On the Ideas of India podcast, Shruti Rajagopalan spoke with Sajjid Chinoy about capital flows, private investment, and India’s next reform agenda.

SHRUTI RAJAGOPALAN: Welcome to Ideas of India, where we examine the academic ideas that can propel India forward. My name is Shruti Rajagopalan, and I am a senior research fellow at the Mercatus Center at George Mason University.

Today my guest is Sajjid Chinoy, managing director and chief India economist at J.P. Morgan. He is also currently serving as a part-time member of the Economic Advisory Council to the Prime Minister of India. Sajjid previously served on the Advisory Council to India’s 15th Finance Commission and has served on a number of expert committees of the Reserve Bank of India.

We talked about India’s current balance of payments and capital account challenges, the constraints holding back private investment, why employment and exports have become first-order policy priorities, rupee depreciation, shrinking FDI, and much more.

For a full transcript of this conversation, including helpful links of all the references mentioned, click the link in the show notes or visit mercatus.org/podcasts. 

Hi, Sajjid. Welcome to the show. It’s such a pleasure to have you here.

SAJJID CHINOY: It’s great to be here, Shruti. Thank you.

RAJAGOPALAN: We’re recording in the last week of May, where the world is a little bit crazy. The world economy is turbulent. The Indian economy has got a lot of challenges that it hasn’t faced in many years, maybe even in decades. The current crisis is that the rupee is well above ₹95 to the dollar or well below ₹95 to the dollar, [chuckles] depending on how we say this. Fuel prices are rising and will only rise further because we’re almost at the end of our inventory and stockpile. The import bill is rising again, same, because of the West Asian crisis.

And, in a more macro sense, FDI has nearly stalled in India over a longer term, maybe a decade-long trend now. Private capital investment has not been picking up, same with domestic demand. And things look like they’re only going to get worse because of the global uncertainty and also the increase in input costs. I don’t think it’s a 1991-style balance of payments crisis, but that phrase is getting invoked in every other newspaper/business column right now.

But before we catastrophize over where we are and where things are going, I just wanted to get a sense from you on how you view the Indian economy right now in the last week of May. You’re my go-to expert whenever I think about how to take stock of the Indian economy. So, maybe we’ll start with that, and then we can go into other things.

Taking Stock of the Indian Economy

CHINOY: Thank you, Shruti. Thanks very much for that. As you rightly point out, these are unprecedented times in some levels because people talk about this being the largest energy shock ever. I think at last count, about 40 million barrels were off-stream. That’s almost 15 percent of global energy supply. It’s not just crude, as we’ve discussed. It’s crude, it’s fertilizers, it’s helium, all of that. I think what’s different about this episode is, in the past, when there have been oil shocks, there was never a concern about availability or shortages. It was a question of price.

As an importer, there was a terms of trade shock, and we know what the familiar playbook is. What makes this more pernicious is you also worry that if the strait doesn’t open soon, there’ll be shortages, which then invoke nonlinearities. 

But I think let’s step back and ask ourselves where the economy was heading into this event. I think maybe we’ll break this down into growth, inflation, and the external sector, if that’s OK.

For growth, I think let’s just step back and paint a bigger picture that India entered COVID on a bit of a weak wicket because, if you remember, growth was already slowing precipitously in 2019, below 4 percent. Then you had the growth shock, and that was the trough. Then you got new growth drivers that were emerging in the pandemic. 

The first was clean balance sheets. We had last seen those things back in 2011, 2012. For a whole decade, we were grappling with the twin balance sheet problem. Well, to policymakers’ credit, they stuck at it. We first recognized those nonperforming assets. Then we had a way to resolve them through the bankruptcy code. Then we recapitalized public sector banks. 

Ten years later, as we were in the pandemic, the good news was bank balance sheets were clean again. Net NPAs were the lowest since 2011, and corporate balance sheets were also healthy. Leverage was very low. Profits were picking up. Cash levels were high.

So, the good news is that you had these new growth drivers emerging. I‘ll talk about four of them. The first was twin balance sheets had been cleaned up, and credit growth was picking up. 

The second was a big public investment push by the government. Again, this was a strategic choice made to say, “We’re going to focus on infrastructure rather than cash transfers like some other economies had.” To the government’s credit, it defied some of the skepticism, both on state capacity as well as fiscal space. We’ve seen altogether—central, state, PSU, public investment—pick up by about 1 percent of GDP. We can talk more about that. 

The third was this huge pickup in service exports. The focus was so much in 2020 about China Plus One, and will India benefit from manufacturing? But the real revelation was it was all in the service export side with the advent of global capability centers. 

The fourth, less appreciated one, was the real estate cycle had finally begun to pick up. For 10 years, real estate was dormant. Then demand begins to pick up. Real rates are negative in the pandemic for the first couple of years. What you see is demand picks up, inventories come down, new construction picks up. 

The good news was, after the pressure points of 2019 and 2020, some of the healing began in ’21, ’22, as these four relatively new growth drivers came together. Now, the hope was that this would finally crowd in gross fixed-capital formation, or private investment. This is something we’ve been waiting for Godot for the last 12, 15 years, but that did not happen. We can talk about what the headwinds there are. 

You enter 2024, where you still haven’t seen private investment pick up, and we should talk about what the reasons for that are. And it was then clear that some of the pace at which public investment was moving was not sustainable. You could not have public investment grow 20 percent, 30 percent a year, both because fiscal constraints began to develop. Postpandemic public debt had moved up. Both the numerator and the denominator were responsible, and absorptive capacity constraints were kicking in at some point in time.

Come the end of ’24, there’s a recognition that public investment will have to slow to more normal levels, grow at 8 or 10 percent a year, and we had not seen private investment pick up. Maybe we’ll address that right up front. 

Why has private CAPEX not picked up? In my mind, I don’t think there’s much of a mystery here, Shruti. We are conditioned to thinking of the Indian economy as being a supply-constrained economy. In the ’80s and ’90s and 2000s, infrastructure was a supply, bank lending capacity was a supply, and credit became a binding constraint for MSMEs. Agricultural production was a supply.

But I would argue that in the last 15 years, we’ve worked to alleviate some of these supply constraints. Instead, the binding constraint has become a demand constraint. And so, if you think about private investment, what you will notice is capacity utilization for manufacturing has averaged about 74 or 75 percent since 2012. 

Now, if you’re in a world in which you’ve got a lot of Chinese excess capacity, which is the new phenomenon post-COVID, and China is exporting that excess capacity around the world to emerging markets, to Asia, to India—India’s imports from China, almost 4 percent of GDP. The trade deficit’s fundamental.

Then you can understand why Indian entrepreneurs would be risk-averse, because your existing utilization rates have not moved up to critical thresholds. You’re struggling to compete with cheap Chinese imports, and then you throw in the fact that we’ve had so many shocks. A COVID shock in ’20, a Russia–Ukraine shock in ’22, a tariff shock in ’25 under President Trump, and now you’ve got an oil shock.

So, my short point is that what we found at the end of 2024—I was not particularly surprised—is that gross fixed-capital formation had not picked up because, while there were some drivers of demand, these were not all firing in unison. Central CAPEX was moving, but state CAPEX was patchy. Urban consumption was strong; rural consumption, what was uneven. Service exports were strong; goods exports had lagged. 

Then we entered ’25, and I think what the government does is one final push to say they had by then recognized that demand is the constraint, so there was one final cyclical push. You had direct tax cuts in the budget in February, GST cuts in September. The RBI cut interest rates by 150 basis points. There was a regulatory easing to act as a force multiplier. We had just 2 percent inflation last fiscal year, so purchasing power picked up, and you had a strong monsoon.

The hope was that all these cyclical factors together, these six factors, would be the straw that broke the camel’s back. Now, as luck would have it, you began to see some pickup in consumption in November, December, January, February, post-GST. The auto sector was doing particularly well. Come end of February, the IEEPA tariffs were reversed by the Supreme Court. India goes from having the highest tariff rate in the world to having a rate closer to 10 percent like everybody else. 

