Staying calm: Better to avoid knee-jerk response to macro indicators

There is no denying that the Indian economy is showing a few red indicators on its macro-economic dashboard. The perennial pressure point, crude oil prices, is once again having multiple negative effects across the board. Fiscal targets look in danger of being missed. The external account deficit has touched 2.4 per cent of gross domestic product and is pushing up towards 3 per cent (though will hopefully stop short of that mark). Inflationary prospects hover on the horizon. The yield on long-term government debt has risen, and its spread with the overnight repo rate has widened dangerously in consequence. There is a very real possibility that the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) will have to send interest rates higher in consequence, which might choke any incipient recovery in growth-boosting fixed capital investment. Two other familiar phenomena are visible: As a consequence of these indicators as well as a larger loss of confidence in emerging markets more generally, the rupee is testing historic lows against the dollar. And high prices at retail outlets have emboldened the political opposition into demanding the government either control prices or reduce fuel taxes.

The government must have a single mantra in response to all this noise: Stay calm. Knee-jerk reactions, or over-reactions, will be even more dangerous. It must not respond to undue panic even if such seems to have infected the markets or the airwaves — both of which are notoriously short of perspective after all. What would be disastrous is if the Union government chooses to itself cut fuel taxes, or even worse prevails somehow upon the oil-marketing companies to absorb losses in order to reduce political pressure. This would have negative consequences for the fiscal deficit — and thus not just hurt the government’s reputation and bond yields but also keep the inflationary momentum building. This is also in its own political interests: The general election is far away and a knee-jerk reaction now might well cause its negative effects to peak at a most inconvenient time in terms of the campaign. Instead the government must focus on how it can boost exports to take advantage of a falling rupee.