India needs to move faster on opening its economy to foreign capital and should manage its currency more actively to ensure job creation and avoid social unrest, a member of its convertibility panel said.
AV Rajwade, who sat on a 2006 central bank appointed panel studying capital account convertibility, said India should allow more foreign direct investment to foster jobs and bring in benefits such as best practices and lower cost of capital.
Furthermore, raising interest rates to curb inflation was unlikely to dissolve pressures stemming from oil and food prices and India needed to think harder about supply-side solutions, rather than just stamping on demand.
"We need a massive movement from agri-based jobs. Otherwise those people will continue to remain below the poverty line," Rajwade told Reuters in an interview at the weekend.
"Because the other side of it is if we don't tackle those problems in a very purposeful and focused fashion, what we are going to see is probably a greater and greater number of districts coming under the influence of the extreme left."
Prime Minister Manmohan Singh has called the country's long-running Maoist insurgency, in which thousands have died, the biggest internal security challenge since independence. The rebels say they fight for the rights of poor farmers and landless labourers.
The government estimates about a fifth of India's 1.1 billion people live below the poverty line. Analysts say the young and growing population will give the country an advantage in the future over other countries with an ageing workforce.
But Rajwade warned Asia's third-largest economy faced a big challenge in employing the young, noting: "We need to create something like 15 million jobs a year."
Nearly 60 per cent of the workforce is employed in farming, which makes up only about a fifth of economic output.
Exchange Rate Challenge
The rupee has been convertible on the current account since 1994, meaning it can be changed freely into foreign currency for specific purposes like trade-related expenses.
But it cannot be converted freely for activities such as acquiring overseas assets. The convertibility panel last year laid out a roadmap towards greater rupee freedom by 2010/11.
Rajwade said he was more in favour of liberalising capital inflows than outflows and had argued on the convertibility panel that the bond market should be fully opened to foreign investors.
"We do need more players. We need a longer term corporate bond market for infrastructure finance."
India attracted $15.7 billion in FDI in the first 10 months of 2007, double the amount in the same period of 2006 but far below the $74.7 billion China attracted in the whole of last year. A further $17.4 billion came into India's stock market.
The inflows have created a monetary and currency headache for the central bank, which intervened heavily to limit rupee gains to 12 per cent against the dollar last year. The central bank issues expensive intervention bonds to soak up the inflation-stoking extra funds resulting from its actions.
Rajwade said he was not a fan of purely market-determined exchange rates as expecting the real economy to adjust to a market-set rate was like "allowing the tail to wag the dog".
Currency gains should be tempered to keep the economy competitive and prevent domestic firms from making capital investments in Vietnam or Eastern Europe instead of at home.
"If you go to corner shops in Mumbai... everything is today Chinese made... I don't think we can afford that because we are losing jobs," he said.
He said China deliberately kept its exchange rate down so that domestic investment and jobs remained.
"Their priorities seem to be clearer," he said.
India raised interest rates five times between June 2006 and March last year, taking its key-lending rate to 7.75 per cent.
Rates are on hold as authorities gauge whether inflation, now about 3.8 per cent annually, has stabilised but Rajwade said real interest rates were closer to 8 or 9 per cent.
"How many businesses have the margins which can afford 8-9-10 per cent real rates? It's absurd," he said.