Just when you thought that maybe this is the year in which all of this comes together and there’s enough demand visibility for private CAPEX to occur, you get this large terms-of-trade shock from the Middle East. I think from a growth perspective, Shruti, that’s where we are.

New drivers have emerged postpandemic, but the heavy lifting has been done by public investment. The fact is private investment is still awaiting sustained demand visibility to invest. I’ll end with one final point. I hate to invoke equations, but you think of GDP as being consumption plus investment plus government spending plus exports.

c + i + g + x − m

In i, we will just keep it private investment. In g, we lump both government spending and government investment; g’s done the heavy lifting.

For fiscal reasons that we discussed, g has to step back. You want i to fire, i being private investment, which is endogenous—i needs c to pick up and/or x to pick up. You need both these drivers to be firing to crowd in private investment. I think from a growth perspective, that’s where we are at the moment.

Factors Dragging on Aggregate Demand

RAJAGOPALAN: I’ll also zero in on the reasons for aggregate demand not picking up, especially on the state side. If we think about how the Indian government is fiscally constrained, because you were talking about how the g needs to get smaller. India’s public debt to GDP is about 75 percent, which is— 

CHINOY: Actually, 85 now. So combined—

RAJAGOPALAN: 85 now?

CHINOY: Yes, 85.

RAJAGOPALAN: OK, so I’m already a little bit behind. The center plus state deficit is above between 7 percent to 8 percent now. We have almost 60 percent of the state government expenditures going towards payrolls, pensions, and welfare transfers. Welfare transfers have really ballooned. This is the post-Jio, post-Aadhaar, post–Jan Dhan account transfer.

It’s a frictionless transfer system and just never-ending election cycles. Now, this has two kinds of impacts in different directions. One is these transfers should have boosted demand. That was part of the reason, other than trying to win elections and support different interest groups, to actually have these transfers. Now, that hasn‘t quite shown up in the numbers, at least not consistently. 

But the other side of it is it crowds out state government-level CAPEX. That obviously has an impact on private CAPEX in those states because all CAPEX gets crowded out because of this.

So far, given the trend, it seems like that seems to be the dominant pull factor in pulling us away from capital expenditures in a way that even welfare transfers are not able to boost aggregate demand to encourage private CAPEX. Is that a good way of thinking about it, or are there other things going on at the state level?

CHINOY: No, that’s a great starting point, Shruti. I think, first, some of this should not be a surprise because if you think about a lot of work that’s been done—theoretical work on fiscal multipliers—It’s no doubt that in the medium term and long term, CAPEX multipliers are much larger than transfer payments. Right? So, it’s not a good tradeoff to be cutting public investment for short-term demand stimulus by giving more cash transfers, A, and we’re finding that out.

B, remember, what’s happened in the state level is also that deficits have widened. This is not just a compositional issue where—of course, there’s a compositional issue here where there’s more cash transfer—if you do, there’s less space for public investment, health, education—but fiscal deficits have widened.

States used to be around 2.5 percent, 2.6 percent of GDP. They’re now at 3.3 percent of GDP. What that does is that this higher borrowing by the states has meant that bond yields have moved up, spreads of states have moved up, which then affects the whole panoply of interest rates in the system. That, too, at the margin has an impact on private investment decisions. 

I think on the aggregate demand question, I come back to first principles, and that is that all of this can temporarily help. We saw between 2013 and 2019, consumer leverage went up a lot. This was the advent of the NBFCs, the nonbank finance companies.

India—households had low leverage, and they levered up, right? But then you had interest rate cuts. Last year, you’ve had welfare payments. All of this helps at the margin, but it ultimately comes down to household income prospects which come down to quality of employment. There, policymakers have tried a lot, but the fact is what we’ve seen is that the quality of employment—we haven’t had the kind of dramatic structural transformation that we had hoped for. 

I think this is not true just of India. We’ve seen in other emerging markets, that COVID reversed some of the structural transformation. Too many people were still in agriculture and not enough in goods and services. For me, that’s the key to long-term consumption. Everything else is a short-term fix that when we get quality of employment, labor productivity, wages, then consumption will be strong and sustained because households are going to say, “Other things may well be shorted,” and so you smooth over that. If it’s a temporary support, you can sometimes smooth. You have to go back to having a permanent income shock. You have to lift consumption more sustainably.

Changing Policy Priorities for Indian Economic Growth

RAJAGOPALAN: Yes.What you just said, I’ve also seen that as an arc in your longer-term writing, let’s say over the last decade. I’ve been reading your columns. Like I said, you’re the go-to person for all of us to understand what’s happening in India, especially in the external sector and economic growth. One way to read your work from say 2016 to 2019, 2020, was your arguments about how India’s first-order task was to institutionalize macro stability, avoid a lot of stimulus, especially premature stimulus outside of the COVID years, and have policy certainty, and also policy credibility in terms of having a very clear pathway towards reforms like for GST and bankruptcy law, and MPC and so on.

Now, when I read your work over, say, the last two to three years, it seems like your to-do list has changed, right? Now the first-order task is employment, consumption, FDI, exports, and private CAPEX, maybe exactly in that order, the way I’ve been reading you. 

What has changed in your diagnosis? Is it that the binding constraints have changed, or is it that we’ve just solved the old macro stability problems? Those are just not big problems anymore. Inflation’s been relatively low, even with relatively high rates of growth. We’re just not in that situation we were in 30 years ago when we did the first stage of reforms. So, now there just has to be a complete change in priorities, both because the global environment has changed, but also what are the binding constraints domestically?

CHINOY: That’s a great question, Shruti. I think you nailed it. It is the binding constraints. We don’t even have to go 30 years ago. We just have to go 13 years ago to 2013 because we had this period between 2010 and 2013, post-global financial crisis, where growth was very strong. 

Those times, growth was 9 percent, 10 percent, but it was unsustainably strong because it was happening where very large fiscal stimulus. Real rates were negative. It was spilling over into a large current account, and some of us were worried that at some point this would unravel, and that’s what happened in the taper tantrum.

So, the morning after the taper tantrum, I think some of us were more concerned to say that we need to recognize as a country that macroeconomic stability is the foundation for sustained growth, that there is no tradeoff either in the near term or in the medium term for sure. I think policymakers credit right from 2013, right from the year of the taper tantrum over the last 13 years. What’s been very encouraging to see is an institutionalization of macroeconomic stability. It started with the inflation targeting framework. I was fortunate to be on the committee—

RAJAGOPALAN: You were part of a lot of these institutional changes yourself, so you should take some of the credit.

CHINOY: Oh, no, there’s no credit, but it was just very nice to see that this happened very quickly. I remember the taper tantrum happens from June to August. By September, a committee is set up—and I was lucky to be on that—which is to think of a new monetary policy framework.

By January, our report is out, arguing that India needs a nominal anchor. We need to go from WPI inflation to CPI inflation. We need to have a target and a band. We need to have a monetary policy committee. De facto, that gets implemented a month later in 2014, February, and then the government notifies it the next year, and here we are 13 years later. Most people, or almost everybody’s, going to say this has been an unambiguous success.

I think when I talk about institutionalization, what I mean is, think of what happened the last couple of months. An oil price shock occurs. We’re just in the early stages of that, and already, commentators are saying, “Oh, my god. Inflation’s going to go towards 6 percent. Will the RBI be raising rates?”

Now, whether the RBI raises rates or doesn’t is less important. What is really heartening is that the framework is immediate recall to everybody. It’s been embedded in everybody that the central bank is serious about inflation targeting. There’s a band here, and I think all the governors over the last 14, 15 years have reinforced that.

Similarly, in fiscal policy—that fiscal policy from 2016, again, the N.K. Singh Committee report on debt management, that we now have an anchor for debt—there’ve been lots of shocks in between, but we now all recognize—we talk in those terms, that public debt is 85 percent.

Postpandemic, I don’t think any level of debt is sacrosanct. What matters more is debt dynamics that as long as debt is not on this inexorable, increasing path, you can stabilize debt first and bring it down. The fact that we have this framework on debt, the center has said, “We want to bring central debt down.” There are a lot of questions about state debt that we should get into. So, these are all extremely encouraging signs for me, and we’ve begun to see the fruits of this.

