Challenges confronting Indian Government

One year after one of the most severe financial crisis hit the world economy, our country is trying best to recover from the downturn. However, there are some serious challenges in front of Manmohan Singh led government. On his recent visit to Hyderabad Prime Minister maintained that the stimulus package has to continue till the economy operates at its full capacity. However, Indian economic scenario is not the same as that of western countries. In western countries, consumer price index is still low while in India it is howering at around 10-12%. This means that continuation of fiscal stimulus would bring inflationary tendency in the economy. Combined with this our country is already facing simultaneous flood and drought situation which has led to large shortfall in the production of foodgrains in India. It is estimated that local production of rice has fallen by 10 million tonnes. After being forced to import sugar now the country is also likely to import rice from international markets. The story does not end here. The rise of rupee vis-a-vis dollar is likely to sustain, hurting exporters further hampering growth. On 8th October rupee rose to its highest more than a year, closing at Rs 46.34 to the dollar, a gain of over 3% in just four seasons.A significant part of the appreciation is due to dollar inflows, both direct and portfolio. Inbound FDI has touched $9.5 billion in the first quarter this fiscal. This appreciation of rupee is likely to bring further inflationary tendency(apart from rising food prices) in the economy.(Appreciation of rupee brings inflationary tendency because RBI tries to counter increased demand of rupee by increasing supply of rupee in foreign markets by buying hard foreign currencies like dollar. However an appreciation of domestic currency generally leads to fall in price index to keep real variables like real exchange rate constant due to purchase power parity theory. However this theory applies when there is no central bank intervention. In Indian case central bank is intervening to keep nominal exchange rate constant, so there will be inflationary tendency and not disinflationary tendency.) This will again lead to increase in interest rates(inflation tends to raise rate of interest) which the government has tried to keep low and will crowd out private investment further hampering economic growth(also exports have declined). At the time when exports have declined for 11th consecutive month and there is evidence of human distress and job losses, a rising rupee would do more damage. Also this rising rupee is seen in short term. In medium term Rupee should fall again.(A rising rupee will distort balance of trade by making imports cheaper and exports costlier, so rupee must fall in medium term so that the economy returns back to its original balance of trade). So rising rupee should not be seen as a sign of strengthening Indian Economy. Unfortunately, any steps to mitigate this disaster- RBI buying dollars and pumping in Rupees- could well be an invitation to a bigger problem. It would add to money supply at a time when there is already surplus liquidity and aggravate inflationary pressures. The solution for RBI is to go back to its tight rope walking: balancing inflation and the exchange rate.

Floods in Andhra pradesh has led to huge loss of Infrastructure and the loss is estimated at around Rs 12000 cr. Such emergency situation is likely further increase fiscal deficit which has already been estimated at 6.8% of gdp in Union budget 2009-2010. Also government's plan to raise revenue by selling 3G spectrum to private players has been put on hold due to security concerns. The Government was planning to raise Rs 35000 cr by auctioning the spectrum.

So we can see that there are so many problems which confront Indian government and specially RBI. They have to decide a suitable monetary policy for this country.

I have written this article by taking references from Economic Times of the month of September and first week of October.