People's Democracy

(Weekly Organ of the Communist Party of India (Marxist)


No. 40

October 06, 2013





Prabhat Patnaik


THE fact that the precipitous fall in the rupee has been halted and even slightly reversed in the last few days has created an impression that India’s immediate economic crisis has ended. This however is erroneous.


The announcement by the chairman of the Federal Reserve Board of the US, Ben Bernanke, that the Fed will continue for some more time with its policy of “quantitative easing”, i.e. of buying bonds and pumping money into the economy, has led to an easier flow of finance to the “newly emerging markets” than had been the case earlier after Bernanke had announced that “quantitative easing” would come to an end. So the stock market and the rupee have looked up.


But this temporary reprieve for the rupee should not obscure the fact that the basic problem, namely of a current account deficit that is way above what the country can expect to finance on a sustained basis through capital inflows, has not gone away. Indeed the latest figures show that in the first quarter, April-June, of 2013-14, the current account deficit was 4.9 per cent of the GDP which far exceeds the 2.5 per cent that the government itself considers sustainable on the basis of capital inflows.


As long as this basic problem of an unsustainable current account deficit is there, notwithstanding occasional reprieves like now, the secular trend for the rupee will be downwards which will also mean a perpetuation of cost-push inflation, with rising rupee prices of imported goods like oil being passed on to the people at large.




There are two alternative explanations of this basic problem, from which two sharply divergent conclusions follow about what is to be done. The first explanation which is common to the neo-liberal perspective is as follows: the large current account deficit is because of excess demand in the economy, i.e. because the overall magnitude of demand in the economy exceeds what the country can produce; this excess demand arises largely because of the excess demand of the government sector which is reflected in its large fiscal deficit; the economy therefore should attempt in the short-run to finance the current account deficit as best as it can, by attracting adequate foreign resources, for which it has to “open up” more to foreign capital; in the long run however it has to reduce this deficit by curtailing the fiscal deficit. The panacea in short is to “liberalise” as much as possible even while imposing austerity on the government.


The problem with this reading is that its very premise is wrong: the large current account deficit is not because the economy’s demand for goods exceeds what it can produce. On the contrary, its productive capacity is lying unutilised in a number of sectors. The large current account deficit is because of an import surge at the expense of domestic production made possible by the neo-liberal policy of import liberalisation, which has occurred even while exports continue to be sluggish owing to the global capitalist crisis. In other words domestic unutilised capacity has been caused by the same factor which has caused the large current account deficit, namely the import surge made possible by liberalisation.


This import surge is not confined only to gold and petro-products. It has occurred in a large number of spheres, and the gold import itself, far from being a cause of the crisis is more a response to it (which no doubt aggravates the crisis at the same time): wealth-holders worried about the prospects of a depreciating rupee, both vis-a-vis foreign currencies like the US dollar and vis-à-vis the world of commodities in general (owing to inflation), wish to hold gold as an asset which explains the increases in its imports.




If the neo-liberal panacea, whose basic premise is wrong, is tried out, then far from alleviating the crisis, it will only aggravate it further, while at the same time worsening the condition of the people. A curtailment of the fiscal deficit typically takes the form of reducing development expenditure in rural areas, welfare expenditure and subsidies for the poor. Such reduction has a direct adverse effect upon their living standards. At the same time however, since the import content of such expenditure is minuscule, its curtailment does not reduce the current account deficit; what it does instead is to reduce the demand for a range of domestically produced goods, which further worsens domestic recession and unemployment.


Take a simple example. Suppose Rs 100 was being handed over to the poor in the form of a subsidy. It would be getting spent on some simple locally-produced goods with very little import content. If this subsidy is cut, then the condition of the poor worsens directly; the local demand generated by it gets curtailed, causing a reduction in domestic production and employment (which further worsens the condition of the poor); at the same time however there is not an iota of improvement in the current account deficit.


Hence, if we follow such a course of action, then the ongoing crisis emanating from the unsustainable current account deficit will continue as before; but it will be further compounded by an additional dose of recession and unemployment caused by the government’s resort to austerity, while making the people worse off, both because of the austerity and because of the additional dose of unemployment.