Inflation has been low and contained. Inflation expectations are far more anchored. One would argue risk premia on government bonds have fallen over the last decade after this. The reason that other priorities have emerged is because we’re a victim of our own success that we’ve prioritized macrostability, and then we’ve had a series of shocks. COVID was not any small shock. 

I think the employment imperative has just become more urgent because we fixed the macrostability problem, and we’ve realized that—just one other thing, Shruti. Sorry, I’m digressing. Underneath all of this has been the fact that manufacturing and now services are getting so automated. If you look at India’s capital-labor ratio, you look at the annual survey of industrial—

RAJAGOPALAN: It’s bananas for a country that is so labor-rich.

CHINOY: Exactly. In 2005, there’s this very sharp increase in capital-labor ratios, which is to say that for every unit of output, we’re using more machines and fewer people. Look at our export basket. It’s all pharmaceuticals, engineering goods, capital goods. The labor-intensive stuff—textiles, leather, gems, and jewelry—have reduced in share. I think it’s a combination of all this. We’ve solved the macrostability problem. The employment problem is coming to the fore because of capital intensity around the world, because COVID has done damage to all emerging markets.

Now it’s become a binding constraint. It’s not a nice-to-have. Only when we get strong and sustained employment will we get the consumption that will drive the private investment. So, it’s become a binding constraint.

Rethinking Fiscal Architecture in a Shock-Prone World

RAJAGOPALAN: I don’t know if some of these reforms would come under micro-level reforms or macro-level reforms. For instance, say fertilizer subsidy, the fuel subsidy and energy subsidy that we give, like free water, free electricity to farmers. These don’t sound like macrostability issues, but when we add it all up, all your agricultural subsidies, it’s like 2 percent of GDP. It’s crazy how large that number is. But the second part of it is, also, it distorts prices in a way that ricochets through the rest of the economy because these are all factor markets or very, very crucial inputs to pretty much everything else.

So, is there a reason that this kind of reconfiguring government spending, which I would think is still a very macro, big-picture question, has just not come within the macro-spending priorities, or is it just so politically difficult that the technocrats have tinkered with whatever they can tinker and said, “OK, we can do inflation targeting in a small committee. We can’t do anything about this, so we’ll just do the inflation targeting in a small committee.” What is a good way to think about that?

CHINOY: That’s a great question. I think there are so many elements to what you’ve asked. One is just how we think about fiscal policy more generally at the macro level. I think the first order was just to take large deficits, ballooning deficits, and bring them to a level where debt will stabilize. That was the first task, which we’re on right now. 

Then you get to the more important task of that—I think we have to reexamine the entire fiscal architecture. First and foremost, I think we have to get—and I’m going to answer your question in particular we have to get to a situation where—this is a new world which is becoming increasingly shock-prone.

First, get our heads around that. The old world is gone, right? Now, just in the last six years, you’ve had a pandemic. You’ve had two wars. You’ve had an AI issue. So, how do we become a more shock-absorbent economy?

Central to that is always retaining fiscal space to be able to buffer some of these shocks. That is going to mean on the revenue side, we have to raise more resources because the only way to meet our expenditure priorities and bring debt down—the only way to square that circle is to raise more revenue. That’s a whole different debate to have. Should this be—we don’t want to do this in a regressive manner, so we don’t want indirect taxes to do the heavy lifting. We want direct taxes. That’s a question we’ve been asking for many decades.

RAJAGOPALAN: Which means we need a broader base.

CHINOY: A much broader base, number one, and we also have to think strategically on nontax revenues. There are lots of government assets that we own. Is there a way to monetize those assets smartly over time to raise revenues? I think of the revenue side as creating the resources that then give you fiscal space to handle shocks. Expenditure side has to do with the reallocation of expenditures, as you pointed out, because in this new world, we also have to be very cognizant that human capital augmentation is so critical that we need more resources going towards health spending. They may not be a sufficient condition; they’re a necessary condition.

Quality also matters, but we need more money on health and education, on the green transition, on creating smarter safety nets. That is going to mean that you have to redirect resources. My guess is the same as yours, that some expenditures from a political economy perspective are easier to reallocate than others are.

But yes, at some point, we have to look at these subsidies from two perspectives. One is how much fiscal space do they open up? Even if it’s fiscally neutral, can we replace a product subsidy with a cash transfer because the former distorts product markets. And the latter doesn’t. These are difficult questions, but ones we have to eventually confront.

RAJAGOPALAN: But here, I want to push a little bit more to unpack the link between the quality of the welfare transfer or the government spending and the macrostability questions. 

There are two ways to interpret what has happened. One is, of course, we’re so happy that we’ve managed to get some kind of guidelines for deficits, for inflation targeting, now for debt, and so on. But that means that there is a limit on how much government can spend. One would have hoped that the first lot of spending goes towards the highest multipliers, which is CAPEX and then health and human capital and education, but that has not been the case. 

Now what we have is, we are within the limits, but that has distorted the quality of spending. Because with earlier governments, maybe even say 15, 17 years ago, they were just spending too much, but then they were spending on all sides of the welfare state, so to speak, right? They were giving the subsidies, but they were also investing in capital expenditure. They were also investing in social safety nets through NREGA and so on. 

Now we have every interest group, as Devesh Kapur and Arvind Subramanian have said, “suckling at the Indian states,” right? We have every interest group doing that, but you have a lid on it, which means they never quite get to the good expenditures. Are these two things just a lot more linked than the policy wonks are giving credit to?

CHINOY: They are absolutely linked because there is no free lunch anymore. Now, fiscal spending has become a zero-sum game, precisely for the reasons you mentioned. Now, there’s one way to break that cycle, and the way to break it is more revenues. If you can do more on tax-to-GDP or non-tax-to-GDP, then you can spend more on everything without changing your fiscal deficit and therefore your debt dynamics.

Therefore, I’m saying these things are not—they’re inextricably linked.If you do a better job in revenue mobilization, there’s more for everything. But holding that constant, then the expenditure side becomes a zero-sum game. If you want to spend more on education and health, as we must, then it has to come from somewhere. And I’ll make one more point that at the central level, what’s happened is, encouragingly, public investment has picked up a lot, but what you’re seeing is noninterest revenue expenditures are down to levels that we haven’t seen before.

So, there’s not much more flab to cut on the bone. Right? And therefore, if you need to do more spending on the green transition, on health and education, hard decisions on subsidies will eventually have to confront us.

At the state level, what’s been worrying is electronic cash transfers. Now the transaction costs have gone away. You press a button and people get cash in 24 hours, in 48 hours. Right? Then you get into a competitive populism, because if state A did x, then it’s incumbent on state B to do x + Δ, and the Δ is often quite large.

So, we need to evolve a national consensus on this because I think there’s a time inconsistency problem from a political perspective. The cash transfers happened today, the election is tomorrow, but the full-blown impact of that on health, on education, on public investment at the state levels, it shows up five, 10, 15 years later, right? I think there is a realurgency that needs to be addressed at the state level.

The other last thing I’ll say is the fact that state deficits have widened so much has partially undermined the center’s consolidation.

So, despite central consolidation, the fact is the combined deficit this year is upwards of 7 percent. Now, in peacetime You can’t be having a deficit above 7 percent. What happens when there’s another shock like we’re experiencing right now?

RAJAGOPALAN: One of the other crazy bits that we spend on is something like MSPs, right? Suddenly, we might be walking into a big supply-side shock, rising fuel prices, and therefore rising inflation. Now, MSP also contributes towards that. 

What is a good way to think about some of these input subsidies that are meant to keep prices high? They hurt you both on the government spending side and the quality of the government spending, but they’re also going to hurt you now very soon on how we think about food grain prices, given that there is all this other rampant inflation coming our way.

CHINOY: That’s right. In fact, in a paper we did, Shruti—I think it was Prachi and me back in 2015 on “What is Responsible for India’s Sharp Disinflation?” That time in which there was a new monetary policy framework, but we also had lower fuel prices, lower food prices. What did we find? That MSPs were actually key on two fronts, not only for contributing to inflation, but there was an embedded persistence in inflation that MSPs caused. Because when inflation was high, the inputs into MSP determination meant that inflation became more persistent.

