The Indian economy has been teetering on the brink for the past few months. The most manifest of these problems has been the crash of the Indian rupee, which has shown a decline of approximately 20% against the US dollar in a short period of time. Tarun Khanna, Director of the South Asia Institute at Harvard University and Jorge Paulo Lemann Professor at Harvard Business School, offers some insights into the causes and conditions at play.
Zeenat Potia: Can you give some context around the downturn of the Indian economy and how it applies to other emerging markets?
Tarun Khanna: First of all, I’ll say that this isn’t a crisis, but a significant correction. It’s the result of a general reduction in confidence in the Indian economy and, in turn, has fed further angst. The fall of the rupee comes at a time of corrections to other emerging market currencies such as the Indonesian rupiah and the Brazilian real. A common cause of these price movements is shifts, or expected shifts, in US monetary policy. The United States is still the big gorilla in the global currency field, and when policies are tightened at home, resulting in the dramatic withdrawal of money from emerging economies, the smaller economies pay the price. The problem is exacerbated by continuing structural weaknesses in developing countries where foreign investments are not necessarily anchored in long-term commitments to infrastructure or projects that require physical plant equipment, but often are more portfolio-like in nature and somewhat footloose and fancy-free.
ZP: What are some of the causes of the decline that are specific to India?
TK: Due to large-scale economic liberalization since 1991, India has had a nice long run of reforms that drove increased investment, both by local entities and foreign investors, but when times are good, people tend to assume that they are everlasting. Sadly, reality isn’t so compliant. During flush times, people borrowed excessively beyond their capacity to repay their debts, which is a common cause of corrections in emerging markets. Now under sobering conditions, people are scrambling and realizing that it’s tough to refinance their debts. For instance, a landlord of an apartment building in Bangalore has a short -term loan in dollars that is being serviced or paid for in rupee receivables. In other words, the landlord still gets the same rent in rupees from his tenants, but that money just became 20% more expensive in the global currency market. So what is she to do? The options aren’t appealing: Default on the loan or change the business model by possible refinancing. As you can see from this example, the current Indian economic crash has real microeconomic consequences causing consternation for companies, small businesses, and entrepreneurs.
ZP:Do you think the Indian political climate has contributed to the current economic situation?
TK: Absolutely. India has, sadly, become notorious for policy paralysis. Laws are often tabled in Parliament, and they get pushed from session to session, despite their urgency. There is a rampant lack of clarity and leadership from the major political parties. The main opposition party, the Bhartiya Janta Party (BJP), recently announced Narendra Modi as their candidate for Prime Minister. The party currently in power, Congress, in the form of the government of Prime Minister Manmohan Singh, does not have a clear successor PM-candidate. Parties are preoccupied with their own internal affairs and not attending to the business of governing – a state of affairs that surely deters serious longer-term investors.
ZP:Are you saying that China would be a better choice for that?
TK: There is a biblical saying that advises one to use a period of feast to prepare for a famine. In the Indian context, if, as was the case in China, adequate investment had been put into roads, bridges, and power plants, I suspect that a much larger fraction of the money coming into India would have been productively deployed into longer-term fixed assets, securing it against the volatility of global currency markets, particularly the tightening supply of the US dollar. India’s economy still has many strengths compared to China, especially thriving entrepreneurship at the grass-roots level, but it’s been sadly overshadowed by the less-than-sterling performance of the state, to put it mildly.
ZP: On a different note, any thoughts on the rising price of onions in India?
TK: This is very bad news for the incumbent government, since the price of onions is a harbinger of electoral distress. It is a bellwether consumer price in India, given its status as a consumer staple, and it indicates potential economic distress for the common man and woman. The Indian government recently passed a massive food security bill, which is an attempt to provide subsidized food to the poorest of the poor and to raise their level of welfare. Nobody can disagree with the need to alleviate the suffering of the hungriest, but the issue in India is that the mechanisms to distribute food to the most vulnerable people are inept and corrupt. The most charitable estimate I’ve seen is that for every rupee of subsidized food, sixty-five paisa doesn’t reach the intended recipient, and the least charitable estimate is that eighty-five paisa goes awry. This speaks to a very large leaky pipe, into which the government is pouring more resources in the futile hope that the pipe repairs itself. The fear is that this is an election sop, before next year’s national elections, in order to boost ratings. If so, it would be a poor use of resources compared to using funds to repair the broken infrastructure. Since sizeable commitments of this sort can further exacerbate the fiscal deficit, already high, it can worsen an already weak fiscal situation. As Indians say, we’re on a sticky wicket, to use a cricket analogy.
