INDIAN EXPRESS EDITORIAL DISCUSSION

1. INDIAN EXPRESS EDITORIAL DISCUSSION 18 September2018

2. Exchange Rate, Appreciation & Depreciation of currency • Anexchange rate is the rate at which one country's currency can be traded for another country's currency. For example, in the United States, the dollar's strength is often judged in relation to other currencies, such as the Japanese yen, the Swiss franc, and the euro. When a currency appreciates, it means it increased in value relative to another currency; depreciates means it weakened or fell in value relative to another currency. • When a dollar buys more than its equivalent in another currency, it's often labeled strong. When it buys less than its equivalent, it's weak.  • In general, however, a weaker domestic currency stimulates exports and makes imports more expensive. Conversely, a strong domestic currency hampers exports and makes imports cheaper. • Let’s use an example to illustrate this concept. Consider an electronic component priced at $10 in the U.S. that will be exported to India. Assume the exchange rate is 50 rupees to the U.S. dollar. Ignoring shipping and other transaction costs such as import duties for the moment, the $10 item would cost the Indian importer 500 rupees. Now, if the dollar strengthens against the Indian rupee to a level of 55, assuming that the U.S. exporter leaves the $10 price for the component unchanged, its price would increase to 550 rupees ($10 x 55) for the Indian importer. This may force the Indian importer to look for cheaper components from other locations. The 10% appreciation in the dollar versus the rupee has thus diminished the U.S. exporter’s competitiveness in the Indian market. • At the same time, consider a garment exporter in India whose primary market is the U.S. A shirt that the exporter sells for $10 in the U.S. market would fetch her 500 rupees when the export proceeds are received (again ignoring shipping and other costs), assuming an exchange rate of 50 rupees to the dollar. But if the rupee weakens to 55 versus the dollar, to receive the same amount of rupees (500), the exporter can now sell the shirt for $9.09. The 10% depreciation in the rupee versus the dollar has therefore improved the Indian exporter’s competitiveness in the U.S. market.

3. Rumble over rupeeGovernment steps in to arrest its slide against the dollar. The panic over its depreciation may be uncalled for. • Last Friday, the government announced five measures to arrest the sharp slide in rupee and also the deficit in the current account. • These include relaxations in investment limits for foreign portfolio investors in the corporate debt market to attract dollars and exemption from withholding tax to companies raising funds through rupee-denominated bonds abroad. • WITHHOLDING TAX : a tax deducted at source. A withholding tax is an amount that an employer withholds from employees' wages and pays directly to the government. It also is a tax levied on income (interest and dividends) from securities owned by a nonresident as well as other income paid to nonresidents of a country. • The government also indicated curbs on non-essential imports and said measures to boost exports will follow, both aimed at containing the current account deficit • In calendar year 2018, the rupee has depreciated by almost 13 per cent, which is seen by the government as too fast-paced a slide.TheREER, or real effective exchange rate, based on 36-currency export and trade based weights, of the rupee for August 2018 stood at 114.54, suggesting the rupee is intrinsically overvalued, and is depreciating only against the US dollar. The panic may thus be uncalled for. The concerns over current account deficit going out of control are valid, but the measures taken are unlikely to attract dollar inflows immediately, and also have been perceived as little to influence the markets. The markets expected the government to announce a foreign currency non-resident bank deposits, or an exclusive window for oil marketing companies to buy dollars from the RBI instead of knocking on the doors of banks. The government would do well to realise that easing capital controls should be part of a larger reform agenda, rather than a reaction to a crisis. India’s experience and academic research show that efforts to manage the trilemma — free capital mobility, rigid exchange rate and monetary policy autonomy — is not possible.

4. A misconceived notion in some parts of the government is that speculators are playing truant and short-selling the rupee- SELL 1ST BUY LATER. The so-called speculators are mostly Indian exporters and importers taking positions on the rupee based on the clues they receive from the market. While senior finance ministry officials have been making statements — irresponsible at times — on the value of rupee, the RBI has desisted from giving any firm signal to the market about where it would draw a line. This suggests lack of coordination between the government and the regulators despite existing forums such as the Financial Stability and Development Council.

