With the US shutdown threatening to become a full-blown debt crisis, and with EMEs reeling from poor growth in the face of bad policies, the global economy remains uncertain. In this context, the recently released IMF Global Economic Outlook is justifiably cautionary. Ira Dugal, in an e-mail interview, gets IMF MD Christine Lagarde?s take on what lies ahead for the world economy,and India, in particular.
What is your broad assessment of the global economy at the current juncture?
While the global outlook remains subdued, we are beginning to see signs of recovery especially in some of the advanced economies. Clearly, however, more needs to be done to support stronger growth, create jobs, and reduce debt.
The Great Recession we have been through is evolving a Great Transition, by which I mean the two big transitions that are taking place: in the patterns of economic growth, and towards a different kind of financial sector. In our increasingly interconnected world, this process needs to be well-managed with appropriate policies and with international cooperation. It is a transition that will be with us for some time.
Are developed economies strong enough to withstand a withdrawal of the monetary stimulus provided in the post-crisis years, and is it your recommendation that this withdrawal come in small doses?
As I said, the situation in advanced economies is gradually improving. We are finally seeing signs of hope in these regions. Growth is looking up, financial stability is returning, and fiscal accounts are looking healthier. But to keep this momentum going, these countries have to adopt credible medium-term fiscal plans, repair and reform their financial sectors, and maintain monetary policy support.
On the last point, we think that the unconventional monetary policies that have been implemented over the past years in particular by the US, UK, Europe, and Japan, have helped greatly to put the global economy back on the road to recovery. There has to be a transition back to more conventional policies over time. As we have said consistently, it will be important that this happens in an orderly way, linked to the pace of recovery and employment, and communicated clearly and in dialogue with others.
Will emerging economies see collateral damage from the withdrawal of this stimulus in the form of pressure on currency and capital markets which could also spill over into the real economy in these countries?
The growth momentum in emerging market countries, which in large part helped keep the global economy afloat during the crisis, is slowing. China and some other emerging market countries are coming off the peaks in their current growth cycles and, in some countries, potential growth has been held back by circumstances that constrain the supply-side. In addition, the spillover from the anticipated reining in of quantitative easing in the US has played into weaker growth prospects, leading to capital outflows, tightening of financial conditions, and currency depreciations.
In this scenario, the key challenge for emerging market countries is to achieve a smooth landing in the short-term and ensure sustainable growth over the medium-term through appropriate policy action. Of course, there is no one-size-fits-all. Countries will have to target their policies to their individual circumstances, while also taking their economic environment into consideration.
Are countries with wide current account deficits particularly vulnerable? At a more theoretical level, what is the view on an appropriate range for the current account deficit for emerging economies? Some in India argue that with capital likely to move back towards developed economies, emerging economies like India should target a near-zero current account deficit. Would you agree?
Current account deficits are not all bad for all countries at all times. In fact, developing countries are expected to run current account deficits, or in other words, invest more than save in order to speed up their development. In many cases, this deficit will be financed by private capital inflows, which can bring substantial benefits, but also carry risks. Weak policies and institutions can magnify these risks.
What really matters is that countries have credible and coherent policy frameworks in place, including adequate financial oversight. The IMF has considerable expertise in these areas and is ready to help our member countries particularly during this period of global rebalancing when monetary policy in advanced countries is gradually being normalised.
In the aftermath of the crisis, the IMF became less opposed to the issue of capital controls by emerging economies. That view was in the context of a surge in inflows. In the reverse scenario, of a possible surge in outflows, how do you view the issue of capital controls?
Rapid capital inflow surges or disruptive outflows can certainly create policy challenges. That?s why it is important that both recipient countries and countries from which flows originate employ appropriate policy responses. And in certain circumstances, capital flow management measures can be useful, but they should not substitute for needed economic policy adjustment.
Policymakers in all countries, including countries that generate large capital flows, should take into account how their policies may affect global economic and financial stability. We believe cross-border coordination of policies can help mitigate the riskiness of capital flows.
What is your view on India? There has been considerable concern over India?s external vulnerabilities?current account deficit, level of reserves and also the excessive foreign currency debt on the books of Indian corporates. Is that worrying to you?
Indeed, some emerging markets have been impacted by recent global market developments, which brought to the fore the domestic risks in many of these countries. India is one of those countries. India?s current account deficit reached its current high levels mainly as a result of several factors, including higher oil prices, a jump in gold imports, and slower export growth?which was partly due to lower external demand. The measures the authorities recently took and the depreciation of the rupee should help lower the current account deficit over the medium term. India has a healthy level of international reserves, and external debt as a share of GDP is relatively low at about 20%. And while Indian corporates? foreign-currency debt has certainly grown in recent years, they are well able to service that debt.
From a growth-inflation standpoint, do you see the current environment in India as a stagflation-like scenario?
Although Indian growth has clearly decelerated, inflation is elevated above historical averages and Reserve Bank of India?s comfort zone. This indicates that there is limited slack in the economy. To moderate inflation and reduce external vulnerabilities, monetary policy will need to maintain its current tight stance. Clearly, low and stable inflation is the best way for monetary policy to support growth over the medium-term, and monetary policy should be calibrated accordingly while balancing the dynamics between growth, inflation, and the exchange rate.
There has been some talk that India needs to secure a line of credit from the IMF. What is your view?
The Indian authorities have not approached us regarding support. As you know, we undertake a regular annual health check of all our member countries? economies, including India. The most recent report for India was published last February. In addition, Fund staff is in regular contact with the authorities and continuously monitoring and assessing economic developments.
What do you think are the biggest risks for India and what does the IMF feel needs to be done in the near term to tackle some of India?s economic problems?
As I mentioned earlier, measures undertaken by the Indian authorities in recent weeks are helpful. They can provide some space for the government to implement much-needed structural measures such as addressing delayed infrastructure projects, issues in the power and mining sectors, energy and food subsidies reforms, and further steps to underpin fiscal consolidation. It is encouraging that the government has started to tackle some of these important issues, in particular, recently passing the land acquisition bill and the pension bill.
Back to the global economy, what to your mind are the biggest risks right now? Have the risks emerging from a possible steep slowdown in China eased?
China?s growth has moderated, but is still very strong compared to most other countries in the world. In fact, the economy has regained momentum in recent months, in part because of improvements in the outlook for advanced economies and various policy measures.
Globally, some new downside risks have come to the fore, while old risks largely persist. I have already mentioned concerns about emerging market economies, but risks also emanate from near-term US fiscal policy. In advanced economies in general, the absence of medium-term adjustment plans and entitlement reforms keep fiscal risks at high levels. Our main worry is a prolonged period of sluggish global growth.
What about the political stalemate in the United States regarding the debt ceiling and the budget? Will this have an impact on the global economy?
The ongoing political uncertainty over the budget and the debt ceiling does not help. The government shutdown is bad enough, but failure to raise the debt ceiling would be far worse, and could very seriously damage not only the US economy, but the entire global economy. As I have said, it is ?mission-critical? that this be resolved as soon as possible.