Slow industrial country growth has made more difficult a traditional development path for emerging markets (EMs), of export-led growth...
Slow industrial country growth has made more difficult a traditional development path for emerging markets (EMs), of export-led growth. EMs have to rely once again on domestic demand, always a difficult task because of the temptation to overstimulate. That task has become more difficult because of the abundance of liquidity sloshing around the world as a result of ultra-accommodative monetary policies in industrial countries. Any signs of growth can attract foreign capital, and if not properly managed, these flows can precipitate a credit and asset-price boom and exchange rate overvaluation. When industrial country monetary policies are eventually tightened, some of the capital is likely to depart EM shores. Therefore, these economies have to take extreme care to ensure they are not vulnerable at that point.
What implications should an emerging economy like India, which has weathered the initial squalls of the “taper tantrums” of the summer of 2013, take away for its policies over the medium-term? I would focus on four: (1) Make in India; (2) Make for India; (3) Ensure transparency and stability of the economy; and (4) Work towards a more open and fair global system.
Make in India
The government has the commendable aim of making more in India. This means improving the efficiency of producing in India, whether of agricultural commodities, mining, manufacturing or services. To achieve this goal, it has to implement its ambitious plans on building infrastructure.
A second necessity is to improve human capital. This requires enhancing the quality and spread of healthcare, nutrition and sanitation to start with, and better and more appropriate education, training for skills valued in the labour markets, and jobs where firms have the incentive to invest more in their learning.
The woes of the small entrepreneur, as she confronts the regulatory maze, and the numerous inspectors who have the power of closing her down, are well-known. The petty bureaucrat, empowered by these regulations, can become a tyrant. It is appropriate the government intends to make him help business rather than hinder it. As regulators, we have to examine the costs and benefits of the regulations we impose.
Finally, we need make access to finance easier, something I have dwelt upon on earlier occasions. All that said, let me add some caveats.
There is a danger of assuming “Make in India” means a focus on manufacturing, an attempt to follow the export-led growth path that China followed. I don’t think such a specific focus is intended.
First, slow-growing industrial countries will be much less likely to be able to absorb a substantial additional amount of imports in the foreseeable future. Other EMs certainly could absorb more, and a regional focus for exports will pay off. But the world as a whole is unlikely to be able to accommodate another export-led China. Second, industrial countries have been improving capital-intensive flexible manufacturing, so much so that some manufacturing activity is being “re-shored”. EMs wanting to export manufacturing goods will have to contend with this. Third, when India pushes into manufacturing exports, it will have China to contend with. Export-led growth will not be as easy as it was for the Asian economies who took that path before us.
I am not advocating export pessimism. Instead, I am counselling against an export-led strategy that involves subsidising exporters with cheap inputs as well as an undervalued exchange rate, simply because it is unlikely to be as effective at this juncture. India is different from China, and developing at a different time, and we should be agnostic about what will work.
Broadly, such agnosticism means creating an environment where all sorts of enterprise can flourish, and then leaving entrepreneurs to choose what they want to do. Instead of subsidising inputs to specific industries because they are deemed important or labour-intensive—a strategy that has not paid off for us over the years—let us figure out the public goods each sector needs, and strive to provide them. SMEs might benefit much more from an agency that can certify product quality, or a platform to help them sell receivables, or a state portal that will create marketing websites for them, than from subsidised credit. Tourism industry will probably benefit more from visa-on-arrival and a strong transportation network than from the tax sops they usually demand.
A second possible misunderstanding is to see “Make in India” as a strategy of import substitution through tariff barriers. This strategy has not worked because it ended up reducing domestic competition, making producers inefficient, and increasing costs to consumers. Instead, “Make in India” will mean more openness, as we create an environment that enables our firms to compete with the rest of the world, and encourages foreign producers to create jobs in India.
Make for India
If external demand growth is likely to be muted, we have to produce for the internal market. We have to work on creating the strongest sustainable unified market we can by reducing the transactions costs of buying and selling throughout the country. Improvements in physical transportation network will help, but so will fewer, but more efficient and competitive intermediaries in the supply-chain. A well-designed GST Bill will have the important consequence of creating a truly national market.
