By Elliot Wilson
The US has lifted its ban on nuclear trade with India, but this is small comfort for a country where growth is slowing and inflation is on the rise. In his first interview as central bank governor, Duvvuri Subbarao sets out his policy principles
After more than three years of testy negotiations and a political tug-of-war at home and abroad, the Indo-US nuclear deal cleared its final hurdle on October 1, with the US Senate voting to ratify it 86–13.
But the historic approval to end a three decade ban on nuclear trade with India came as a bit of an anti-climax for both administrations, with Washington and New Delhi preoccupied with other more pressing issues – Washington with the financial crisis, New Delhi with a spate of bombings, which have left the country in shock.
Nevertheless, for India’s establishment, the approval is a ringing endorsement of its increasing weight in international affairs, which has accompanied its economic expansion over the past decade. Indeed, democratic and entrepreneurial India is often cited as evidence that Asia’s economies have not only emerged on the global scene but are racing towards global dominance. Rising profits at leading companies such as Tata Group, Infosys and ONGC have been parlayed effortlessly into major overseas acquisitions, notably in Britain and the US.
But now, real questions are being asked about whether India’s growth story can be sustained, or if the country’s rising star has begun to lose its lustre.
For a start, rising company earnings by and large have not led to higher wages, and Indian workers increasingly fear for their job security. The killing of Lalit Kishore Chaudhury, chief of a multinational in a dispute with staff over pay, has sent shockwaves through India’s business community.
India’s trade minister Kamal Nath insisted that the incident “would not be allowed to mar India’s position as an investment-friendly destination”. But others have warned the incident could be just the tip of the iceberg – unless India’s politicians act quickly to boost economic growth and cool inflation.
Gross domestic product (GDP), which rose at an average rate of 9% between 2002 and 2007, is expected to fall to 7.4% this year, according to the Asian Development Bank, and 7% in 2009 – downgrading the multilateral’s previous forecasts of 8% and 8.5% respectively. Inflation meanwhile has moved “beyond intolerable levels”, India’s chief statistician, Pronab Sen, said in early September. The rate of inflation in Asia’s third-largest economy, although showing signs of easing in September, tripled this year to touch 12.63%, the highest since 1992, in August.
Meanwhile, headwinds from the US financial crisis continue to batter India’s markets, raising fears that the fallout might sully the economic outlook. The rupee slumped to the lowest since 2003 as the stock market slid recently, adding to speculation investors will take money out of the nation. By October 4, the currency completed its eighth weekly loss, the longest drop since December 2005, on signs the US economy is headed for a recession that may damp global growth.
The rupee also fell after India’s central bank said the current-account deficit widened to a record in the three months to June 30. India’s current account shortfall, the amount by which imports exceed exports remittances and other income from abroad, increased to $10.7 billion from a $1.04 billion gap in the previous quarter, the Reserve Bank of India said on September 30. Investors are also worried that India could be the next to see a collapse of a major bank. The country’s largest private bank, ICICI, has demanded a probe of alleged manipulation of its share price.
Meanwhile India’s officials have moved to soothe jittery markets, saying the widening global financial crisis would have only a marginal impact on the real economy, which remains fundamentally sound. Whatever the long-term picture, it’s clear that the Indian economy is losing momentum, at a time when global risks are increasing.
On the first day of his appointment (September 5) as the new governor of the Reserve Bank of India (RBI), Duvvuri Subbarao made it clear he would uphold the commitment to growth and price stability of his predecessor, YV Reddy. But he added that he would focus most urgently on managing inflation and anchoring price expectations. The challenges ahead for Subbarao – a former finance secretary now in a role once described by prime minister Manmohan Singh as “perhaps the loneliest job in India – are considerable.
Here, in one of his first interviews with the international press since joining the central bank, he sets out his policy principles.
Should the RBI follow the Fed in relaxing monetary policy? If not, why not?
The Reserve Bank of India (RBI) takes into account a number of factors, both domestic and international, in formulating its monetary policy. The Fed’s extant monetary stance is an input into our decisions, along with the actions of other important monetary authorities. The Fed’s current easy monetary stance is driven by the objective of restoring financial stability, whereas our priority concerns are reducing inflation and maintaining the growth momentum, along with the maintenance of financial stability.
India’s financial sector is relatively robust, well regulated and well capitalized. Although in view of the growing financial integration and linkages through trade and capital flows, we too are impacted by the international financial turmoil, the effects are only at the margin.
What is your plan to keep inflation under control?