So, for all of these reasons—but these are easy for me to say from a political economy perspective—much more challenging to do. But in a perfect world, you want to move everything to cash transfers. You want to be providing support, but you don’t want to be distorting prices, misallocating resources, and then creating this import dependence. Fertilizers are a huge import. The Strait of Hormuz makes us more vulnerable. My sense is that, yes, these are not easy questions to address. The good news, I will say, is that we’ve been very restrained on MSP increases for the most part. 

RAJAGOPALAN: Except recently.

CHINOY: Except recently. But I think—and this is not unrelated to the inflation target because when the central bank makes a public commitment to inflation then it’s incentive-compatible for the fiscal authority to play along, recognizing that if MSPs were to be extraordinarily high, and that pushes inflation up, then the RBI would have to offset that by tighter monetary policy.

But you’re right. Holding that apart, tough decisions on subsidies await the fiscal, but I would say it’s not just subsidies. We need to rethink the entire fiscal architecture. What level of debt do we want to reach? What burden-sharing will happen between the center and the state? Remember, central debt is coming down. State debt has been—

RAJAGOPALAN: Debt is going up.

CHINOY: —risingon a monotonic path, right?

CHINOY: So, if you’re going to have an overall public debt target, who has to do the heavy lifting: center or states? That’s not an easy federal question to answer. Then the question about what are our new spending priorities? Where will that fiscal space come from? There’s a whole architecture, here, question on fiscal, I think, that extends beyond just subsidies.

RAJAGOPALAN: Yes.The reason I wanted to zero in specifically on fertilizer MSP and so on, it feels like this is that crisis that maybe we should make use of because the fertilizer bill is just shooting up.  Is this the time to kill the fertilizer subsidy? The war has given us a great opportunity and yet another, not balance of payments crisis, but balance of payments problem.

CHINOY: External events open up political space. It is the best time to do it from an economist’s perspective. Of course, politicians may have a different view. And we saw this in 2022. In ’22 as well, the fertilizer subsidy ballooned. In a way, Shruti, this going to—the tradeoffs that we spoke about will be in full display in the coming year because if the fertilizer subsidy bill is higher, then you’ve got uncomfortable tradeoffs between, do you want the fiscal deficit to widen beyond what you had budgeted, which then has implications for debt dynamics, interest rates, reputational costs? Or do you keep the fiscal deficit within target but then you make hard decisions about cutting public investment? So, both those tradeoffs will come to the fore in a year like this.

Let the Rupee Depreciate

RAJAGOPALAN: Yes.And especially now with the rupee depreciating, our import bill is going up. So, both on fertilizer and fuel, we’re going to feel the pinch very, very soon. We’re already feeling the pinch, but it’s only going to get worse depending on how long this continues.

Now, this is a multipart question, but just to start with, you have been a very vocal supporter of letting the rupee depreciate and find the appropriate level for various reasons, which we can get into in a minute.

You held this view right now in your column a few days ago. You held this view in November last year with all the Trump tariffs piling on. You held this view in 2019.

What is it about the Indian establishment that has this obsession with a strong rupee? Is that just an optics thing? Is it a very self-serving thing that the people who are IAS officers have to pay college fees in dollars [chuckles] and want the rupee to be stronger? What exactly is going on with the Indian establishment that this is not about global prices and thinking about export competitiveness?

CHINOY: Thank you, Shruti. I think, first and foremost, I’m very happy that in the last 15 months, 16 months, 18 months, we’ve let the rupee depreciate. The rupee has depreciated almost 14 percent or 15 percent in real effective exchange-rate terms, so I’m glad that that Rubicon has been crossed. 

Now, it’s not just the establishment. There’s skepticism among market commentators, the private sector, industrialists, and there’s a belief that, “Oh, we‘re an importing country, so when the rupee depreciates, our imports become more expensive in rupee terms. This is going to be inflationary.”

And there’s an overriding skepticism about exchange-rate elasticities that, “Oh, if the exchange rate were to depreciate, you’re getting inflation.” But you’re not going to do much on exports and imports, and so the burden of proof is on us. And again, [the] paper that I wrote for the IPF in 2018 - RBI has done some similar work—clearly shows that when you control for these things carefully, the real effective exchange rate clearly has an impact—holding other things constant—clearly has an impact over time on export competitiveness. What you see sooner, and the part that’s less appreciated, is the import part.  So, on the one hand, we’re complaining that Chinese imports are flooding India. And then until the beginning of this year, the real effective exchange rate vis-à-vis China—India versus China in bilateral terms—had strengthened by 10 percent. That’s a fancy way of saying, in real terms, Chinese imports at the beginning of ’26, before the recent depreciation, were 10 percent cheaper than they were five years ago.

China already has this advantage in terms of cost, and we give them another 10 percent cost, so I think it’s incumbent upon some of us—there is skepticism across the board—to prove that. Remember, I keep saying the rupee is like a shock absorber in the following sense: When you’re driving a car, think of the rupee as being your seat belt.

When you brake suddenly, something has to take the shock. If not the seat belt, you are. The variables we should care about are employment growth, inflation. The rupee is just an enabling mechanism.

[The] rupee by itself should not be attracting so much attention. If it absorbs the shock, other domestic variables that matter to us don’t have to move as much. I’m glad to see that in the latest episode, that thinking has taken over. I will say one quick caveat to my own thinking: One needs to be careful about speed and inflation because—

RAJAGOPALAN: It shouldn’t spiral such that then foreign inflows start rethinking their—

CHINOY: Correct, that’s it.

RAJAGOPALAN: —India strategy and things like that, right?

CHINOY: I think that’s the balance you have to get right because what you see in the latest episode—in fact, in my last column, I was saying, we definitely want the rupee to depreciate but if you put too much burden on the rupee being the only adjustment mechanism for the balance of payments then you risk such a rapid depreciation that this becomes self-fulfilling. Already, you’ve begun to see, the last few weeks that importers, corporates, foreigners have begun to hedge their stocks: stock of FDI, stock of ECB, stock of FPI. And once you go down that path, then you get into a self-fulfilling loop because you hedge your stock. That puts more pressure on the rupee. The more the rupee weakens, the more the desire to hedge. And we want to break that cycle, so we want rupee depreciation, but not too rapidly so as to un-anchor expectations in the rupee market.

RAJAGOPALAN: That makes perfect sense. But when I was reading all your columns now, again, to prepare for this conversation, all the more recent columns where you’re calling for rethinking rupee depreciation and doing it slowly and in stages, it reminded me [of] one of your older papers with Toshi Jain on the Dutch disease. 

The Dutch disease, for those who are unfamiliar, comes from this windfall that the Netherlands got in the ’60s because they discovered more natural gas and energy resources and so on.

But what happened immediately was that there was this big inflow of foreign exchange, which made the guilder, those years before they had moved to the unified currency, stronger, and it made Dutch manufacturing less competitive. Basically, one booming sector effectively strangled their other competitive sectors.

Now, that’s not exactly the argument, but you make a pretty elegant argument in this paper where you talk about the fall in oil prices and therefore the import bill being the big windfall gain equivalent for India. That led to the rupee appreciating in real terms, which also coincided with a decrease in its export competitiveness. What is a good way to think about that, given the situation we’re in right now? Right now, we’re seeing the exact reverse of what happened in your paper, right?

You’re seeing the import bill rise. You’re seeing the rupee depreciate. Now, which factor is going to have more impact? Are we going to become more competitive in our exports because the rupee has depreciated close to 15 percent? Or is it going to be harder because the fuel bill is going up, and the overall cost of production is going to go up, and it’s going to weaken our export competitiveness? 

CHINOY: No, I think there’s no doubt that this is all controlled for when you measure these things that, as long as there’s some domestic value content, your exports become more competitive, right?