But that is not all. The greater “opening up” to foreign capital which is resorted to for financing the current account deficit, also has a two-fold effect. On the one hand it entails the displacement of local production by foreign capital, which raises imports and reduces domestic employment. The classic example here is the entry of retail giants like Walmart, who not only displace large numbers of petty traders, but also additionally displace other local producers because they import their wares from the cheapest global sources, which means from third world producers even more hapless than those in India. Increased unemployment is thus caused along with larger imports and hence a worsening of the current account deficit.


On the other hand however the economy becomes even more vulnerable to capital outflows with every such “opening up” to foreign capital. Naturally, the greater the magnitude of foreign capital operating in the economy, the wider the area over which it holds sway, the greater the potential outflow in the event of a loss of “confidence” in the economy or in the value of the rupee. Hence if the panacea for the long-term problem of an unsustainable current account deficit in the form of a curtailment of the fiscal deficit, is counterproductive, then the  measures for meeting the short-term problem of financing this deficit within the neo-liberal regime by attracting foreign capital, are no less so. Attracting foreign capital, quite apart from its other effects in terms of causing unemployment by displacing domestic producers, is a double-edged weapon: it may help the balance of payments immediately by financing the current deficit, but by the same token it makes the balance of payments more vulnerable over time.


All this should come as no surprise. The world economy continues to be in a crisis. The very announcement by Ben Bernanke that the Fed will continue with “quantitative easing” for a longer period, which has brought some immediate relief to the rupee, is caused by the Fed’s belief that the recession in the US is nowhere near ending. Neo-liberal policies whose wisdom is questionable at all times, make very little sense in periods when the world economy is in a recession, since they only serve to import the recession into the domestic economy.


It is for this reason that we observe a clear historical pattern: periods of crisis in the world economy are periods when third world economies get delinked from it (usually involving major political upheavals within the countries to permit such delinking). The Great Depression of the 1930s for instance saw a spate of political upheavals in the Latin American countries, resulting in the introduction of protectionist measures that facilitated a wave of industrialisation in that continent.




The second course before us consists precisely in such delinking, in rolling back neo-liberalism, by introducing import restrictions, and, since such introduction will cause loss of “investor confidence” and hence flight by finance capital, imposing controls on capital flows. Capital controls can take a variety of forms, ranging from a minimum period after coming into a country before capital can move out, to restrictions on the sale of assets (such as in China where foreigners can sell shares only to other foreigners), to a rationing of foreign exchange outflow, such as what India had for decades before liberalisation.


Those with a neo-liberal mindset may feel that capital controls of this sort, apart from risking the wrath of the big capitalist powers, are also questionable on the grounds that they violate a solemn promise on the basis of which capital had flowed into the country in the first place. But wrath of the big powers cannot stand in the way of pursuing policies in the interests of the people; indeed if that had been the consideration then there should have been no freedom struggle against British colonialism. And as regards solemn promises, not only do the same considerations apply, namely that the interests of the people take precedence over all such promises, but additionally such solemn promises are systematically violated by the most powerful capitalist country, the US. It imposed an embargo, during its confrontation with the Islamic regime, on Iran’s assets in US banks being taken out of the country, in violation of all solemn promises on which capitalist business is supposed to run. And it has repeated such violations on numerous occasions.


Besides, after the East Asian crisis of 1997-8 when Malaysia imposed capital controls and emerged comparatively more unscathed from the crisis than the others who did not, even the IMF concedes that capital controls may be necessary in certain circumstances. Of course the IMF, being the IMF, typically insists on a set of measures where capital controls are accompanied by substantial privatisation of public sector assets and other neo-liberal initiatives. The IMF in other words extracts a price for agreeing to capital controls; but the wisdom of capital controls is conceded even by that guardian of international finance capital.


The second course will entail not only a quick end to the collapse of the rupee, and hence an end to cost-push inflation, but also a revival of demand for domestic producers and an immediate improvement in capacity utilisation and employment in domestic units. It will also provide elbow room to the government that adopts this course to undertake an alternative trajectory of pro-poor growth without having to worry about the “confidence” of international financiers.