It’s entirely true that the average voter isn’t entirely right up to date with the intricacies of trade theory. Heck, most politicians aren’t and they set trade policy. Thus governments often enough pander to the misunderstandings of the voters rather than explain reality to them. Which is the explanation for this but not an excuse, or not a valid one:
The government will ease overseas borrowing norms for the manufacturing sector and impose curbs on the non-essential imports in an attempt to check rising current account deficit (CAD) amid the steady slump in the rupee’s value, Finance Minister Arun Jaitley said after a crucial economic review meeting chaired by Prime Minister Narendra Modi late on Friday.
The bit that’s being missed is that the current account deficit and the value of the rupee are already linked. Already linked in a manner that the change in price of the one solves the other.
The government on Friday announced an array of steps, including removal of withholding tax on Masala bonds, relaxation for FPIs, and curbs on non-essential imports, to contain the widening Current Account Deficit or CAD and check the rupee fall.
In fact, they’re linked in a manner which makes trying to deal with them as is being suggested counter-productive.
The government, in a meeting chaired by Prime Minister Narendra Modi, also decided to remove restrictions on external commercial borrowings, masala bonds to control the current account deficit, which slipped for the first time in six quarters in April-June. Masala bonds are rupee-denominated instruments through which Indian entities can raise funds by accessing overseas capital markets.
As a technical point, eliminating the withholding tax on Masala Bonds will make it easier and cheaper for Indian companies to borrow abroad. Thus they will do more of it. The problem here being that the capital account is the mirror image of the current account – more capital flowing into India will and must mean a higher current account deficit.
But at a deeper level the idea of trying to deal both with the falling rupee and that deficit doesn’t work. A falling rupee makes foreign goods more expensive in India, makes Indian exports cheaper outside. The currency falling in value in and of itself thus closes the current account deficit. Trying to both raise the value and close the deficit doesn’t therefore work.
Sure, it takes time for this to happen. There’s that “J-Curve” to deal with. It takes time for foreigners to decide to buy the now cheaper Indian production, time for domestic production to arise to fill the import gap. Thus the deficit will get worse at first, then recover and be lower in the end as a result of the falling currency. That’s the “J” in our curve.
But there it is, there’s the mistake. The value of the currency and the size of any trade deficit are intimately bound up with each other. Thereby it not really being possible to both have a strong rupee and also a closing trade deficit. It all works the other way, the falling rupee is the very cure for that perceived problem with the balance of trade. Leave well alone and one will solve the other.