When Raghuram Rajan gave his inaugural speech as Reserve Bank of India governor on September 4, 2013, critics lauded him as India’s would-be financial saviour: the man who would inherit and address the triple threat base economic woes of a record high current-account deficit and company bond yields at above ten per cent levels. Rajan has, in fact, already made moves to tackle these problems. He has begun to lower inflation by increasing the repo rate, the rate at which the central bank lends money to commercial banks in the event of a shortfall, and also reduce the marginal standing facility rate to offer some immediate relief to the financial sector by lowering the cost of funds. The latter decision should also tighten liquidity and halt volatility in the foreign exchange markets after the recent Rupee fall. Still, even with these controls, India will be a far cry from recovery for reasons beyond the RBI’s control. In order for India to reposition itself for the better after the fall of the rupee, politicians must internally support the changes required of the country, and external circumstances must be such that the country will be sustain itself long enough to make those changes.

Image courtesy of Petr Kratochvil, @ 2013, some rights reserved.

Image courtesy of Petr Kratochvil, @ 2013, some rights reserved.

To some extent, India’s mere and unavoidable participation in global markets has perpetuated the decline it is seeing now. Three problems specifically come to mind: (1) the Indian Rupee’s (INR) peg to the US Dollar (USD), (2) India’s oil supply, 80% of which is imported, and (3) the presence of less expensive skilled labour in markets such as those of the Philippines.

With regards to the first, the recent rise in the exchange rate, peaking at INR Rs. 68.54 for every USD $1.00, is attributed to speculation with foreign exchange markets that that the US Federal Reserve would soon begin terminating its bond buying program, which currently serves as part of the stimulus package. This scare is far from gone, as the Federal Reserve is likely to begin terminating the program within the next few months. The problem with a high USD exchange rate is that it not makes imports more expensive, seriously damaging the purchasing power of those using INR and having the most severe effects on the poorest of the nation. Benjamin Bernanke’s recent announcement that the Federal Reserve will continue to support its stimulus package and quantitative easing program until clearer signs of the US economy’s recovery are available comes as good news to India. The update offers the INR a little a breathing space and will temporarily reassure investors in the Indian economy, but more long-term measures, likely in the control of RBI, will need to be taken to address the issue.

The second problem area is India’s oil supply, 80% of which is imported. Speculation on whether or not the US plans to get take military action in Syria after the recent chemical weapons accusation has greatly destabilized oil prices through indications of higher risk. Whilst this certainly spiked up oil prices for India, there are causes affecting this spike. The first is the risk and the second is the fact that oil is typically traded in US dollars, further increasing the cost per INR.

The third major problem India faces is its supply side labour market. Since the current administration, led by the Indian National Congress, took up office in 2004, as Arvind Subramaniam notes, India’s labour force has been largely made up of “cheap, unskilled, semiliterate” labour, whereas the institutions and business that have built up over the past several years cater to the limited class of skilled labour that focuses on the software, call centre, and back-office industries. Families dominate the business world, and nearly one million low-skilled persons enter the labour market without finding work each month. Whilst there is a tremendous potential for a manufacturing class, demand is very strong for more highly skilled labour. This demand in India has, in turn, increased labour costs and made alternative labour markets, such as those in the Philippines, more appealing- forming another crisis on the supply side for the country to deal with.

Whilst Raghuram Rajan takes the helm at RBI to address immediate economic concerns, India needs to address the more long-term factors affecting the economy in order to soften the blows of the activity of international markets. Rajan’s policies will only maximum impact, if, in addition to demand side policies, politicians work on either developing the infrastructure and industries necessary to provide demand for an idle, unskilled labour class, or ensuing that this class is able to gain the skills necessary to fit industrial demand in the future. Currently, although developing the supply side labour market in India seems like the long-term ticket out of the economic crisis, the upcoming elections next year may side-line the issue for more politically feasible options. However, the working class should be careful about holding leaders accountable for both the increasing deficits as well as improving the labour market and employment options.

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