Dr Bharat Jhunjhunwala
Focus during the impending China visit of PM Modi will be on sorting out the border disputes. But economics will not be far behind. Commerce Ministry sources have already asked China to open up her markets for Indian products especially in pharmaceuticals, agricultural produce and software. Prime Minister Modi also wants China to make more investments in India. Our trade deficit with China continues to increase. India exported goods worth mere 17 billion dollars last year to China against imports of more than three times that figure at 54 billion dollars. Modi wants to adopt a two-pronged approach of increasing exports and inward foreign investment to bridge this imbalance.
The foreign trade policy of any country consists of inward flow of dollars from exports and foreign investments; and outward flows of dollars for imports and accumulating foreign exchange reserves. India’s policy is to obtain more dollars from foreign investments and use them for imports of goods for consumption like Chinese toys, American apples and Australian coal and Saudi oil. China’s policy is entirely different. China has kept its currency renminbi low so that exports are buoyant and imports are less. A low renminbi means that Chinese importers get fewer dollars for their renminbis. Consequently US imports such as those of Washington apples into China are more expensive. The huge earnings of dollars from buoyant exports are being used to buy US Treasury Bills. China purchased 107 billion dollars worth of US T-Bills in the first five months of 2014. This is equal to about one third of India’s total foreign exchange reserves of 300 billion dollars. China’s policy is to throttle domestic consumption for increasing its strategic power over the United States. Huge holdings of US T-Bills means that the US economy is at the mercy of the Bank of China. The Bank of China can start selling the T-Bills in the global market. The US Federal Reserve Board will have to print dollars to pay for these T-Bills. That will increase the supply of dollars in the world economy and lead to reduction of its price. That will bring the US economy crashing down just as an entrepreneur’s world comes crashing down when the bank sells the house mortgaged as collateral security.
The Chinese approach of buying US T-Bills throws light on the character of India’s policy. India is increasingly mired into debt since it is receiving huge amounts of dollars as foreign investment. Foreign investment is a debt. Indian Government guarantees that foreign investors can take out their monies from India whenever they wish. Last year there was a mayhem in Indian share markets when the US Federal Reserve Board increased the interest rates and that led to foreign investors selling their holdings and the Sensex crashing. The remittances made by foreign investors had simultaneously led to the rupee slipping to Rs 70 to a dollar. That event clearly shows that foreign investment is a kind of debt that can be recalled at the whims of the lender. The foreign investment taken in by India is fundamentally different than that taken in by China. China takes in less dollars from foreign investment than it sends out for the purchase of T-Bills. Hence China can easily sell its huge holdings of US T-Bills to obtain dollars if foreign investors decide to exit. China is like a prudent moneylender who takes fewer loans than he gives out. China is safe.
The different approaches to foreign trade taken by India and China are of momentous significance. India is taking in increasing amounts of foreign investment so that it can pay for imports. India’s policy is like that of head of the family mortgaging one’s house to buy expensive consumption goods like cars, TVs and Chinese toys. China’s policy is exactly the opposite. China is cutting domestic consumption to lend money to the US and establish its control over that country.
Modi may have ambitions to make India a superpower. Unfortunately, however, the policies espoused by him will make India a super debtor.
So what should be done? The Reserve Bank should start purchase of dollars for purchasing US T-Bills or other American assets. That will lead to increased demand for dollars, an increase in the price of dollar and a corresponding decline in the value of the rupee. This should be allowed to happen till the rupee reaches about 75 to a dollar. This will make imports expensive and exports profitable and eliminate the need for us to attract foreign investment to pay for these imports. Our exports to China will spontaneously increase because the effective price of our products for the Chinese consumers will decline. The price of coal and oil in the global markets is falling. The Government should impose a hefty “energy” tax so that consumption of these goods as well as needs for their import is reduced.
The import tax imposed on coal and oil will lead to increased price of electricity and transport. The voter will be adversely affected. The solution is to distribute the money obtained from the energy tax among all the households in the country by depositing the amount in their bank accounts. The poor who consume less energy will be net gainers while the rich who consume more energy will be losers. Modi’s voter base will be protected. The objective of providing 24×7 electricity, therefore, should be accompanied with a steep increase in price of electricity.
Devaluation of the rupee will lead to a huge surge in our exports. The dollars earned from these should be used to buy US T-Bills in a joint strategy with China. This will truly make India a superpower.
Foreign investment proposals should be subjected to a thorough technology and social audit. Only those proposals should be given green light that bring in advanced technologies and do not have a negative impact on employment. Less foreign investment will reduce the risks of destabilization of our economy due to exit of foreign investors.
Modi must focus on getting China to dismantle the trade barriers during his visit. He should also do some plain speaking. Fact is that Chinese goods are cheap, in part, due to large-scale production espoused by that country. The other part is more critical. China is destroying her rivers, air and soil to produce cheap goods for exports. In this situation India has a choice either to destroy her environment and make cheap products as done by China; or it has to impose an “environment import tax” on Chinese goods . Modi should tell China in plain words that China must not subsidize its goods by destroying her environment otherwise India will be forced to impose such a tax on Chinese goods.
(The author was formerly Professor of Economics at IIM Bengaluru)
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