just 176%. China stands at 285%. The Great Financial Crisis and the European Sovereign Debt Crisis pushed Germany’s total non-financial debt-to-GDP ratio from 193% in 2007 to 211% by June 2012.

But moderate economic growth with low inflation from 2012 onwards reduced Germany’s debt-to-GDP ratio to 185%. If Germany could reduce its debt-to-GDP levels, India, too, can without adopting a monetary policy aimed at inflating away its debts.

Third, during covid, banks in the developed world were encouraged to lend despite lockdown-led recessions. In India, broad money growth returned to its pre-covid level in February 2022, while in the developed world, it remains above its pre-covid levels. India’s low debt-to-GDP ratio suggests it has greater policy flexibility, and the trends in broad money growth suggest that local policymakers are taking advantage of this flexibility.

What is the challenge in front of India?

One, the new developed world monetary system would create new problems for India. For example, higher global inflation. There is a dilemma whether India should continue with its current monetary policy while there is too much capital inflow along with the import of inflation.

Two, Indian policymakers are not prepared to let the exchange rate be constrained from capital flows. It is evidenced by the rapid rise in India’s foreign exchange reserves since 2014. The intervention has kept the exchange rate weak at a time when it might naturally have appreciated. And, India now faces even larger capital inflows, hence the scale of intervention could rise.

Three, there is also an issue of capital allocation because history shows that investors place savings in a system where capital is efficiently allocated.

What is the way forward?

First, managing the scale of capital inflows through administrative restrictions is essential. Otherwise, it will risk market-determined interest rates being pushed too low relative to inflation.

Second, Indian policymakers should partially protect the economy from the pro-inflation policies of the developed world’s repressionary monetary system. It will enable to attract and allocate capital more efficiently.

Source: This post is based on the article “India’s structural opportunity in a new age of financial repression” published in Live mint on 21^st Feb 2022.