Narendra Modi hasn't been the luckiest of PMs on the economy. In his first term, he inherited an economy in a paralytic mess. In his second term, a once-in-a-century pandemic struck. That was followed by the Russia-Ukraine war. In his third term, the economy has been hit by Trump - first tariff wars, then war with Iran.
Each time, Modi has come out relatively unscathed. How best can he do this time?
For now, the PM is using the Covid playbook to appeal for behavioural change. He is asking people to consume less heavily imported commodities like oil and gold (import duties were raised this week), while postponing foreign travel. During Covid, there was every chance people would follow the suggestions because their lives were at stake.
But humans rarely respond to calls for voluntary action, particularly if it entails reducing living standards. They respond to diktats. The only way people will cut down on consuming oil products is if prices rise sufficiently. Similarly, they will not go on foreign vacations if they become too expensive. GoI should allow the prices of oil products to rise.
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In a similar vein, it should allow the rupee to depreciate: the exchange rate is also a price. A declining rupee also acts as a stabiliser by making imports more expensive, leading to a cut in consumption while making exports more competitive, thereby shoring up forex requirements.
Why has Modi chosen to appeal for voluntary action, instead? Because he knows there will be economic and political consequences of allowing oil product prices to rise and the exchange rate to fall. The most obvious fallout is high inflation because oil prices feed into most supply chains. Inflation disproportionately hits the most vulnerable. Historically, voters tend to punish governments for high inflation more often than for sluggish growth.
On rupee, GoI is cornered, partly out of its own making. By making the value of the rupee against the dollar a matter of political and national prestige in the past, it is difficult to shrug off now as an economic compulsion. But there's an economic reason as well. India's biggest imports are oil and gold, and both tend to have a somewhat inelastic demand - people continue to buy them even when prices go up.
In the case of oil products, it's necessary. People need to cook and use transport. In the case of gold, it's a choice. But in a time of great economic uncertainty, people buy more gold, not less. Even central banks are doing the same. So, in the short run, a sharp rupee depreciation will put even more pressure on current account and forex. Exports will not rise as quickly because there is a time lag in the placement of orders. And, in Trump's world, only the short run matters.
A better option may be for GoI and states to cut taxes on fuel. Say, a litre of petrol costs ₹94, only ₹47 is actual price. The other half of ₹47 accrues to GoI and states in taxes. A cut here can allow OMCs to get a higher price without changing retail price for consumers. This will blow a hole in the fiscal deficit and will likely require both GoI and states to cut expenditure. That may affect growth, but it will prevent inflation.
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Other options specifically target shoring up the forex position. There has been a foreign investment outflow of over $20 bn in the last 2 mths (from financial markets), one of the largest such movements in such a short time frame in the last 3 decades. This is driven by global factors, but some tweaks in policy can reverse it, at least partially.
GoI can reconsider LTCG tax and STT. It can also issue a large dollar-denominated sovereign bond, perhaps for NRIs. RBI can also raise interest rates, which will come with a cost in growth.
Almost inevitably, GoI will have to do more than appeal. The least inflationary way forward may be the best.
The writer is chief economist, Vedanta.
