Arvind Panagariya, the Chairman of India's Finance Commission, has strongly advocated for a policy shift in managing the nation's widening current account deficit. He asserts that allowing the Indian rupee to depreciate naturally is a far more effective and less distorting approach than the government's current strategy of imposing higher duties on gold imports.
In a recent interview, Panagariya, who previously served as the first Vice Chairman of NITI Aayog, acknowledged the government's concern regarding the current account deficit. However, he critically questioned the decision to target gold, which recently saw duties increased by 5% on findings and 5.4% on platinum findings, contributing to record gold imports of $72 billion.
Rethinking Gold Import Curbs
Panagariya described commodity-specific duties, particularly on gold, as a "blunt instrument." He explained that such targeted interventions distort the broader economic adjustment process, which should ideally be driven by market forces. "Let the rupee depreciate, which will make imports a little more expensive in rupees across the board, and the depreciation will also make exports more attractive," he stated.
He further warned that while higher duties might initially reduce formal gold imports, they carry an inherent risk: an increase in smuggling and informal trade. This undermines the policy's effectiveness and creates parallel illicit economies. Panagariya stressed that market-driven price signals should determine import demand, rather than administrative restrictions based on arbitrary figures.
The Power of Rupee Depreciation
For Panagariya, exchange rate adjustments offer a comprehensive solution to external imbalances. A depreciating rupee would make all imports more expensive in local currency, thereby discouraging overall demand for foreign goods and services. Simultaneously, it would make Indian exports more competitive internationally, boosting foreign exchange earnings.
This mechanism, he argued, works "on all margins" across various industries, both goods and services, leading to a natural contraction of the current account deficit. Panagariya highlighted India's successful reliance on exchange rate flexibility to manage current account deficits since the 1991 liberalization, underscoring its proven effectiveness.
Moral Suasion vs. Market Signals
While Panagariya expressed full support for Prime Minister Narendra Modi's public appeals for behavioral changes, such as reduced travel and work-from-home initiatives to conserve fuel, he differentiated this "moral suasion" from direct economic interventions. He likened Modi's appeals to those made by former Prime Minister Lal Bahadur Shastri during the 1965 food shortages, recognizing their potential to influence citizens voluntarily.
However, when it comes to economic policy, Panagariya consistently favored broader market mechanisms. He suggested that allowing petrol prices to rise in response to global crude prices, for instance, would automatically prompt citizens to cut back on non-essential transportation and energy usage, rather than relying on targeted administrative measures.
In essence, Panagariya's counsel to the Indian government is to trust market forces and leverage the flexibility of the exchange rate as the primary tool for managing economic imbalances, rather than resorting to selective, potentially distorting, duties on specific commodities like gold.