Even if the import content is 70 percent, yes, that 70 percent moves in line with the exchange rate, but on the export side, the full 100 percent is moving in line with exchange rate. So, the larger the domestic value content the greater the competitive advantage on exports from a weaker rupee, and those are the estimates that we found. Now to be fair, these things have attenuated over time and show that, but it’s still economically and statistically significant. We found that for the exchange rate. The RBI has found it. So, Shruti, a weaker real effective exchange rate over time will help not just export competitiveness but make imports more expensive and therefore help domestic substitutes on the import front. We tend to ignore that part.

RAJAGOPALAN: So, on that the elasticities that you find were not very reassuring in terms of spurring domestic supply chains, right?

CHINOY: No, that’s on the import front.

RAJAGOPALAN: What is a good way to think about that?

CHINOY: I think, again, different studies find different estimates. Some other studies find the opposite of what we found that they found the import elasticity is larger than the export elasticity.

RAJAGOPALAN: Oh, wow. 

CHINOY: Exactly, and that moves faster because imported goods get more expensive immediately—  And then to the extent that there are domestic substitutes, those tend to expand.

So, there are different ways in which this happens, but I think it’s fair to say prices matter! Right? And in India, studies that look at this carefully find that when you do get exchange-rate depreciation, that that compresses the current account.

Now, the larger point about—we need to also think a little bit more—first principles. The equilibrium unobserved real effective exchange rate is a function of many things. When you get a positive terms of trade shock through lower oil prices, your equilibrium rate itself should rise, right? When capital flows increase, for example, your equilibrium rate should rise.

Part of this is to understand where is the real effective exchange rate vis-à-vis its equilibrium. One of the reasons that I think we should let the rupee weaken is because by all accounts, with FDI slowing in the last three years, and India experiencing a large negative terms-of-trade shock, both of these would argue for a much weaker real effective exchange rate.

So, those that say, “Oh, the RBI’s index was 100 three years ago, and now it’s 92, means the rupee is undervalued by 8 percent,” are presuming some static real effective exchange rate. This is a dynamic concept that changes when exogenous shocks happen, and I would argue India’s equilibrium rate is much weaker, and we are facilitating an adjustment towards the new equilibrium.

Coping with Shrinking Capital Flows

RAJAGOPALAN: So, you talked about FDI, and also—this is your most recent J.P. Morgan report, along with your coauthors has talked a lot about the capital flows. Capital flows have shrunk, you point out, from 2.6 percent of GDP between 2015 and ’19, to about 1.4 percent in 2024 to virtually nothing last year, in 2025. 

Another finding that you have in the paper, which is related to this, is that in the last 15 years, net FDI to India is inversely correlated, and very strongly so, with U.S. treasury yields.

One, FDI has been slowing down. Two, a lot of it is outside of our control, but there are things which are within our control, which also are things that you talk about, because Vietnam has not had a similar plummeting of FDI, right? They’ve done pretty well despite the same global situation. So, what is a good way to think about the factors that India needs to focus in the very short run and the slightly longer run on how to bring in FDI inflows with the rupee where it is?

CHINOY: That’s a great question. I think the way to think about FDI is that FDI flows because there are both push factors and pull factors. The push factors are global.

When global interest rates went to zero in the pandemic money flowed to all emerging markets, right? But then you lose control of your own destiny, because when global factors change, FDI can dry up, like we’ve seen the last three years. What’s more important is to focus on pull factors. What is it that a country can do to come across being attractive, and FDI gravitates towards that?

What we show in the paper is that there’s one clear episode where India has a strong pull factor. It’s between 2005 and 2010. What happened then? You had this big private investment cycle. A big private investment cycle, and so the quantum of FDI that we attracted could not be explained by where U.S. rates were, and that was India’s pull FDI.

After 2010, Shruti, as you pointed out, it’s been more push FDI. It should be no surprise because we’ve just discussed earlier, we haven’t seen private investment pick up. Right? Now, Vietnam, in contrast, all appears to be pull FDI because Vietnam’s FDI has been almost flat as a pancake at 4.5 percent of GDP, and in variance to global financial conditions. I think the lesson is very clear. What do we do to make India a more attractive destination? It all boils down to starting a fixed-investment cycle. My impression is always FDI is complementary to domestic investment. When domestic private investment starts, it tends to catalyze FDI. I think that’s the sure-shot way of doing that. 

This matters because in the past, we always talk about India’s sustainable current account deficit being 2.5 percent of GDP. That, in a way, was because we were attracting 2.5 percent of capital flows. 

If your capital flows reduce, then your sustainable current account deficit reduces, right? That then has implications on what your investment rate will have to be because ultimately, the current account is nothing but the investment minus savings rate.

As an emerging market at our level of per capita income, we don’t want a current account which is 0.5 percent of GDP. We want a current account which is 2.5 percent of GDP because that’s telling us that investment rate should be higher and potential growth is higher. It’s like blood pressure. You don’t want blood pressure to be too high, but blood pressure that’s too low is equally worrisome.

RAJAGOPALAN: Right now, our current account deficit is too low, right?

CHINOY: It is too low. It’s been 0.5 percent of GDP the last year and 0.8 percent of GDP the last three years. That’s another sign about investment because if you think of the current account as being investment savings gap that is the sum of the public investment savings gap, which is the fiscal deficit and private investment surplus. Savings minus investment. So, with the combined deficit of above 7 percent of GDP, your current account is only 0.5 percent of GDP. It’s telling you that private corporates have too much saving and are investing much too little. All of this, whichever way you cut it, comes back to what do you need to do to boost private investment?

RAJAGOPALAN: I have a couple of different questions on FDI, but I’ll start with Press Note 3, which happened for multiple reasons—pandemic, Galwan. It didn’t start out as an anti-China FDI policy, but it effectively became one. It was all Indian bordering states, and it wasn’t saying no to FDI from bordering states or neighboring states. It was that we look at it, and you need a permit like the good old License-Permit Raj world.

We did with FDI what we’ve done with Quality Control Orders, [chuckles] or what we did in the 1980s with the rest of the economy. Do you think this plummeting has in large part been because of this—because the one country that does have the ability to invest in India in fairly large proportions is China, and we shot ourselves in the foot with Press Note 3—which we’ve now amended. You’ve been talking for many months about relaxing the constraint on China and actually inviting more Chinese FDI. But is that the reason that things went so bad so quickly for FDI?

CHINOY: I don’t think so, actually. Now, prospectively, opening up investment to China will help, and I’m arguing for that for different reasons, for risk management reasons.

Because I think China now is looking for outbound FDI, and you see this all across Asia. But I don’t think it’s the primary reason, Shruti, because if that was the case, then you would see that in 2019, FDI would have gapped down instead, right? Because this happened in 2020. Instead, the opposite happened. FDI went up in 2020.

RAJAGOPALAN: Yes, but that’s because of the U.S. yields just dropped, right? 

CHINOY: My sense is at the margin, every bit helps so I think prospectively—and the reason I’m saying this is because it’s not just FDI. Yes, we want more FDI, but it is for risk management. I think one of the things we’ve realized in this last six months, is quite apart from energy dependence, it is choke-point vulnerability. It’s well understood that now, a lot of our LPG comes from the Strait of Hormuz, a lot of our gas comes from Qatar, and we need to diversify that. But we should be cognizant of the vulnerabilities we have with China, right? Seventy percent of our APIs come from China. By some estimates, for antibiotics, it’s ninety percent.

RAJAGOPALAN: Ninety percent, yes.

CHINOY: All the silicon, which is used for solar panels, almost all of it comes from China. Lithium-ion batteries, all of it comes from China. So, my argument is that allowing Chinese FDI does two things. It helps you with FDI as a source of capital goes to finance current account, but B, you take away the prospect of imports being weaponized.

You’ve got that FDI in India and the domestic companies with a joint venture with a Chinese company, and you’re getting some domestic production capabilities, value is being created onshore, jobs are being created onshore. You become less vulnerable to those imports suddenly being shot down. I think for all of these reasons, we need to think carefully and try and get more Chinese FDI into India.

