Miraculous effects of a rising rupee

Suddenly, euphoric predictions for the Indian economy are proliferating. Goldman Sachs, the global investment company, says India will become the third biggest economy in the world after China and the USA by 2050, dwarfing Japan and Germany .

Vijay Kelkar, special advisor to the finance minister, claims that India is entering a golden age of growth that could touch 8 per cent.

This euphoria will puzzle many people. GDP growth has been stuck for two decades at around 5.8 per cent per year, leading some to call it the neo-Hindu rate of growth. Kelkar is wrong to claim that GDP growth is accelerating. In fact, it reached a peak of 7.5 per cent annually in 1994-97, and has subsequently averaged barely 5 per cent a year. A good monsoon will bring a temporary spurt this year, but that is clearly not sustainable.

So, should anybody believe that India is about to take off? I would advise caution. Yet, one thing has changed so dramatically that it could indeed mean take-off. The rupee has started rising, and looks like keeping on strengthening. If that continues, India will indeed become an economic superpower even with no improvement at all in GDP growth.

To understand why, consider what GDP is. It is the total value of goods and services produced in a country. In countries totally open to global competition, goods will be valued at international prices. But in markets protected by high import barriers, the value of goods will seem much higher. This is an illusion that will remain till tariff barriers are lowered. Then, what earlier looked valuable may turn out to be worthless.

This was exemplified in the Soviet Union . Its statistics consistently showed higher GDP growth than the USA ’s. This led the gullible to believe that it was only a matter of time before the Soviet economy overtook the American one. This never happened because much value addition in the Soviet economy was illusory.

A Soviet machine tool often used twice as much steel, labour and electricity as an American one. Soviet statistics showed this machine tool to be twice as valuable as a corresponding American one. Yet, in the international market the Soviet product was unsaleable, and so had zero value. Using double the inputs does not make a product twice as valuable, it simply represents prodigious waste. This waste is cloaked by import barriers which enable the producer to sell a fundamentally worthless product.

India had a similar problem in the 1980s. Import duties went up relentlessly in the decade, with the peak rate exceeding 800 per cent. GDP growth in this decade was a very respectable 5.8 per cent, yet part of this was illusory. It represented wasted inputs rather than true value. Hindustan Machine Tools looked a champion in this period of rising protection. But when import duties fell in the 1990s, HMT rapidly went from hero to zero. By contrast BHEL survived, even thrived, because it really did create value.

Since 1991, India ’s peak import duty has come down to 30 per cent. Though still high by global standards, this means that Indian prices are much closer to global ones. So GDP has become more real and less illusory. GDP growth of 5.8 per cent in the 1990s with falling import duties represented a much better real performance than the same rate when import duties were rising in the 1980s.

One measure of GDP illusion is the exchange rate. India ’s currency crashed from Rs 8 per dollar in 1980 to Rs 30 in 1992, a fall of 73 per cent. Then, between 1992 and 2002 it depreciated much more slowly (by 39 per cent) to Rs 49. So, while GDP growth looked no faster in the 1990s than in the 1980s in rupee terms, it was much faster in dollar terms. A more revolutionary change may be in the offing. The rupee has strengthened from Rs 49 to Rs 45.30 to the dollar over the last year, and forex reserves have crossed $90 billion. Exports of goods and services are booming, and dollars from both NRIs and foreign investors are cascading in.

If GDP rises 5.8 per cent and the rupee appreciates 2 per cent annually, that will represent a growth of 7.8 per cent in dollar terms. What looks like a neo-Hindu growth rate will actually be a miracle-economy rate.

Besides, annual population growth has fallen from its historic 2 per cent to 1.6 per cent, and will drop over the next three decades gradually to zero. This factor alone will push up per capita growth by 2 percentage points compared with the 1980s. Thus an economic miracle may emerge from India ’s bedrooms, no less than board rooms.

Is this realistic? Can India really sustain 5.8 per cent growth with a rising rupee? I am far from sure. But for the first time I will say that it no longer looks implausible.

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