Do remittances and FII inflows lead to build-up of Dutch disease in Indian economy?

An interesting piece from AV Rajwade in recent EPW. It is quite a change in the views considering capital inflows which is amazing.

He says this continued reliance on remittances and FII inflows is actually leading to weakening of Indian industrial sector. This resembles the Dutch disease which hit the same economy in the past:

Economists often describe resource-rich countries as suffering from the “Dutch Disease” or “resource curse”. The expression comes from the experience of the Netherlands half a century back, when abundant natural gas output brought in foreign revenue but reduced the competitiveness of the domestic economy on account of a rising exchange rate. There are many other examples of this phenomenon including countries as different as Australia and Nigeria. The symptom of the Dutch Disease is the inability of the domestic economy to compete globally, thanks to a bloated exchange rate.

The bacteria which have infected our economy with the Dutch Disease are not so much export earnings of oil or other
natural resources. Perversely, even where we have very large natural resources, coal for example, we are importing it. In my view, the causes underlying our variety of the Dutch Disease are two:

One is remittances. In our case, inward remittances as a percentage of gross domestic product (GDP) are one of the highest in the world. Since it is conventional to account for them as “current income”, this signifi cantly reduces the reported defi cit on the current account.

The second source of the Dutch Disease is the inflow of finance capital for  investment into asset markets like bonds, equities, etc, rather than as investment capital in the real economy. The latter adds to productive capacity and creates employment. Finance capital does neither. However, it does help finance the external defi cits leading to complacency about the real exchange rate, and its impact on competitiveness.

He says as inflation differentials remain high, rupee should be allowed to depreciate. Moreover, there is no case of generating rapid growth because of imported capital. The high growth comes from real stuff which means agri, industry and so on.

But then what does one do? The glamour and capital to generate these flows is way too much. It is all about convincing the foreign investors at the cost of anything. The markets are driven largely by FIIs and that is what interests most experts. The crisis has hardly managed to change this thinking much.

The author starts the piece by quoting some media piece which polled five top econs to list the agenda for the next government. As per the author none discussed this issue of rela exchange rates and competitiveness. Well, when have experts discussed anything meaningful. And this is not just an Indian problem, but seen globally too.

Coming back to the short paper, it is an interesting way to think about the impact of these negative flows. One and most research suggests that such flows are highly useful. The limited literature which criticises all this is based on excessive finance and so on. This connect of capital inflows to dutch disease is worth pondering on. The development literature does not discuss the role of exchange rate much. But it has played a crucial role in most parts of the world..


One Response to “Do remittances and FII inflows lead to build-up of Dutch disease in Indian economy?”

  1. TAK Says:

    So true. Now it’s cheaper for P&G to import their newly launched Oral-B toothpaste from China and HUL’s new Magnum ice cream comes from Thailand.
    Also count the number of cars that are parked but have the driver or the owner inside keep the engine and air conditioning on. Shows that Petrol and diesel are too cheap in India. India is able to burn increasing amounts of imported oil while not developing public transport for the same reason.

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