Economy

KEY POINTS

Dutch Disease

·         It refers to the negative consequences arising from large increases in the value of a country's currency.

·         Primarily associated with a natural resource discovery.

·         But, it can also result from any large influx of foreign currency into a country, reducing the competitiveness of domestic enterprises, thereby boosting imports and hurting exports.

Are Excess inflows a problem?

·         Except three years, all other in the last three decades, India had a current account deficit (CAD).

·         Foreign capital in the form of FDI, FPI, or ECB’s funded this excess consumption.

·         Foreign capital is not just about financing consumption, often these bring in technology and expertise, and also provide risk capital (which India is short of) and cheaper funding for long-term investments.

·         But the persistence of the CAD and the consequent dependence on external flows to keep the currency stable raise questions on sustainability.

How to deal with currency volatility?

·         Weaker currency – Half of our goods imports are things that we do not have and another fourth are things that we cannot make.

·         A weaker currency will only push local prices of these goods higher — while this may bring down demand for them, this would also mean a broad-based slowdown in the economy.

·         A minor decline in the value of the rupee thus is unlikely to drive export acceleration that will narrow the CAD meaningfully.

·         And a big depreciation could disrupt the economy for a few years.

·         Raising Interest rates – A Conventional approach to protecting the currency is raising interest rates.

·         This signals to the currency markets that the economy is willing to bear the pain of a domestic demand slowdown to protect the currency’s value.

·         But pushing down growth for the whole economy is perhaps too high a cost.

Way ahead

·         Targeted mechanisms to slow these down may help.

·         Politically unattractive as they may be, higher retail prices of petrol and diesel may also help.

·         Over the medium-term, measures like a change in our energy mix, greater indigenisation of electronics and defence manufacturing, and higher agricultural exports can help the economy get over the worryingly frequent bouts of currency volatility.