5. Rupee in a global worldIndia’s macroeconomic framework is based on an antiquated(OLD-FASHIONED OR OUTDATED) belief that the economy is closed. • I understand that the optics of an 8.2 per cent GDP growth rate followed by a 6 per cent depreciation of the rupee against the dollar is not pretty, but from an economist’s point of view, I do not understand the brouhaha surrounding it. • After languishing for two years, economic growth has begun a recovery of sorts in the last two quarters on the back of a straggling(SLOWLY) pickup in investment. • However, with the government deficit (Centre and states combined) running at over 7 per cent of GDP and likely to widen, the rise in investment is largely being financed abroad. This has raised India’s current account deficit (the part of investment that isn’t funded by domestic savings) from 1.9 per cent of GDP in 2017-18 towards 3 per cent this year. • When fiscal and current account deficits widen, the economy adjusts through higher interest rates and exchange rate depreciation. That is exactly what has happened to bond yields and the rupee. • With tighter global financial conditions since April and a reassessment of emerging market risk since August, it should not even be surprising that the rise in bond yields and the rupee depreciation has had to be large. With no support from fiscal policy and only modest monetary tightening, all the adjustment has been borne by the exchange rate. When only one variable has to do all the heavy lifting, the adjustment is usually outsized. And that’s what had driven the slide in the rupee. None of this is out of the ordinary. It is exactly what any Economics 101 textbook would say.

6. Therefore, the ongoing soul searching among analysts and policymakers whether the government and the RBI should or should not stop the slide in the rupee is largely misplaced. It is not about whether one should or should not react to the rupee, but about whether one should or should not react to changes in economic fundamentals that are driving the rupee. In my view, we are asking this question for the umpteenth time in the last 10 years because India’s macroeconomic policy framework has long been overrun by economic reality. • The crux of the problem is that India’s macroeconomic framework is based on an antiquated belief that the economy is closed when in reality it is far more open. For example, the RBI has rarely linked its policy decisions to changes in global interest rates even after shifting to an inflation-targeting framework. It is the same with fiscal policy. Every budget document begins with a perfunctory paragraph on “global developments” but neither taxes nor expenditure has been changed in response to what has happened outside of India except when forced by crises. The overall fiscal deficit has remained virtually unchanged around 7 per cent of GDP since 2013-14, the year of the Taper Tantrum, despite the global economy, financial conditions, and oil prices undergoing large cyclical changes There is an entrenched and widespread belief among the same analysts and policymakers that India is a closed economy protected by its much vaunted regulatory and capital controls. Nothing can be further from the truth. Every time the world sneezes, India catches a cold. It happened in 2008 when Lehman collapsed; in 2011 during the European sovereign debt crisis; in 2013 when hit by the Taper Tantrum; and it is happening now. Consider what happened in the Lehman crisis. On Friday, September 12, 2008, the call money rate in Indiaclosed at 6.15 per cent and banks borrowed about Rs 45 billion from the RBI that day. Over that weekend, Lehman collapsed. By the next Wednesday, the call rate had jumped toover 13 per cent and bank borrowing from the RBI had risen to nearly Rs 600 billion! In neighbouring Indonesia, with a significantly more open capital account, the inter-bank rate barely inched in the first week of the crisis.

