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Dr Ila Patnaik - Economy 
Sawal sau crore ka   New
Sawal sau crore ka
by Dr Ila Patnaik

Dr Ila Patnaik is a senior economist at National Council of Applied Economic Research.

How much protection is enough protection?
Everyone is aware that the Indian government has mollycoddled its domestic industry with protectionist barriers for four decades now. It then continued doggedly along the same track even after reforms were initiated in 1991 - by not pushing Indian companies hard enough to become more competitive. Now that the damage is well underway, the government is desperately seeking ways to hide all the different inefficiencies that abound in the Indian economy as a result of its protectionist methods.

These inefficiencies were well known, though usually discussed only in a select circle of businessmen, bureaucrats and economists. But the imminent removal of Quantitive Restrictions (next April) and the current scare of cheap imports have brought the high costs of Indian production into sharper public focus. Exactly the same thing had happened in the US during the 1980s with cheap Japanese imports flooding the markets. But while US producers had the excuse of costly labour - and, therefore, a comparative disadvantage in the production of labour intensive goods - Indian producers have high infrastructure costs and government policy to blame. Transport delays, expensive and erratic power supply and poor telecommunications lead to inefficiencies and push up their production costs, they complain and not without reason.

India's closed economy floundered in a free market environment
This mattered little when India functioned in a virtually closed economy regime. But now that it has to face up to the pressures of an open economy, these higher costs will make domestic industry uncompetitive. Abroad, Indian exports face threats from products from more efficient economies. At home, the domestic industry faces price competition from cheap imports. Last year, China exported plastic products worth US$8b; in contrast, the US$4.4b Indian plastic processing industry could export goods worth only US$520m.

Plastic manufacturers attribute the Chinese performance to the easy availability of labour, higher productivity, better government policies and excellent infrastructure facilities. The same story is replicated across scores of industries. No wonder, then, that there is such a strong case being made for greater protectionism. So QRs are being replaced by anti-dumping duties and BIS standards. The Budget may even introduce higher tariffs on imports.

Is there room for Mr Nice Guy anymore?
What this will do is buy some time, but what happens when imports meet Indian standards and when the anti-dumping cases fructify, one way or the other? How will the government protect the industry then?

In the long term, the government has to undertake the reform of various policies in various areas of the economy - labour, exit, financial markets, company law - that are holding back Indian industry growth. But to the extent that the long term is made up of a series of short terms, it will probably want to hide the inefficiencies of Indian industry behind the protection bush, explicit or implicit.

Explicit protection or the use of tariffs and subsidies is one available option. Duties can be raised to make imports more expensive while export subsidies can be provided to make exports cheaper. Such measures, though, may create difficulties under the new WTO regime. Other countries could complain about India's policies to the Disputes Panel and then India would be hard pressed to defend itself. Once duties reach bound rates and subsidies lead to anti-dumping measures against India, this no longer remains a viable option.

Currency depreciation: taking the back door
This leaves the implicit protection way, the use of the exchange rate, that achieves the same objective albeit in a way that no one can call explicitly protectionist. Depreciation of currency makes exports cheaper and imports more expensive. Indeed, South- and East Asian economists have followed aggressive depreciation as a strategy to push exports. This, indeed, is the most important lesson of the 1990s: opening up has meant a permanent pressure to shift from the first set of policies to the second, namely, the exchange rate.

While the trademark of the 1970s and 1980s was protection and subsidies, the 1990s saw a reduction in explicit protection and a move to a "market determined" exchange rate. To some extent, India has followed the strategy of pushing exports through the exchange rate strategy, though not very aggressively. For example, the RBI resists all pressures on the nominal exchange rate to appreciate in order to keep exports competitive. And, if the real exchange rate appreciates due to inflation differentials, RBI's policy has been to prevent this as well. The Tarapore Committee, for instance, recommended that the real exchange rate should be allowed to move only within a five-percent band.

RBI has, in the past, often prevented the rupee from becoming stronger even when in the market there was a pressure on it to do so. This was quite clear, for instance, in the period when foreign portfolio investment first entered India in 1994. The RBI did not allow the rupee to appreciate and kept buying dollars for over a period of a year and a half in order to prevent the rupee from rising. Now that there will be much greater pressure to open up in terms of removal of constraints, the temptation to hide our inefficiencies behind a weaker rupee will be much stronger.

Time for some good old-fashioned discipline?
The question is really whether the government will still take the more myopic path and continue to shield industry by hiding its inefficiencies behind a weaker rupee, just because it is easier to do so. Or will it give the Indian industry the shock treatment by letting the rupee remain strong and force it to cut costs and improve efficiency? Of course, this will have to be accompanied by necessary changes in policy and improvements in infrastructure. But it will do so if it no longer wants to spare the rod and spoil the child.

For next year, we'll be keeping our ears peeled for the government's answer to this sawal sau crore ka!

Copyright © 2000 Sharekhan.com & SSKI Investor Services Ltd. All Rights Reserved.

The views contained in this column are that of the author. Sharekhan.com may or may not concur with the views expressed by the author. We do not represent that it is accurate or complete and it should not be relied upon as such.


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