Most importantly, in the mid-quarter review, there is a very candid observation, a recognition of the fact that postponement of unwinding of the US monetary policy is only a postponement. Governor Rajan has observed that there is a need for bullet-proof national balance sheet and growth agenda to inspire confidence in citizens and investors. There are two options available for such an agendaone, coordinated approach and the other, India follows it, singularly.
Earlier this month, Prime Minister Manmohan Singh observed at the G20 Summit that there was a need for a coordinated approach between the member countries to address the issue of unwinding of the unconventional monetary policy. He had proposed a coordinated approach between the advanced and the developing countries, especially the BRIC nations. India was affected by a surge of capital flows from the loose monetary policy in advanced countries which, in some ways, helped to finance its current account deficit (CAD). In the last two months, with rising expectations of unwinding in the US, India had been affected by currency volatility. The problem, at least partially, was domestic with the CAD rising to 4.8% of GDP and gross fiscal deficit (GFD) to 4.9% in FY13. And now India is making efforts to restrict CAD to 3.7% and gross fiscal deficit to 4.8% in FY14.
In 2008, when the financial crisis hit the global economy, the International Monetary Fund (IMF) under Dominique Strauss-Kahn initiated a coordinated approach which became explicit in October 2008 when six major central banks simultaneously cut policy rates and the Fed Reserve authorised temporary swap lines to 14 monetary authorities. The most important consideration behind the IMF initiative, probably, was that the US, the largest shareholder of the IMF, was at the epicentre of the crisis and such a measure was necessitated to preserve employment and growth in the US economy. That compulsion does not apply in the unwinding operationsprobably, the US and other advanced countries would not benefit from a coordinated approach now. Therefore, the US has not indicated any such urge, and the IMF has not initiated any such dialogue so far.
If India wants that the initiative be led by the IMF, then the PMs statement at G20 is strategic. India should strengthen its efforts for gathering support from a group of friendly emerging and developing economies, especially the BRICS, to raise the issue collectively at the forthcoming IMF-World Bank annual meetings scheduled to start on October 11, 2013. However, India should recognise that China may not be genuinely interested to stand by BRICS because Chinas interests are already intertwined with that of the US, given its financial investment in the US markets.
Moreover, there have been reports coming from the IMFfor nearly a month now thatChina is already designing its own policy adjustments to face the unwinding without appealing to any country or any multi-lateral institution. The only way left for countries like India and Brazil would be moral suasion but it may not succeed.
Therefore, India needs to prepare its own blue print to address the issue of unwinding of the unconventional monetary policy, capital flight from India and slowing growth rates. This would require a two pronged approachdomestically, maintaining fiscal space to use fiscal stimulus to stir and sustain growth if need be, and internationally, exploring expanded economic relations with countries from Africa and Latin America. The stalled reforms, which the PM had termed as difficult, need to be initiated to sustain global interest in India and help establish a macro-environment that is friendly to stable foreign flows.
Calibrating Indias response to the unwinding is going to be complicated because of the uncertainties associated with global recovery, domestic growth dynamics, and behaviour of financial markets within the country and rest of the world. There may be a need to sequence the difficult reforms in these difficult times of both, the domestic and the global economies. For now, the guide-post for policymakers could be the words of Rabindranath Tagore If they answer not to thy call, walk alone. In this context, Raghuram Rajans statement with the mid-quarter review seems very resolute.
The author is the RBI Chair professor at IIM-Bangalore