7. Let me make this more concrete by using monetary policy as an example. The policy statements and the minutes of the Monetary Policy Committee (MPC) meetings suggest that the policy interest rate has been set based on the committee’s view on the 6-12 month ahead inflation and its drivers including inflationary expectations, the slack in the economy, government policies etc. This is the right framework only if the economy is closed. • In an open economy, apart from the drivers of inflation, interest rate separately and explicitly responds to changes in global financial conditions too. Many inflation-targeting central banks with open economies, in both developed and emerging markets, routinely publish not only their assessment of how global financial conditions might evolve but also the extent to which their policy actions are determined by the changes in these conditions. That does not mean that these central banks insentiently react to every twist and turn in global financial conditions. They react just as they do to inflation dynamics: Assess the drivers of the changes, determine whether they are transient or permanent, and decide if a response is needed. • While the binary description of being either open or closed does not work for India, it is palpably obvious that in the last 10-15 years, the country has de facto become more open despite extant de jure capital controls. However, India’s fiscal and monetary policy frameworks have not been adapted to the higher and rising degree of external openness. • Consequently, when faced with a global financial shock, neither fiscal nor monetary policy has, as matter of course, adjusted to safeguard the economy. Instead, we have scurried around for ad-hoc solutions, as is gaining currency now with suggestions for more NRI deposits or external bond issuance. I am sure we will come up with another clever scheme and then pat ourselves on the back on how that staved off a crisis. However, we will face the same challenge again the next time global conditions change. • The solution is to recognise that India has become more open, that capital controls do not provide adequate protection, and therefore both fiscal and monetary policies need to be adapted to the increased openness. It is not a question of whether one should respond to the rupee slide; it is a question of whether India can continue not to respond to changes in global conditions.

8. TerrorisedBy LawCriminalising the mere espousal of an ideology under the UAPA is unconstitutional. • The Unlawful Activities Prevention Act 1967, was enacted by Parliament in 1967, as sections 123 and 124 of the Indian Penal Code were thought to be inadequate to control organised crime and acts of terrorism. Oddly enough, these provisions were considered adequate by the British colonial government to quell anti-state forces!Today several human rights activists, communist thinkers, poets and Dalit voices are being detained under this Act. Even the reading of a translation by Bertolt Brecht, the famous German playwright, is being called an act of inciting sedition. • To determine whether these voices are voices of sedition, we must start with the Constitution. The Preamble to the Constitution makes a solemn resolve to constitute India into a sovereign socialist secular democratic republic and to secure to all its citizens, justice, social, economic and political and equality of status and opportunity. The Directive Principles of State Policy enshrined in the Constitution provide that the State shall in particular, direct its policy towards securing — (a) that the citizens, men and women equally, have the right to adequate means of livelihood; (b) that ownership and control of the material resources of the community are so distributed as best to subserve the common good; (c) that the operation of the economic system does not result in the concentration of wealth and means of production to the common detriment. The Constitution of a democratic and decolonised country could not have read any differently because the basis of true freedom is socialism. • Therefore, criminalising the mere espousing of socialist or communist ideology under the UAPA is patently unconstitutional as the objective is neither illegal nor unconstitutional. However, Article 19 of the Constitution sets limits to our freedom of speech and expression, even for legitimate and legal objectives. To test the scope within which a citizen is legally permitted to voice their protest against a government or organise opposition to it even for a constitutional purpose, we must consider the scope and ambit set by the Supreme Court to Article 19 in the context of sections 123 and 124 of the IPC, in the matter of KedarNath vs. State of Bihar (1962).

9. The Supreme Court clarified that the freedom of speech has three components: Discussion, advocacy and incitement.It is only when discussion and advocacy reach the level of incitement not just in words but deeds to provoke people to violate the law, that it falls in the realm of the mischief sought to be quelled by Section 124 A of the Indian Penal Code, according to the Court • The conviction of people for merely questioning the injustice of a government or possessing or reading socialist or communist literature, even if it is associated with banned groups (that believe in the unlawful method of armed struggle) on the basis of assumptions, without evidence, that those reading such literature must be inciting violence, is in fact an extra-legal act of violence by the state upon the citizen • The National Crime Bureau Statistics indicate that 67 per cent of the cases under the UAPA 1967 end up in acquittal or discharge of the persons accused, after their having lived in detention, often for years, as the draconian provisions of the Act, deprive the accused of the right to bail, allow police remand for over 30 days as opposed to the 14 days under the IPC and give leave to the prosecution to file a chargesheet in 180 days rather than the usual mandate of 90 days • If a democratic state is permitted to arm itself with legislations such as the UAPA, empowering it to deny someone who opposes the government their freedom for an almost indefinite period of time, it casts a duty upon the judiciary to ensure that the arrest itself is based on cogent and irrefutable evidence. It requires the magistracy to be alert and willing to jealously guard the citizen from unlawful arrest. Because the abuse of the UAPA, if unchecked by the judiciary, poses a greater threat to the sovereignty and integrity of India, than the people being arrested under this Act because nothing incites hatred like injustice.

