Amongst other things, the Financial & Eurozone crises have imparted a significant degree of clarity to economic beliefs, despite the profusion of over-simplified economic rules which surround them. Standard Debt-GDP ratios and requirements of fiscal discipline have given way to rules specific to each country's economic situation. They have proved, with some finality, that different rules apply to Europe, The US and countries like India.
Countries adopting the Euro face a particularly challenging environment. Being used to the luxury of owning their respective currencies, they failed to fathom their changed circumstances after adopting the Euro. Most of the PIIGS nations will default at some point. It's no longer if... Just when.
At the other extreme is the US. Despite borrowing & spending way beyond it's capacity to repay, the US will not default. Not on it's explicit debt and even on it's implicit debt, not for a decade or two. It's currency is desired by the rest of the world and is, for all practical purposes, it's primary export. Till such time that foreigners, including foreign governments, buy the US Dollar and invest it back in the US, there is no reason for the US to default. But only till such time... If this inflow of foreign funds stops and the US needs to earn a currency foreign to it, default would be a heartbeat away. Right now, the bigger fool theory is firmly in place. Everyone believes they will get out before getting splattered by the fan.
Which brings us to India. As one would expect, India's floundering somewhere between the two. We own our currency, but aren't really sure how much the world wants it. Capital account flows would suggest that demand exists, but we haven't yet reached a stage where the world wants our currency for itself and not for the assets it can buy. No one wants to own a weakening asset and we don't want an appreciating Rupee.
India has choices to make. It is at a point in it's existence when it can go any way it wishes to. It could continue with policies formed during times of shortage and tweak them to reflect our current surpluses. This positions India as a producer for goods and services demanded by other nations. It would necessitate a weak currency which would assist competitiveness, but deprive the local population of the purchasing power they desperately need.
Or we can discard these policies and adopt the Economics of Plenty. This would position us as a nation of 1.2 billion consumers, not 1.2 billion hungry mouths and necessitate a strong currency which increases our purchasing power. Yes, it would increase our current account deficit but, coupled with the right policies, increase demand for the rupee as an asset in itself.
In our current policy framework, India competes in other markets for a share of their business against players who have set the rules. True progress will lie in changing the rules. In becoming the market others want to compete for. In an environment where major markets are shrinking, or growing at a snail’s pace, India’s emergence as a market will be welcomed by the world. In changing its policies to favor domestic consumption over exports, India will have to change the way it thinks. And the first change will need to be our currency policy.
India's future lies in this choice. India will grow regardless, probably faster than most countries in the world. But, in the former we will need other markets to grant us our progress. In the latter, we will drive it ourselves.
A version of this post appeared on my Business Standard Blog on June 10, 2010