Columns

Undoubtedly, last week’s policy changes will create severe hardships to people. The devaluation of the Rupee and price revisions will worsen hardships people have endured for some time, as prices of essential items will increase to unbearable levels.The salient question is whether these policies will resolve the financial crisis and usher in an economic recovery.

Scarcity to high prices

Policy changes announced last week will worsen the already parlous plight of people. The scarcities in gas, diesel, petrol, basic foods, and medicines may fade away. Instead, people will now face sky-rocketing prices of these essential commodities. A regime of scarcity and unavailability of essentials is being replaced by a regime of high prices.

The earlier regime limited the supply and availability of essentials. The new policies will limit people’s access to essential requirements due to high prices and inadequate incomes. The price escalation will render the livelihoods of the poor unbearable.

Painful solution

The adoption of this painful solution was inevitable. The delay in adopting a realistic or market-determined exchange rate and the imprudent management of foreign reserves intensified the problem and delayed the remedial measures.

Instead, the alternate undefined and unknown homegrown solution that was promised was not forthcoming.

The consequent delay in adopting measures to resolve the problem aggravated and intensified the economic and financial crisis, increased the needed policy adjustments, and increased their pain much like a patient who has delayed taking early medication.

Now we have to endure the more severe pain of the delayed medication that we have to endure till there is a solution.

New policies

Last week’s new policies included the devaluation of the Rupee from Rs. 204 to Rs. 230 and floating it. Last Friday the Rupee reached a record high of Rs.260 for a US dollar. On Wednesday, the Rupee had depreciated to around Rs. 275-280 for a US$ and the black market rate had peeked to Rs. 290 to 300.

Hardships

The depreciation of the Rupee increases the price of imported goods. These include food, medicines, kerosene, diesel and petrol. In turn, these increase transport costs and wages. Consequently, there is a spiraling of prices. These cause severe hardships to the middle and lower classes, especially wage earners and informal workers.

An imported commodity that was Rs.100 would be at least Rs. 140. At the same time, international prices are escalating owing to the war in Europe. This is especially so in respect of fuel and grain prices that are rising in international markets. Fuel prices that escalated sharply last week abated slightly at the time of writing, but may not remain so in the volatile geopolitical conditions and economic sanctions.

Pricing

The complementary change in policy to let gas, diesel, petrol  wheat and other prices to be revised would increase the cost of living directly and indirectly and make the livelihoods of the poor that is already unbearable more so.

Last week diesel and petrol prices were increased by Rs.75 and by Rs.50 a litre, respectively. Gas prices exceeded Rs.3000 for a cylinder.

Cascading prices

These fuel price increases would have a cascading effect. Transport costs would increase. Most commodities, including vegetables, fruits and grains are transported by diesel using vehicles. Therefore prices of domestically grown produce too would increase in price.

No sooner the currency depreciated, the trade announced an increase in the price of bread by Rs. 35; a 50 percent increase. Prices of wheat products and meals too increased. The prices of most essential consumer items will increase.

The increase in consumer prices as measured by the official index as 14 percent is likely to rise by much more in the coming months.

Solution 

The question uppermost in the minds of people is whether devaluation and pricing policies that increase hardships of people will resolve the crisis?

Foreign reserves

The most critical issue is whether the new exchange rate policy will resolve the nation’s foreign currency crisis. The devaluation and floating of the currency are expected to make exports more competitive and increase merchandise export earnings. On the other hand, the higher costs of imports to consumers are expected to curtail import expenditure.

Both these may happen to a limited extent. However, the structure of our trade is such that the gains in the trade balance will be minimal. This is especially so with respect to the curtailment of imports. The bulk of imports is of essential items: food, fuel, medicines, fertiliser, raw materials and machinery that are essential.

While the curtailment of consumer expenditure will be limited, costs of imports are escalating owing to global trading and geopolitical reasons. Consequently, import expenditure will increase and the trade deficit will widen.

It is this structural nature of our trade that has resulted in persistent trade deficits in the last 71 years. We have had small trade surpluses only in four of these years.

Exports

Hopefully, merchandise exports would increase to contain the trade deficit. As export manufacturers are heavily dependent on raw materials, it is vital that there are no shortages of these nor disruptions to manufacturing owing to power cuts and shortages of gas.

Solution

An improvement in the balance of payments is in fact expected this year from a recovery in remittances, increased earnings from tourism and ICT services. It is to these that we have to hope for an immediate improvement in the balance of payments and replenishment of reserves. An improvement in the balance of payments is expected from especially remittances and tourist earnings.

Remittances

The most urgent need is to boost the reserves by increasing inward remittances to around US$ eight billion, which was achieved in 2020. Remittances are about half that now. In January it was the lowest for a month and increased in February.

There may be increased remittances and capital inflows, if there is a conviction that there would be a more liberalised trade and payments regime.

Right direction

Most economists would agree that the changes in policies were in the right direction, but perhaps too little and too late. The policy changes indicated a reversal in thinking. Implicitly, they recognised the failure of the so called “home-grown” solutions and the need for market-oriented policies.

Longer view

The economic crisis has been brought about by a plethora of bad economic policies over time. The crux of the problem has been aptly summed up as due to the country living beyond her means and borrowed for investments on costly terms with no returns. Conversely, the government has discontinued projects on favourable terms amounting to nearly gifts.

The trade balance has been in deficit for the last 44 years indicating that we import much more than we earn from our exports. Public expenditure far exceeding revenue has increased the public debt to about 114 percent of GDP.

These fundamental problems have to be addressed by comprehensive reforms. The IMF will no doubt insist on them.

Conclusion

The recent policy changes are as inevitable as painful. They are only one step in the right direction. They have to be complemented with fiscal and monetary policy changes, liberalisation of imports, relaxation of restrictions on foreign exchange and other reforms.