10. Failed by stateReport on the poor health of tribal communities raises questions about delivery of government programmes. • The litmus test for any government programme should be the impact it has on the most vulnerable section of the country’s population. • If a report of an expert committee of the Union ministries of health and family welfare and tribal development is anything to go by, projects that deal with primary healthcare, nutrition and sanitation have some work to do to satisfy this fundamental criteria of success. The report, released last week, points out that tribal communities in India live at least three years less than the non-tribal population, have higher malnutrition, significantly lower immunisation coverage, substantially higher low-birth-weight children and are much more susceptible to diseases like malaria, tuberculosis and leprosy. • The committee was set up in 2013 to assess the gaps and special health needs of the country’s 705 Scheduled Tribes.It does note that tribal groups have registered substantial improvement in health indicators since the past two decades. However, several of its findings raise questions about the delivery of government programmes. • For example, the finding that three out of four tribal people continue to defecate in the open point to the unfinished task of the Clean India Mission. Similarly, the report’s conclusion that an “unacceptably high” number of tribal people suffer from malnutrition throws light on the shortfalls of the Right to Food Programme and the Public Distribution System. The fact that only about 30 per cent of tribal children of different age groups consume diets “adequate in both protein and energy,” shows that implementation problems continue to dog the Integrated Child Development Services 17 years after the Supreme Court began to monitor the programme. Even more worrying is the report’s conclusion that “the intake of various nutrients, calories and vitamins in tribals has decreased in the last decade”.

11. The report is a reminder that the country’s health divide is also about the development disparity between tribal and non-tribal areas. • Its conclusion that access to health services, even where they exist, is bedeviled by poor roads should hold salience for the government as it plans to bolster the country’s primary and secondary healthcare network. • But another endeavour demands as much urgency: The lack of a regular system of data collection of morbidity in tribal areas often comes in the way of a comprehensive health picture of tribal health in the country. Government programmes, as a result, are often ad hoc. A project for the tribal areas along the lines of the recent state-level analysis of the country’s disease burden may well be in order.

12. From Plate to Plough: Drowning in sweetnessThe sugar industry faces a crisis of plenty. Unless bold steps are taken quickly, it can prove costly to the Modi government. • The sugar sector is heading for a major crisis of plenty. India will begin the sugar season (October to September) with a sugar stock of about 10 million metric tonnes (MMT). The industry’s production estimate for 2018-19 is 35.5 MMT, up from 32.3 MMT in 2017-18, against an annual consumption of about 26 MMT. Contrast this with the production of just 20.3 MMT in 2016-17, and one can imagine the enormity ofover-flowing stocks. • But the real problem is of rising arrears to cane farmers, which stood at Rs 21,675 crore on April 15, up from Rs 8,784 crore a year earlier. And it won’t be a surprise if these arrears spike further by 50 to 100 per cent by April 2019, if no bold corrective action is taken quickly by the government. More than half of these cane arrears will be in Uttar Pradesh. And this may hit the government hard, politically, as it heads for parliamentary elections, presumably in March-April, 2019. • Before we think of possible solutions, we must get the diagnosis right. The root cause of the mounting cane arrears is that in 2016-17, domestic sugar production was as low as 20.3 MMT, necessitating imports, and domestic sugar prices (ex-mill) crossed Rs 36/kg (see graph). Global sugar prices were also high ($490/tonne in October 2016). This led to an expansion of the area under the crop, and with a good monsoon, improved yield and recovery ratio, lead to dramatic increase in sugar production from 20.3 MMT in 2016-17 to 32.3 MMT in 2017-18, a historic increase of 59 per cent. This production boost substituted imports and replenished stocks, but it became a problem when the world prices of sugar dropped by almost 50 per cent to $244/tonne by August 2018 (see graph), making Indian sugar non-competitive in global markets.