Improving India’s Pull Factors

RAJAGOPALAN: Yes.You’ve been talking about how the more recent pressure, which is so weird for those of us who’ve been looking at this over the last few decades. Is capital account-led? Net FDI has dried up because of high yields. All the other pull factors not working out as you talked about. But can you think about a similar push-and-pull framework when it comes to foreign institutional and portfolio inflows?

Some of the outflow is obviously global, which is U.S. yields and geopolitical risk, but some of it may also be India-specific, which is just weak earnings across the board. There’s a fair bit of regulatory uncertainty, right? SEBI changing its mind on its derivatives framework. Do we have a sense of what kind of market we wish to be for institutional investors? And are we consistent with that, or is there just too much regime uncertainty caused such that there’s also outflows on that margin?

CHINOY: I think regime uncertainty has been in India forever. [laughter] We’ve always had that and we’ve had a situation where we’ve had strong portfolio flows come in even back then, right? This is yet in the 10 years ago, 20 years ago, 25 years ago. I think what markets are looking for is, in a world in which there are compelling pull factors now—I now look at Asia, you can see what’s happening in Taiwan and in Korea and in Singapore and in Malaysia—they’re all intrinsic and part of the AI supply chain.

You look at Latin America, and equity flows are going there because they’re benefiting from commodity exports. I think what we need to look at is, what is the India-specific pull factor? When you talk about 1991, my sense is this is not 1991 in terms of a balance of payments problem because the conditions are very different, but this should be a 1991 moment in jumpstarting reforms.

I think the sense is that the reforms of the 1990s have run their course.  Yes, we’ve seen some new reforms in recent years, the bankruptcy law, GST, labor laws last year. We’re getting some China Plus One, but I think what we need to do is—what is the next set of measures that’s going to improve India’s structural competitiveness?

I want to emphasize structural competitiveness. What can we do? This is the right moment in time, Shruti, because I think of global value chains as being a club with closed membership. For many years membership was closed. 

Now because of what’s happened in China, China Plus One, multinational companies are looking around to say, “I want to hedge away from China,” and the old hedge, which used to be ASEAN economies, is not deemed to be as much a hedge because after the transshipment risk under the Trump administration, getting a hedge from China means actually leaving ASEAN as well. If you go through Vietnam, there’s always the risk of you being accused of transshipping goods through Vietnam and attracting high U.S. tariffs.

So, this is an opportune moment because firms are looking for other destinations. I think this is when we need to think of this as being a 1991 moment to push forward the next set of reforms on factor-market reforms and on deregulation on import tariffs and QCOs. Or an export push to say, “Listen, this is India’s compelling pull story.” I think when that happens whether it’s FDI or FII, India will get it. Earnings are simply a symptom. When we have private investment, earnings will reflect that. 

RAJAGOPALAN: Yes, so they all go pro-cyclically, right? If one thing picks up slowly, all of them will start picking up and all of this has to be done at the state level. It should technically be more doable on an experimental basis. All the reforms that you talked about. Most of the structural reforms are state problems.

CHINOY: Not only more doable. This is where comparative federalism matters. And it’s good to see that. That now states are actively competing with each other and in fact, when the next dollar of investment goes to state A, there’s visible disappointment and disenchantment in state B. That’s healthy competition. Now of course, I think, as you said, reform some more at the state level, more horizontal, but this also takes more time. I think the center will need to enable an ecosystem where this can happen rapidly.

Export-Led Growth and Improved Resilience

RAJAGOPALAN: Yes, so, one of the areas where you have been consistent now for 25 years, not just the last five, 10 years, is on exports being the growth story, right? On this, most of our colleagues who were on our side have changed their mind. Some of them more recently just because the tide has turned. Five years ago, it was about Dani Rodrik and premature deindustrialization, and that old, globalized world has just ended. More recently, it’s about resilience and geopolitical shocks.

Now, your argument’s actually very consistent that it’s not going to build resilience. Export-led growth is really the only way out and the only way to build resilience, and having industrial policy import substitution, these things are actually eventually going to hurt your export competitiveness, which means they will hurt your growth and therefore lead to lower resilience. What is the part of the tradeoff that other people are not seeing?

Because the way you set it up, if I understand it correctly is, we need economic growth. That’s what gets you resilience. There’s a certain tradeoff on how many percentage points of growth you’re willing to trade off, depending on whether you’re at war with China or there’s some global geopolitical event. But it can’t be too high and it can’t hurt your export growth too much because that’s what’s going to lead to your economic growth overall. What is the part of this tradeoff that you and I are on one side on and everyone else is on another side? I don’t know what’s going on anymore. [chuckles]

CHINOY: We’re preaching to the converted over here, you and me. But let’s just stipulate some facts because sometimes it needs repetition. If India needs to get to $15,000 per capita by 2047 which is the prime minister’s goal. I think it’s a real aspiration.

RAJAGOPALAN: It’s a great goal, yes.

CHINOY: It’s a great goal. It’s doable. We need to get there. What does that mean? Let’s break it down. In per capita dollar growth terms this means we have to grow at 8 percent, 7.9 to be exact. The last decade we’ve grown at 6 percent, 5.9. So, over the next 20 years, we’ve got to up our dollar capita growth rates by two percentage points. Right? Now, that’s the ask. Only 13 economies in the world over the last 100 years—

RAJAGOPALAN: Have ever grown at that pace, yes. 

CHINOY: —have ever grown at 7 or 8 percent for this length of time. They all had one thing in common: lots of global engagement, lots of exports. Why? Because the global market is just that much bigger. And really, for all the reasons you and I have discussed in the past, exports force a certain economic scale. It forces a disciplining mechanism. Think of our whole IT sector, right?

Just look at the productivity growth and the Infosys and the Wipros and IT sectors. Again, because they were globally exposed, they had to be world-class. India’s own economic history, which is the time we had very high growth in the first decade of the millennium—people don’t fully appreciate this. It was export-led growth. Exports grew in real terms at 16 percent a year between 2003 and 2011.

Because exports were the driver of growth, investment, which is endogenous, responded to that. Capacities expanded, and investment grew at 9.7. Consumption growth was less than 6 percent. 

India’s burst of miracle growth happened because of exports. We should first mandate that there is no example in history of 7 percent growth for two decades, which is our aspiration, which is not based on global engagement. Now, the question is, how do you get that global engagement in this economic environment? That should be the real question.

I would argue that here, starting point, we’ve seen that even in the last three, four years, yes, the global environment has become more vitiated. But our service exports, for example, have gone from strong— 

RAJAGOPALAN: Have done really well.

CHINOY: Goodness, yes. So, when you’re globally competitive, it doesn’t matter how fast the pie is growing. I think that’s going to continue. On the goods front, we’re still less than 2 percent of global market share, which is, at this point, an advantage, because what it means is that, even if the pie is not growing, I don’t need for the pie to grow. Yes, a rising tide lifts all boats; that’s easy. But even if the tide is not rising, if my share is only 2 percent—

RAJAGOPALAN: It has nowhere to go but up.

CHINOY: Nowhere to go but up, 3 percent or 4 percent. The difference is that early export growth and the rising tide lifts all boats, you don’t have to do very much.

But now, the importance of improving structural competitiveness is even higher, because to get that 1.7 percent or 2 percent manufacturing share to go to 4 percent, we have to increase market share. Increasing market share means doing better than the next guy, which means you have to become more competitive. That’s one part. 

I’ll just take two quick points because it’s a very important question. As you know, graduate school first class of trade, Anne Krueger, whom you and I know well. Anne’s first point is the Lerner’s Symmetry Theorem – “An import tariff is the same as an export tax.” Right? When we think about import tariffs, we have to be very careful to understand that’s as pernicious as an export tax. Worse, a nontariff barrier on the import side is even worse because they’re opaque and transparent. Now, the good news, Shruti, is it’s not all gloom and doom. In the last two years, I sense a perceptible shift in India.

We’re signing more free trade agreements. I think the 50 percent tariff last year gave us a boost. We’ve begun to bring import tariffs down. We have much more to go on that front.

We’ve begun to look at the stock of QCOs, Quality Control Orders. We need to do more on that front. But we need to be mindful that if you’re pursuing an export-led growth, we have to rationalize the import side. The last thing I’ll say is, in my mind, there is no tradeoff between resilience and export-led growth. Resilience means identifying the weakest point of your supply chain.

