Suman Bery: Going for Broke

India and China need to support the liberal international order.

How the world changes! With the indulgence of the editor I took a month's break in October, to permit me to travel to Europe and the US. Returning to this column after a two-month absence, I find life has moved on in significant ways.

Two mega trends have been further confirmed in this time. These are the continued progress of the centre-left in virtually all parts of the world, and the increasingly severe leadership vacuum among the G-7 countries.

With respect to the first, a trend that perhaps began with the triumph of the Socialists in Spain (and of the UPA in India) has continued unchecked through much of Latin America (Chile, Bolivia, Brazil; Colombia is a significant exception) and showed its continued power in the Italian elections and the recent US mid-term elections. With regard to the second, Germany, Italy, France, the UK, Canada and the US are all at weak points in their political cycles. The surprising exception for a change is a reinvigorated Japan.

Yet the world economy booms as it hasn't since the 1960s, seemingly impervious to these storm-clouds. When one asks why, the increasingly common answer seems to be: the rise of India and China. China's rise has been an established fact for some time. What seems new is a growing international conviction that India has irrevocably joined the party, and can keep the party going for a while longer.

To those of us who actually live here, this seems a triumph of hope over experience. Indians are optimistic in their private lives, but have low expectations in the public sphere. The Prime Minister is perhaps correct when he says that the external constraints to India's growth have significantly eased. At the same time (as Bimal Jalan has repeatedly argued), domestic political and governance impediments seem so massive and pervasive that one is inclined to believe that, as ever, India flatters to deceive. It is only the truly bold, like my fellow columnist Surjit Bhalla, who are ready to assert that 10 per cent growth is here, and here to stay, irrespective of policy. NCAER's own medium-term forecast is more cautious, projecting an average GDP growth rate of 8.2 per cent for the Eleventh Plan period 2007-08 to 2011-12.

Clearly India is benefiting from a strong global economy while itself increasingly contributing to that strength. Those of us who are professional commentators are loath to admit it, but considerable credit is due both to this and earlier administrations for deft economic management.

Consider how many of the seemingly intractable problems of the last few years have silently melted away. Remember lazy banking? Now the problem is excessive credit growth. Remember the growth of small savings? Now depositors are flocking to the banks and small savings are shunned by states who once lapped them up. Remember jobless growth? Welcome skills shortage. Those hoary chestnuts, the fiscal deficit and public savings, are on the mend, largely because of a strong economy, though not as much as they should be. Even the delays in adjusting retail oil prices now seem less suicidal, in the light of the sharp pull-back in the price of crude.

Second, seeing the unbelievable mess in which China has ended up through the pursuit of mercantilist policies, I cannot agree with Surjit Bhalla when he argues that India should pursue sustained, deliberate undervaluation of the nominal exchange rate. Our exchange rate management has gradually become increasingly astute and has allowed us to manage both the oil shock and the surge in inward capital with finesse. Clearly much more needs to be done, including greater competition in banking and more rapid decontrol of the capital account, but as Deepak Lal (another Business Standard columnist) argued at a seminar on Chinese banking at NCAER, India's financial system is poised to be an asset in its growth while the Chinese banks and capital market are still in dire shape. This is despite the more welcoming attitude towards foreign investors in the Chinese case.

On my overseas trip I was surprised by how many questions I received about the potential shortage of lendable resources in the banks as a possible constraint. I have been even more surprised to see the same theme repeated in the pink press, particularly after the monetary policy review of end-October.

In a world with a closed capital account the money stock is a policy variable within the control of the monetary authorities (otherwise why do we need them). With an open capital account demand and supply equilibrate through capital movements""what is called the monetary theory of the balance of payments.

A cursory glance at the various excellent publications put out by the Reserve Bank of India (RBI) would make it clear that, in the name of sterilisation the RBI has been busy decumulating its holdings of government securities such that it has plenty of capacity to absorb more public debt on the secondary market. As for the banks, a gradual reduction in the statutory liquidity ratio (SLR) would give them plenty of additional lending power. The pressure on the government debt market could be relieved through further easing of the limits on foreign ownership of public debt. So for me credit shortage is not the issue, although a shortage of capital in the public sector banks could be more onerous.

If a credit crunch is not greatly to be feared, a much more serious concern going forward is the fragmentation of the international liberal political order, given the political developments mentioned above. The Prime Minister hinted as much in his speech commemorating the silver anniversary of ICRIER in New Delhi last week. There he urged greater discussion and understanding of India's role in international trade and financial governance. It is in this context that the coming visit of China's President Hu represents an important opportunity. From press reports one gets the impression that, while the industry lobbies are adamantly opposed to bilateral trade liberalisation with China, the Prime Minister in his infinite wisdom has been keeping the door open. Let us wish him luck in the discussions. A carefully prepared programme of mutual liberalisation could not only be a tonic for India, but could in time be instrumental in reversing the global protectionist tide.

The author is Director-General, National Council of Applied Economic Research. The views here are personal.