India Needs to Treat Its Foreign Trade Same as Defense Sector, Part-1

Susmit Kumar, Ph.D.

Published at South Asia Monitor on May 17, 2016

A country spends significant amount of money on its defense without thinking about any monetary benefit from defense sector. For an example when India buys an aircraft carrier or dozens of fighter aircrafts, it does not get any monetary benefit out of them. In this two-part article, we will see that a country like India needs to treat the increasing negative Balance on Current Account same as it does with the defense sector. Balance on Current Account is defined as the sum of the balance of trade (goods and services exports less imports), net income from abroad and net current transfers.

The 1991 FOREX crisis in India, when RBI had to airlift sixty-seven-ton gold to London as collateral to get a $2 billion loan from IMF, is considered to be a watershed moment in Indian economy. India needs to learn to keep its trade deficit in check which has caused demise of many countries in past. Despite having no significant setback in domestic economies, the countries suffered heavily for decades to come when they have FOREX crisis. As they have to go to the IMF to get loans, IMF imposes its bitter pills, like to devalue the currency, raise interest rate by double digits, sell prized public sectors at throw away prices to foreign investors and reduce budget deficits by reducing subsidies and spending on social services. Their stock markets crash wipe out significant amount of money and also devaluation of the currency results in drastic decrease in entire wealth of the country, like real estate, minerals and labor, with respect to other currencies, which finally results in inflation.

Let us study countries, devastated by FOREX crisis:

The 1997 East Asian Economic Crisis – After China devalued its currency by 35% in 1994, only Japan devalued its currency to maintain its export level. Other Asian countries delayed devaluation until 1997. This caused a sharp fall in the exports of East Asian countries like, Thailand, South Korea, Malaysia, and Indonesia while China’s 1997 exports increased by 20 percent. Japan also had a trade surplus of $91 billion that year. This resulted in sharp drop in FOREX reserves of the former countries, making them venerable to the currency manipulators. For an example, South Korea’s foreign exchange reserves at the end of 1997 were only $8.87 billion, compared to $29.4 billion at the end of 1996. After the 1997 crash of the economies of Thailand, Malaysia and Indonesia, these countries have lost their place in global economy, i.e. nobody talks about them right now.

The 1991 Collapse of Soviet Union – Soviet Union needed external funding for modernizing its economy under Mikhail Gorbachev’s Perestroika and Glasnost policy. There was drastic reduction is price of crude oil, the main Soviet export, during late 1980s and early 1990s after the end of Iraq-Iran War (1980-88). Crude oil price dropped from an average of $78.2 a barrel in 1981 to as low as $7 a barrel one time. These two factors led to a rise in Soviet external debt. In 1985, Soviet oil earnings and net debt were $22 billion and $18 billion, respectively, whereas these numbers in 1989 were $13 billion and $44 billion, respectively. By 1991, when external debt was $57 billion, creditors, many of them major German banks, stopped making loans and instead started demanding repayments, contributing to the collapse of the Soviet economy.

The 2001 Argentina FOREX crisis – Argentina went through an economic crisis in 2001. Instead of bowing to IMF dictates, it defaulted on $132 billion, mostly of foreign debts, and the investors had to take haircuts on their investments. At the height of the crisis in 2001, four Argentinian presidents took oaths and resigned in just ten days. At that time, Argentina’s fiscal deficit and debt were only 3.2 percent and 54 percent, respectively, of its GDP. Due to 2001 default, Argentina is still having trouble in getting foreign loans.

During the 2009 Euro Crisis, the affected countries, called PIIGS (Portugal, Ireland, Italy, Greece and Space), had significant negative Balance on Current Account in last more than a decade whereas Euro countries, like Germany, Holland, Belgium, Finland and Austria, had positive Balance on Current Account in the same period.

Since 2010, the United States also has been proposing limits on “sustainable” trade surpluses and deficits. The proposal has been rebuffed by the BRIC (Brazil, Russia, India, China) countries and also Germany, which currently produces the second-largest trade surplus in the world. The US proposal is nearly the same as the one proposed by the British economist John M. Keynes and his team (the Keynesian stimulus plan is named after him) during the deliberations that led to the 1944 Bretton Woods Accord. Keynes was a brilliant economist who foresaw a global crisis due to large trade imbalances that would lead to instability in the global economy.

When the future of world trade was discussed, and the Bretton Woods conference was planned in the early 1940s, many Third World countries were still under colonial rule and had absolutely no say in those discussions. The main deliberations took place between the United States and Britain exclusively, and at Bretton Woods all other countries were invited simply for the formal signing-in ceremony.

During the 1944 Bretton Woods agreement deliberation, there were two competing plans for the future of the global economic order—Britain’s Keynes plan and United States’ Harry Dexter White plan. Keynes favored a world currency, to be called bancor, and managed by a global bank and an International Clearing Union. That “neutral” world currency would be exchangeable with national currencies at fixed rates of exchange. Under Keynes’s plan, both debtors and creditors would be required to change their policies. A country with a large trade deficit would pay interest on its account and devalue its currency to prevent the export of capital. On the other hand, a country with a large trade surplus would increase the value of its currency to permit the export of capital. A country with a bancor credit balance more than half the size of its overdraft facility would be required to pay interest on it. Keynes went so far as to propose the severe penalty of confiscation of surplus if at the end of the year the country’s credit balance exceeded the total value of its permitted overdraft.

Under the White plan, the US dollar was to be the global currency and the United States was given veto power in the workings of the IMF and the International Bank for Reconstruction and Development (IBRD, later incorporated into the present World Bank). Because of the two world wars the European countries were deeply in debt and had transferred huge amounts of gold to the United States. They also needed money from the United States for their postwar reconstruction. Therefore, the United States was able to impose its will and its plan at Bretton Woods.

During the 1997 East Asian economic crisis, a popular phrase was used to characterize the IMF and its policies: For the average person the actual meaning of IMF was “I’M Finished.” After watching IMF at work during the crisis, Joseph E. Stiglitz, the 2001 winner of the Nobel Prize in economics, wrote in April 2000: “I was chief economist at the World Bank from 1996 until last November, during the gravest global economic crisis in a half-century. I saw how the IMF, in tandem with the US Treasury Department, responded. And I was appalled. … The IMF may not have become the bill collector of the G-7, but it clearly worked hard (though not always successfully) to make sure that the G-7 lenders got repaid.” In the IMF, major decisions, including the election of its managing director, require an 85 percent super-majority. The top three countries, having the highest votes, are the United States (16.75 percent), Japan (6.24 percent), and Germany (5.81 percent). Hence in IMF, nothing can happen without the wish of the US.

In his book Globalization and Its Discontents, Stiglitz, who was also a member of the Council of Economic Advisers under President Clinton, described meetings where President Clinton was frustrated because an increase of one-quarter to one-half percentage point in the interest rate by Federal Reserve Bank Chairman Alan Greenspan might destroy “his” nascent economic recovery. A comparison here with the actions of the IMF during the East Asian debacle is instructive: There, the IMF forced interest rates to raise by 25 percentage points—fifty times the interest rate Clinton complained about—for economies going into recession

Copyright Dr. Susmit Kumar 2016

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