If you don’t have polysilicon or lithium-ion batteries or LPGs, solve for that. Resilience doesn’t mean replicating the entire supply chain at home and import substitution. We should make a big distinction between resilience, which is to say, look for the weakest link of the chain, and solve for that. Either build buffers at home, diversify your imports, look for substitutes. It does not mean we have to go back to autarky and make everything ourselves. I think that’s a very important distinction. I don’t see any tension here between becoming a more resilient economy. Yes, for certain highly sensitive areas, we’re going to build buffers. We’ll have multiple imports to be placed from. There’ll be a fiscal cost. There’ll be a dollar cost. There’ll be an opportunity cost. That’s just a cost of avoiding shocks. It does not mean that we regress into autarky.

Navigating Choke Points While Avoiding Autarky

RAJAGOPALAN: Here, just to play devil’s advocate, the trouble is we have one very, very, very large and dominant player who is dominating virtually every supply chain. We don’t know what that choke point is until they hold it over our head. Right? No one thought rare earths and lithium were an important part of any supply chain until China made the crazy move. Only more recently, as solar has become [a] larger and larger portion of our entire energy production, have we realized how important Chinese imports are in that particular space? Same with pharmaceuticals during COVID. One way of thinking about it is, are they on the opposite side of this tradeoff relative to you and me?

Because now they are worried that every single thing that is produced in China - and China produces pretty much everything - is just that much cheaper. Depending on what the geopolitics are, they can hold it over our head. We need to build some resilience in every area, if not autarky. The process of building resilience means some protective barriers, which means we get somewhere closer and closer to very high trade barriers, if not autarky. Is that how they are thinking about this?

CHINOY: I can’t speak for them, but this is a slippery slope I worry about.

RAJAGOPALAN: Yes, it’s the slippery slope I worry about too. [chuckles]

CHINOY: If you put on a path, then how much of the supply chain do we want to replicate? Therefore, I began by saying that if you think about risk management at the macro level, first is on highly sensitive areas, fearing a global cutoff, you build buffers. China has built buffers on agricultural commodities, weather. Some areas, you can say, very sensitive goods, build buffers. Wherever you can, diversify. We are now buying more LPG from Australia.

We could have been doing that before the crisis. We’re buying more LNG from the US. Third, and I’ll get to China second, the third issue is hedge prices. Mexico exports oil. It does the famous “Hacienda hedge” in financial markets. It pays 0.1 or 0.2 percent of GDP and buys two options to take away the price risk. India could have been doing that for the last decade. I’ve been pushing for— 

RAJAGOPALAN: Yes, but we don’t like markets, so we don’t do that. [chuckles] 

CHINOY: For the China stuff, you’re right. China is a monopolist. There is no way to diversify that risk. Therefore, I said, if we can get more FDI from China— 

RAJAGOPALAN: FDI, especially in those areas, encourage them more.

CHINOY: That becomes a hedge. I think it’s a combination of building buffers, getting more FDI from China in the areas where they’re a monopoly, hedging prices, and diversifying imports. I think if you do this, you can take care of most, if not all, eventualities. We don’t need to be replicating the entire supply chain at home.

RAJAGOPALAN: Yes, so, the second part of trade liberalization—which again, 15, 20 years ago, was a big topic of discussion, even when people were protrade—was on labor elasticities. You’ve written about this. You have a paper with Devashish Mitra and Praveen Krishna on Turkey. I think Devashish Mitra, Rana Hasan, and Ramaswamy did one for India. The message is either mixed or not good. Trade liberalization has definitely increased pressure on labor markets, especially in India at the subnational levels. These papers were written 15 years ago. The trouble is now the capital-labor ratio is even worse. There is much more automation. The pressure on labor is even higher. If I were to be a betting sort, I would bet it’s worse news now. 

That’s no longer a hot-button topic the way it used to be 15 years ago. But is that another big problem we need to worry about when you and I are still extremely pro-trade and liberalization, even in the current climate, when we’re trying to bring manufacturing up—but  not just manufacturing, jobs growth in manufacturing?

CHINOY: Great question, Shruti. Firstly, in our paper, we actually found a different result.Of course, it was quite special that we found that trade liberalization in Turkey—there was a good national experiment there—did not increase labor demand elasticities despite liberalization. Now, that was unique to Turkey. It probably increases it in India’s case. The broader issue is the following, that we must appreciate what trade does and what it doesn’t do. Trade increases the size of the pie.

Right? That efficiency gain we’ve seen in the world in the last 30, 40 years—that  efficiencies have gone up, millions of people have been pulled in emerging markets out of poverty—created jobs—so the size of the pie goes up. There are clearly distributional consequences from trade. The US has seen this the whole hollowing out of the Midwest into emerging markets. What you’re getting at is when you do trade, the size of the pie goes up, but this is going to skew bargaining power of capital versus labor, make certain factors of production more vulnerable. 

This is where public policy has to step in. This is where public policy has to step in to buffer the impact, to say, “We want a larger pie, and the distribution of that pie, public policy has to step in to offset or mitigate the distribution of that pie.” 

But this leads to a broader question, Shruti, because I’m worried about how India’s capital-labor ratio has steepened so much. 

This is even before AI, and what’s going to happen on services. We have a lot of global capability centers. We worry that if AI continues at this pace, what does it do to jobs over there? The broader question is, how do we make labor a more attractive factor of production?

That’s just another way of saying capital is going to be becoming more productive forevermore. Right? That’s inexorable. How do you give labor a better chance to compete with capital?

RAJAGOPALAN: Yes.That’s about skilling and education and building the human capital. Yes.

CHINOY: I know it sounds really boring, but it’s never been more urgent. Education, skilling, health, midcareer training, all of that stuff, right? And welfare nets where labor gets left behind. Part of this issue of trade elasticities is, yes, there will be winners and losers. We know that from trade. The winners outsource the losers, but the losers tend to be concentrated. People may lose some jobs. The winners are more diffuse. Consumers gain. 

How does public policy compensate the losers? But I think that has never been more important now, quite apart from trade. Technology! There’s this debate in the US about what caused some of the job losses in the US. Was it really China joining WTO, or was it technological progress over time? 

Today, it’s trade. Tomorrow, it’s going to be technology. But the question is, what can we do to give labor a better chance to compete with capital? I think that’s the fundamental challenge that we face at this moment in time. It’s not an easy one.

India’s Trilemma

RAJAGOPALAN: Before I let you go, one last question on where you think we are in India on the Mundellian trilemma. Now, the world is a little bit different because now this is a capital account issue, not so much a current account one. 

Maybe that’s part of the bigger problem. You have on the one side a question of inflows. You want to have a rupee managed—or rather, the rupee is managed by the RBI. It’s not determined by the market. We want to determine monetary policy and keep inflation low, which we’ve been remarkably successful at doing in the last decade. 

Now, you’ve switched corners within that triangle. India has never been in any particular corner. We manage all three in some way, but you’ve switched corners because now you’re like, “We need more FDI, so we need to think about capital inflows, and we need to think about how we manage the rupee.” Do you worry at all about what that does for independence in monetary policy and stability in monetary policy, and how we managed it so far?

CHINOY: Great question. I think actually that’s one area where we’ve actually gained success. Let me explain to you why. Firstly, I think there’s no doubt that we need more capital flows into India. We need more FDI for technological transfer, to finance our current account for higher investment rates. We can’t abandon that. The pace of capital account liberalization, we can debate. The direction, we should not. 

Now, the good news has been that—see, the Mundell trilemma, the trilemma presumes that you only have one instrument, but in the practical world of central banks, you actually have more than one instrument. As the RBI has shown that what’s happened in the last few years—and I’ve been very encouraged by it, that we’ve actually used interest rates and liquidity for domestic growth inflation dynamics in that interest rates have been independent of where the Fed has been.