The current episode of inflation has been supply driven, and is largely a global phenomenon, triggered by key international commodity prices, especially of crude oil, metals and food grains. These external pressures have been exacerbated by strong domestic demand pressures. Though demand was not the main problem, in the absence of further flexibility on the supply side, demand management had to be part of the solution. Moderating demand and anchoring inflation expectations has been the logic behind the RBI’s monetary stance.
Both the government of India and the RBI took a number of measures to rein in inflation. From the supply side, the Government implemented a host of fiscal and administrative measures. From the demand side, RBI took calibrated action to withdraw monetary accommodation and moderate aggregate demand. We believe that the combination of fiscal and monetary measures has had a stabilizing influence on the economy through a period of unprecedented uncertainty and turbulence in the international environment.
On the issue of the future course of monetary policy, there are several known unknowns. First, we have to watch the impact of the measures already taken. Second, there is a need for continuous monitoring of inflation and inflation expectations as well as watching the sectors driving the demand. Third, in a globalized world, one needs to watch developments around the world and make an assessment of their potential impact on domestic economic management. While international commodity prices have come off their recent highs, new pressures have emerged from volatile currency movements and large shifts in liquidity conditions. We are monitoring and will continue to monitor the situation closely and take action as appropriate. In doing so, we will be mindful of the impact of any monetary policy action on both the emerging growth prospects, and the maintenance of financial stability, while focusing on inflation.
What are the main lessons of the US financial crisis for India?
Although the origins of the current financial crisis lie in the US subprime mortgages, and widespread financial innovation in the use and spread of complex derivatives, its ramifications have been unprecedented.
Ironically, whoever thought that a quintessentially non-tradable sector like ‘housing’ would trigger a global financial crisis! It is too early to draw ‘text book’ lessons from the crisis, but some key learnings are clearly evident. I will try to list a few important ones, some of which, though not immediately relevant for India, will be guidelines moving forward.
First, it is tempting to let the guard slip on credit quality in easy liquidity situations. It is important not to succumb to that temptation. Second, the use of complex derivatives has dispersed risks widely across the entire global system with considerable uncertainty about where the risks lie. So, we need to design and institute systems for greater transparency in this regard.
The third lesson relates to regulatory arbitrage. With regulators focusing on risks to institutions, particularly banks, a highly leveraged ‘shadow banking system’ – comprising hedge funds, broker-dealers, private equity, structured investment vehicles and conduits and money market funds – invested heavily in these complex financial products and spread the risk across the financial system and around the world. We need to address this by focusing not just on preventing institutional failures but also on preventing systemic failures.
Fourth, arguably some regulations have been behind the curve. There is no denying that regulations have to keep pace with innovations. But in doing so, we have to be sensitive to the risks of tightening regulation so much that it stifles innovations. Finally, the unfolding crisis underscores the importance of coordinated action within and across countries in times of crisis. This is important both for containing the crisis and for managing its resolution.
What is your view of where India’s exchange rate policy ought to lie going forward?
The RBI does not take a view on the level of the exchange rate. India’s exchange rate policy of focusing on managing volatility with no fixed rate target, while allowing the underlying demand and supply conditions to determine exchange rate movements over a period in an orderly way, has stood the test of time. Continuation of such an approach will serve us well in the current disturbed international financial market conditions.
What specifically can be done to speed up India’s slowing economy?
The Indian economy clocked growth of 8.8% on an average annual basis over the last five years. Despite the slowdown in advanced economies, the global financial turmoil and volatile commodity prices, growth in the first quarter of 2008–09, on an annualized basis, was 7.9%, one of the highest in the world. India’s remarkable economic expansion from an average of 5% in the 90s to close to 9% in the recent period has been led by a rise in private consumption, a rise in private investment and a surge in exports. Although the Indian economy is not fully decoupled from global developments, these engines of growth are still on track, and the recent moderation is only a cyclical down-turn.
To accelerate the growth momentum, India has to address several challenges. First, we need to raise the level of investment in infrastructure significantly. Evidently, this requires both domestic and international financing. We need to institute the necessary financial sector reforms to make this possible.
Second, we need to focus on creation of productive jobs. India, it is said, will have the advantage of demographic dividend, but we will get this dividend only if we can expand employment opportunities.
Third, we need to improve productivity and competitiveness. Towards this end, we need to raise the skill endowment across the board and raise the quality of service delivery, especially of education and health.
Finally, we need to move on vigorously with public finance reforms including fiscal consolidation. This has to include also, importantly, attention to the quality of public expenditure and outputs and outcomes.