13. What are the policy options when the sugar sector is jolted by such volatility? The first option is trade policy. In June 2016, India had imposed an export duty of 20 per cent to discourage exports as domestic production was low and sugar prices high. In 2017-18, when production jumped, export duty was removed, though belatedly, in March 2018, and import duty raised from 50 to 100 per cent in February 2018. Although the import duty of 100 per cent seems very high, yet the direction of trade policy is broadly right.

14. The second option is exporting 5-7 MMT of sugar. But at prevailing world prices, this is not feasible. Unless the rupee falls further and global prices improve, the export situation may remain grim. Exporting sugar through heavy subsidisation has its limits, as exporting countries like Brazil, Thailand, and Australia may drag India to the WTO. • The third policy option is to create a larger buffer stock (of say 5 MMT). This may help India stabilise prices in lean years. But it will cost quite a bit and, given the surplus supplies and low domestic prices, the sugar industry cannot bear this burden without the government underwriting a part of the stocking costs. • The fourth option is to divert cane to ethanol. The government has already taken a bold step by allowing ethanol from sugarcane juice or B-molasses and deserves compliments for this decision. It will help the industry diversify and reduce risk. Just to cite an example, in 2017-18, Brazil put almost 60 per cent of its cane to produce ethanol as global sugar prices were depressed. The Government of India (GoI) has also announced soft loans to the sugar industry for capacity expansion to produce ethanol. This is a proven technology and much better than the idea of producing ethanol from agri-waste, an idea that some oil companies are toying with, with capital investments of Rs 8,000-10,000 crore. However, one critical point in ethanol business is its pricing. Since ethanol is a substitute for petrol from imported crude, its pricing should be linked to the import parity price of petrol (IMPP). At a crude price of about $75-80/barrel, IMPP works to around Rs 47/litre, after accounting for its refining and other costs. But the sugar industry is asking for ethanol price of Rs 52/litre based on its cost of production, where pricing of cane remains a key factor. • That brings us to the core of this problem — the pricing of sugarcane. The GoI announces Fair and Remunerative Price (FRP), but the UP government tops it with the State Advised Price (SAP). In UP, the SAP was about 39 per cent higher than what its adjusted FRP would have been during 2010-11 to 2017-18. No wonder, sugarcane remains one of the most profitable crops.

15. For the 2018-19 season, while the GoI is trying to ensure 50 per cent margin over cost A2+FL for kharif crops, in case of sugarcane this is already 87 per cent at all India level and 97 per cent in UP. The problem is that the SAP is quite divorced from prevailing sugar prices. Ideally, cane price should be a contract price between cane farmers and sugar mills, with the government acting as a referee. • The Rangarajan Committee on the pricing of sugarcane had recommended 75 per cent of the sugar price to be given to farmers as cane price. Karnataka and Maharashtra had agreed to this formula but UP did not. Anything above this 75 per cent threshold speaks of a political component to cane pricing. • If the UP govt wants to give a higher price for sugarcane than 75 per cent of sugar price, the best way would be to give it as bonus directly to farmers, as Chhattisgarh and Madhya Pradesh did for paddy (Rs 300/quintal) and wheat (Rs 265/quintal), respectively this year. A similar principle should apply to sugarcane. Else, if we force the sugar industry to pay irrationally high prices of cane, it will be pushed towards sickness, large NPAs, and an even bigger mess. • Can the government convert this crisis into an opportunity to reform sugar policies? If it does, it will be good economics and good politics, ensuring sizeable votes from UP in the parliamentary elections.

16. African author IdowuKoyenikan’s words “Your pride for your country should not come after your country becomes great. Your country becomes great because of your pride in it.”

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