We’ve managed the external sector by sterilized intervention. So, I’m not sure that we’re stuck in the trilemma, Shruti. In fact, the best evidence of this is if you look at India’s interest rate differential with the US there used to be a time where we were 300, 400 basis points higher than the US,. We could only cut when the Fed cut or when the Fed hiked, India was forced to hike. We’ve broken out of that syndrome a long time ago. I would argue for the last six, seven years, our interest rate differential has narrowed very sharply.

India’s interest rates today are, what, 150, 175 basis points above the Fed, And it’s much lower—the fact that interest rate differentials narrowed is the best sign of monetary policy independence because monetary policy has not become hostage to the Fed. When the Fed does move, the exchange rate comes under pressure, but the RBI has got multiple instruments on that front to ensure that those exchange rate pressures do not mean an automatic hiking of interest rates.

To give you an example, over the last year, from ’25 onwards, we’ve cut much more aggressively than the Fed has. Yes, there was some exchange rate depreciation. Let me put it simply. We’ve allowed, in the last year and a half, more exchange rate flexibility, which has meant that you’ve broken out of the trilemma. Then you’ve maintained capital flows and monetary policy independence. Even when there is a tradeoff, there is more than one instrument.

If you use centralized intervention, central banks, within some degrees of margin, can do both. They can manage the exchange rate, and they can keep monetary policy independent. That said, I think we should be very conscious that exchange rate should be managed not only when there are large shocks like this, but on a more day-to-day, week-to-week, month-to-month basis, because then markets develop.

RAJAGOPALAN: You just smooth it out, and markets will develop, yes.

CHINOY: What happens is right now we’re worried that, “Oh, everyone’s going to start hedging. “But when there’s exchange rate stability, too much stability, it dissuades people from hedging. You want to be in a situation where people hedge in the normal course of events, and then there’s no moral hazard on the exchange rate to remain stable. I don’t think that’s the most acute trilemma that we face. I think we’ve found a way to manage that. Should we take more exchange rate movement? Yes, it unshackles us even more.

RAJAGOPALAN: But are you at all worried that the kind of capital inflows you wish to attract, and I specifically mean you in this instance, is going to make the management of the other two a little bit harder, especially on the monetary policy side?

CHINOY: Not really, because we want to get more FDI, right? We want to get more FDI. Let’s say we’re successful in getting FDI. What happens in that case is that the RBI will simply absorb that in terms of higher reserves. Even if it lets the exchange—we shouldn’t be puritanical about this. 

The first task is going to be once this pressure point boils over, and capital flows return—let’s hope that’s sooner—we will need to rebuild reserves.Right? You don’t want the exchange rate to take the full adjustment. But even in the case, let’s say the exchange rate does appreciate, that’s not where the pressure point is because in that case, that’s disinflationary. So I think capital flows come in, and letting the exchange rate do the work is disinflationary, which means it takes the pressure off the RBI. The problem happens in the other direction.

RAJAGOPALAN: Other direction, yes.

CHINOY: When capital flows out— right? And the exchange rate is under pressure. Sometimes emerging markets want to raise interest rates to prevent that from happening. That, in a way, is not in sync with your domestic growth inflation dynamics and monetary policy gets stuck defending the rupee. But the good news is we haven’t seen that in India the last couple of years. In fact, the whole idea of inflation targeting was monetary policy should not be defending the rupee; it should focus on growth inflation dynamics and let the rupee be determined by external fundamentals.

RAJAGOPALAN: Buton the other hand, if we start opening up our markets such that we get more capital inflows then that also opens the door to have more capital outflows. The downside that you were talking about, isn’t that just a natural consequence? It’ll be cyclical one day, right? At some point, we’ll end up having to manage this.

CHINOY: The way to manage that is twofold. When you’ve got a large chunk of reserves— you let the exchange rate be the first stock absorber. When that exchange rate movement gets disruptive, then you intervene with reserves to slow the pace of depreciation. I think this is a well-oiled playbook for this.

RAJAGOPALAN: And we have the reserves for it also.

CHINOY: We have plenty of reserves. When capital flows in, they tend to be very pro-cyclical. At some point, capital flows out. When capital flows out, so be it. Let the exchange rate depreciate like it is now. If that depreciation gets too disruptive, then you use your foreign exchange reserves to slow that depreciation down. 

But you don’t use interest rates to hike, right? I think successive governors have ensured that doesn’t happen. We’ve not raised interest rates to stop—because of rupee depreciation. Interest rates will move when that rupee depreciation translates into higher core inflation, and your inflation mandate gets threatened. Then you use interest rates as a second argument.

RAJAGOPALAN: Is that coming our way, by the way, just because of the fuel prices shock that is approaching us? We thought this war will be over in two or three weeks, and now it’s just gone on, and we’re getting into June. Is this where we’re headed?

Positive Signs of Resilience in the Indian Economy

CHINOY: We’ve spoken about all the challenges. Let’s end on some positives here. 

Let me give you three positives. First and foremost, we began the pandemic with an economy that was slowing sharply on a weak wicket. In contrast, we’ve entered this episode with a cyclical upswing. We spoke about the six factors that drove growth, and growth was strong in March. Right? So, we’ve got a good starting point on growth. The other good starting point is on inflation. Last year, inflation was only at 2 percent. And core inflation is still running at 2.2 percent.

RAJAGOPALAN: Yes, but that’s because of good inventory management. When that ends, any time in the next few weeks, are we looking at a serious oil shock?

CHINOY: A couple of things—so, I don’t think so. Two parts. One is, the good news is—not good news, but the inevitable outcome is oil prices have begun to move up, retail prices of petrol and diesel have begun to move up. That’s very important because you want prices to reflect their opportunity cost, so you get the right behavioral response. That will push up headline inflation. Will it push up core inflation, which is when central banks get concerned, is an open question.

I would argue, Shruti, one thing we haven’t talked about is India is still 5 percent below its prepandemic potential path. That has meant there’s still slack in the economy. Also, Chinese imports have exerted lots of disinflationary forces. You marry both those things, and that tells you why, in the last two years, despite growth being resilient, India’s core inflation has averaged only 2 - 3 percent. There’s still slack, and there is the Chinese disinflationary impact.

In that environment, you need to see very sharp and sustained input price increases for second-round effects to be elevated and sustained.

I’m less worried about where inflation is headed. I’m more worried about the balance of payments. The good news is growth was strong coming in. We can take a bit of a hit this year. Inflation was benign. There’s some ways to go before the RBI gets worried. 

The third piece of good news, which may be temporary, is that—we began by discussing shortages. The worry in March was that we will see widespread shortages by the month of May if the strait doesn’t open. There, the good news is that we’ve been able to source more crude and more energy from around the world.

RAJAGOPALAN: And we have diversified.

CHINOY: Diversify. LPG is still a problem. But at least for now, these are the three silver linings. Of course, if this continues for a while, all of this will come under question.

RAJAGOPALAN: Irrespective of what’s going on with the West Asian crisis or even the broader geopolitical trade stuff, we just need to get the house in order when it comes to reforms, right? We need to get our factor markets in order. We need to remove distortionary prices for all these inputs, like fertilizer. I think a crisis is a good time to do it but anytime would be a good time to do that stuff. [chuckles]

CHINOY: The problems are well known. Right? The problems are well known. The hope is that a crisis like this opens up the political space to push on some of these. And we saw that last year. 

You see, when the 50 percent tariff came, I think it pushed us to do the GST stuff. That was being negotiated for a long while, but it focused the mind to do it quickly. We got something on labor reform. We began discussing the two deregulation committees. We began thinking of import tariffs and QCOs coming down. So, we got some of that momentum started. We should hope— 

RAJAGOPALAN: We’ll just keep on building on it.

CHINOY: Yes, when the firefighting from this episode is over, we use this to say, “Listen, the world is changing in undesirable ways. For India to compete and be attractive and pull FDI and pull flows, we need to take on some of the hard decisions that we’ve been faced with for many decades now.”

RAJAGOPALAN: Yes. Hopefully, you and I will be in business and have lots to talk about in terms of reforms. Thank you so much for doing this. This was such a pleasure.

CHINOY: Always a pleasure, Shruti. Thank you so much.