Abstract
Overview of the Studies
Balance of payments across developing countries, emerging market economies in particular, behaved erratically during the past one decade. The net payments for most countries have turned into large deficits of late from a situation of ‘near-balance’ or low to moderate surplus in the recent past. In India, there was a burgeoning current account deficit in the recent past following a large trade deficit only to attain a near BOP equilibrium situation thereafter. This is evident in Figure 1. Effective domestic policy measures of import restriction and, more importantly, softening of global crude prices, led to improvements in the current account position since 2013. The overall situation can change in the future depending on changes in various parameters on which India’s current account depends, an inference which follows from an understanding of the nature of the current account deficit in India and many other similar economies.
In situations of a current account deficit, the currency depreciates and brings the external accounts to a balance. Currency appreciation takes place responding to BoP surplus, which eventually wipes off the surplus in the balance of payments. With frequent changes in the balance of payments position, the currency value is likely to see-saw with frequent incidence of depreciation and appreciation. The current account and the currency value thus remain a major cause for concern for the central bank in some countries including India. Managing the balance of payments has remained a major preoccupation for the policy makers in these countries.
A large body of literature shows relative price as the factor determining the BoP equilibrium, the elasticities condition holding the key in attaining equilibrium. Often, exchange regimes are found to be related to current account reversals. For instance, De Haan, Schokker and Tcherneva (2008) find that under a peg and a moving band in advanced countries, a deeper current account deficit has less a predictive power of current account reversals than under a crawling peg. Edwards (2004) suggests that such reversals in the current account deficit have largely been owing to sudden stops in capital inflows; and it had a negative effect on real growth. However, Chinn and Wei (2013) show that current account adjustments do not depend on the exchange rate flexibility. In contrast, some view the disequilibrium being caused by structural factors (Malan & Wells, 1984), while others show the balance of payments disequilibrium resulting from domestic absorption (Alexander, 1952). Milesi-Ferretti and Razin (2000) identify foreign exchange reserves, GDP per capita and terms of trade as robust predictors of reversals in current account imbalances. Chinn and Prasad (2003) find that current account balances are positively correlated with government budget balances and initial stocks of net foreign assets, whereas among developing countries financial deepening is positively associated with current account balances, while trade openness is negatively correlated with current account balances. The policies pursued by developing countries, as a result, differ sharply depending on the factors underlying current account adjustments.
Apart from a quantum and sustained increase in exports for improvements in trade balance and hence the current account balance, options before policy makers for managing the balance of payments are limited. While exchange rate policy often continues to remain the main policy thrust, traditional fiscal and monetary policies are no less important. If it is believed that the huge current account deficit is on account of the country living beyond its means in terms of large domestic absorption, fiscal instruments can become viable policy options in taming current account imbalances. On the other hand, if the decline in the currency value is assumed to contain a speculative component along with a core component arising from macroeconomic fundamentals, the central bank often intervenes to stabilize the market either through interest rate adjustments or by supporting the local currency. However, such interventions in the currency market and money market may counter the mechanism needed for the current account as well as other macroeconomic adjustments. There can be many other fiscal and monetary issues involved in managing the balance of payments when it is out of bounds.
A proper understanding of these issues is warranted for designing an optimal policy intervention as well as for the appreciation of policies already implemented in managing the balance of payments. To discuss all these issues and the dynamics involved in current account adjustments, a two-day workshop on ‘Managing Balance of Payments: Fiscal and Monetary Issues’ was held under the aegis of the Centre for Advanced Studies, Department of Economics, Jadavpur University, Kolkata, in conjunction with the Centre for Training and Research in Public Finance and Policy, Centre for Studies in Social Sciences, Kolkata, in 5–6 March 2014. Out of about ten papers that were presented in the workshop, three papers on various dimensions of the balance of payments and exchange rate issues are published in this volume. The papers, independent in their approach and dealing with distinctive features of the observed BoP crisis-like situation in India, provide with a menu of policy options.
Hiranya Lahiri, Chandana Ghosh and Ambar Ghosh (LGG), in their theoretical paper, begin with an empirical anecdote that India has slumped into a recession since 2011 accompanied by severe BoP difficulties and high rates of consumer price inflation. India’s federal government has responded to this crisis-like situation by cutting down subsidies and hiking indirect tax rates. In this context, the LGG paper develops a simple Keynesian model to assess the policies noted above. It argues that the policies adopted so far by the Government of India are likely to aggravate the problems of recession, BoP difficulties and inflation. The paper concludes by recommending hikes in personal income tax rates with a suitable expenditure policy to get out of the present macroeconomic instability.
Indrani Chakraborty, in her paper, analyzes the behaviour of capital inflows in India in the context of global financial crisis and dealt with the question of ‘policy trilemma’ in a regime of liberalized capital inflows in India. The study finds that the volatility of capital inflows increased after the global financial crisis. Further, on account of the global financial crisis, there were substantial changes in the relative importance of the factors that explain capital inflows. Although the ‘pull factors’ played major roles in both the periods, before and after the crisis, there were significant changes in their relative importance. In the first sub-period, real effective exchange rate and foreign exchange reserves played the most important roles in determining capital inflows whereas, in the second sub-period, it was only current account balance. While dealing with the ‘policy trilemma’, we observe that monetary policy independence was maintained in the period before the crisis, which has been sacrificed in the later period.
The paper by Dilip M. Nachane shows that the recent global crisis has brought the following issues to the forefront of macro-policy analysis: (i) pro-cyclicality of the bank capital regulation, (ii) role of asset bubbles, (iii) high social costs of financial failures and (iv) high leverage of financial institutions. The study shows that it has been realized by the global community that tackling these problems calls for a coordinated approach in which various national and international agencies have a vital role to play. The paper provides an extended discussion on the role of national regulatory and supervisory authorities in seven key policy areas including (i) making monetary policy respond to asset prices, (ii) strengthening and expanding the scope of regulation and supervision, (iii) controlling leverage of financial institutions, (iv) dampening pro-cyclicality of capital requirements, (v) reducing costs of financial failures, (vi) devising market incentives for prudent behaviour, and (vii) a shift from micro-prudential to macro-prudential regulation. The paper examines the extent to which the official financial supervisory and regulatory authorities in India have succeeded in global macro policy coordination in a bid to ensure financial stability.