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Arvind Subramanian: the man who advocated a Noah's ark of Fx reserves to steer clear of future financial tsunami

Sameer Kochhar, Editor-in-Chief, INCLUSION and author of best-seller, ModiNomics

Chief Economic Adviser Arvind Subramanian interacting with media in New Delhi.

The post of Chief Economic Adviser is often mired with controversy - some look it as just a finance minister's aide while others perceive it as the government's chief economic trouble-shooter. Whichever way you look at it, the new CEA Arvind Subramanian's task will not be that cushy considering his own predictions about the Indian economy soon after the Lehman crisis of 2008.

While the media glare is on the new CEA's academic achievements in US varsities and multilateral institutions, not many people know that Subramanian has all through kept his ears close to the ground when it came to the Indian economy. Going by the impact of Lehman crisis on India (GDP growth plunged from 9.3 per cent in FY08 to 6.7 per cent in FY09, Fx reserves fell from $309.7 billion to $252 billion and the rupee depreciated 25 per cent within two months), Subramanian cautioned that the country remains vulnerable and what policy makers ought to do to ward off another crisis, even if it comes 10 years hence. In an paper titled "Preventing and Responding to the Crisis of 2018" written for my festschrift in honour of Vijay Kelkar, titled "India on the Growth Turnpike", Subramanian argued that India needs to revisit its macroeconomic policy especially exchange rate and management and capital account convertibility.

The senior fellow of Peterson Institute for International Economics and Centre for Global Development advocated that India requires to build up a war chest of foreign exchange reserve as a self-insurance to ward off another crisis, weigh the risks of pursuing a export-led strategy and preventing currency appreciation, strengthening the sovereign (government) balance sheet by restricting debt:GDP ratio of 30-40 per cent.

The next question is what should be the amount of Fx reserves that can be considered as "adequate". To this question, Subramanian offers a valuable advice - the old rules that Fx reserves need to be as much as debt falling due within a year has to be revisited and India has to factor in gross foreign liabilities of all financial institutions and corporates falling due within 12-18 months, foreign investment in equities and other channels.

Citing China's experience, Subramanian wrote, "One should not just save for the rainy day but that to prepare for the deluge, one should build nothing less than a Noah's ark.... The more open the capital account, the greater the likely deluge and the bigger the required ark". Indian policymakers need to take lesson from this considering that our foreign exchange reserve is just a little over $300 billion as compared to China's $3 trillion while the capital controls are much more relaxed here than in the Himalayan neighbour, which means foreign capital can flow out faster from India during a crisis and put pressure on the economy.

Subramanian’s forecast that GDP growth would climb back to 8-9 per cent considering that India's exports were "hyper-competitive" with the rupee at Rs 50 to a dollar came true - the GDP growth did bounce back to 8.6 per cent in FY10 and 8.9 per cent in FY11 from Lehman year's 6.7 per cent. Then comes a golden question - should India allow the rupee to appreciate, if it wants to build a Fx reserve of $500 billion or even $1 trillion? "That will be the next big policy challenge," he wrote five years back. Unfortunately, India has failed to address this issue - the Fx reserve that had risen from $252 billion at the end of FY09 to $279 billion in FY10 to $305 billion in FY11, remained slightly below $300 billion in FY12 and FY13, and then inched up to $304 in FY14 and was $312.7 billion on October 10, 2014. 

Clearly, we are way off the $500 billion and need to take some big strides to reach the $1 trillion mark that Subramanian indicated. It now remains to be seen how Subramanian, as the government's chief economist, offers his ingenuity to the finance ministry in resolving the riddles of the economy and help build India a Noah's ark of Fx reserves that can help the country steer clear of any future financial tsunami.

(Sameer Kochhar can be reached at skoch@skoch.in)

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