Why Raghuram Rajan Believes India Will Not Be Next Sri Lanka, Pakistan

At a time when experts’ apprehensions of India ending up like the crisis-struck Sri Lanka are rife, former Reserve Bank of India (RBI) governor Raghuram Rajan sounded confident about the concerns being misplaced when he recently praised the RBI for its discretion in increasing reserves and handling inflation. 

Touching upon foreign reserves, a primary pain point crippling Sri Lanka today, Rajan said to a publication, “We have sufficient foreign exchange reserves. The RBI has done a good job in increasing the reserves. We are not having problems like Sri Lanka and Pakistan. Our foreign debts are also less.” 

Rajan, who is currently in the economic advisory council to Tamil Nadu chief minister, was of the opinion that India’s robust foreign exchange reserves and low external debt make it more resilient to deal with price shocks.

India’s forex reserves for the week ended July 22 stood at $571.6 billion. Till the end of March, India’s foreign debt obligations were at $620.7 billion, as per RBI data. The external debt-to-GDP ratio fell to 19.9 per cent in March this year from 21.2 per cent a year ago.

Rajan also pointed out how the policy rate hikes that the RBI opted for would help in easing inflationary pressures. In 2020, the RBI reduced the benchmark lending rate sharply to spur economic activity and recover from Covid’s blow. But even before the full impact of a low-rate regime could play out, the Russia-Ukraine war worsened inflationary pressures, thus forcing the RBI to raise the short-term borrowing rate twice—first by 40 basis points in May and by another 50 basis points in June.

Food and fuel, Rajan said, have been hit by inflation the most but he is optimistic. “As we can see, food inflation is coming down in the world and will decrease in India also,” he said. 

The former RBI governor is not the only one dispelling the apprehensions. Recently, even former NITI Aayog vice-chairman Arvind Panagariya said that while it would be a good lesson for India’s future macroeconomic management to learn from the crisis Sri Lanka is facing, the comparison is “silly”. 

In an interview to a publication, Panagariya pointed out that India’s fiscal deficits have been kept in check and that India has rarely borrowed foreign capital to finance its fiscal deficit. He also mentioned that while the exchange rate has been allowed to depreciate to keep India’s current-account deficit low, RBI’s monetary policy has kept inflation in check and the opening of financial capital flows has been done in a calibrated fashion. ”Suggestions of any parallels between India and Sri Lanka currently are laughable," he said

Behind The India-Sri Lanka Link-up

For a while now, economists have been drawing parallels between India and Sri Lanka’s economic situations.

The neighbouring island country is facing its worst economic crisis in 70 years with its year-on-year inflation touching a record 60.8 per cent in July. In May, Sri Lanka’s foreign exchange reserves also depleted and its usable reserves fell below $50 million, resulting in the country’s failure to repay its foreign debt obligations.

The country also defaulted on its debt for the first time in its history. A month’s grace period to repay $78 million worth of unpaid debt interest payments expired earlier in July. A defaulting country finds it difficult to borrow from international markets with the defaults dealing a death blow to its currency and economy. Soaring inflation, depleting foreign exchange reserves and failure to import essentials like medicine, fuel and food have together impacted its ability to repay sovereign debt. Its government has had rounds of discussions with the International Monetary Fund for a $3-billion bailout. 

The fears of India heading the Sri Lanka way have been further aided by India’s crippling inflation numbers. India’s June retail inflation came in at 7.01 per cent, breaching the RBI’s target range of 2-6 per cent. In the food basket, inflation in cereals and products was seen at 5.66 per cent, meat and fish at 8.61 per cent, and vegetables at 17.37 in June.

However, there is more to the experts’ worries than just inflation. On July 21, the rupee breached the 80 level in intraday trade for the second time. High crude oil prices, a strong dollar overseas and heavy foreign fund outflow from the domestic markets are among the reasons for the rupee's fall. Experts have said that the depreciating rupee is unlikely to be good for exports as global income is subdued. In June, India’s trade deficit widened to a record $25.63 billion. There are also concerns of a falling rupee giving rise to bankruptcies and imported inflation.

While Rajan and Panagariya may have rubbished the parallels between the two countries, India still has its work cut out for itself.