Domestic demand has to be financed responsibly, as far as possible through domestic savings. Our banks have to learn from past mistakes in project evaluation and structuring. They have to improve their efficiency as they compete with new players such as the recently-licensed universal banks as well as the soon-to-be licensed payment banks and small finance banks. We should not make their task harder by creating impediments in the process of turning around, or recovering, stressed assets. RBI, the government, as well as the courts have considerable work to do here.
We have to work on spreading financial services to the excluded. New institutions and new products to seek out financial savings in every corner of the country will help halt the erosion in household savings rates, as will a low and stable inflation rate. Income tax benefits for an individual to save have been largely fixed in nominal terms till the recent budget, which means the real value of benefits has eroded. Some budgetary incentives for household savings could help ensure the country’s investment is largely financed from domestic savings.
Ensure transparency and stability of the economy
Even developed countries like Portugal and Spain have been singularly unable to manage domestic demand. Countries tend to overstimulate, with large fiscal deficits, large CADs, high credit and asset-price growth, only to see growth collapse as money gets tight. The few countries that have avoided such booms and busts typically have done so with sound policy frameworks.
As a country that does not belong to any power bloc, we do not ever want to be in a position where we need multilateral support. It will be more important to get our policy frameworks right.
A sound fiscal framework around a clear fiscal consolidation path is critical. The Dr Bimal Jalan Committee’s report will provide a game-plan for the former, while the government has indicated its intent to stick to the fiscal consolidation path laid out. Whether we need more institutions to ensure deficits stay within control and the quality of budgets is high, is something worth debating. A number of countries have independent budget offices/committees that opine on budgets. These offices are important in scoring budgetary estimates.
On the monetary side, a central bank focused primarily on keeping inflation low and stable will ensure the best conditions for growth. In reacting to developments, however, the central bank has to recognise that EMs are not as resilient as industrial economies. So the path of disinflation cannot be as steep as in an industrial economy. A “Volker” like disinflation was never on the cards in India, but an Urjit Patel glide path fits us well, ensuring moderate growth even while we disinflate. Going forward, we will discuss an appropriate timeline with the government in which the economy should move to the centre of the medium-term inflation band of 2-6%.
In addition to inflation, a central bank has to pay attention to financial stability. This is a secondary objective, but it may become central if the economy enters a low-inflation credit and asset-price boom. Financial stability sometimes means regulators, including the central bank, have to go against popular sentiment. The role of regulators is not to boost the Sensex but to ensure that the underlying fundamentals of the economy and its financial system are sound enough for sustainable growth. Any positive consequences to the Sensex are welcome but are only a collateral benefit, not the objective.
Finally, India will, for the foreseeable future, run a CAD, which means we will need net foreign financing. The best form of financing is long-term equity, i.e. FDI, which has the additional benefit of bringing in new technologies and methods. While we should not be railroaded into compromising India’s interest to attract FDI, we should ensure policies are transparent and redress quick. This means a transparent and quick legal process to deal with contractual disputes, and a proper system of bankruptcy to deal with distress. Both are issues the government has taken on.
Work towards a more open and fair global system
As a country that doesn’t export vital natural resources but is dependent on substantial commodity imports, India needs an open, competitive and vibrant system of international trade and finance. Our energy security lies not in owning oil assets in remote, fragile countries but in ensuring the global oil market works well and is not disrupted. We need strong independent multilateral institutions that can be impartial arbiters facilitating international economic transactions.
Unfortunately, the international monetary system is still dominated by the frameworks put in place in the past by industrial countries, and its governance is still dominated by their citizens. To be fair, it is changing, albeit slowly. But there is a more immediate reason for faster change. With slow growth, as well as the need to finance large debt loads, the interest of industrial countries in an open global system cannot be taken for granted. We have to recognise that slow growth may direct industrial economy policymakers’ attention inwards, even while politics turns protectionist. The existing multilateral governance system may not provide a sufficient defence of openness.
EMs may, therefore, have the responsibility of keeping the global economy open. For this, not only do they have to work on quota and management reforms in the multilateral institutions, but they also have to work on injecting new global thinking and agendas. It will not suffice for India to simply object to industrial country proposals; it will have to put some of its own on the table. This means our research departments, universities and think tanks have to develop ideas that they can feed to India’s representatives in international meetings.
Edited excerpts of the talk delivered by Raghuram Rajan, RBI Governor, at the Bharat Ram Memorial Lecture on Friday, in New Delhi