Suman Bery: The challenge of July

History is never easily judged properly at close range, but it is arguable that, when the economic and political history of our era is written, July 2005 will be seen as a moment when the tectonic plates of north-south relations moved decisively.

Two events mark this shift: the reception Prime Minister Manmohan Singh received on his recent visit to Washington, and the decision by China to break the fixed exchange rate between its currency, the yuan (or renminbi as it is also called), and the dollar.

Both events, in their own ways, were markers of the re-emergence of the two Asian giants onto the world stage, progress on a journey that will last for much of this century. This emerging role carries opportunities, risks, and responsibilities, both diplomatic and economic.

The opportunities are demonstrated by the nuclear deal with India agreed to by the United States. This deal would not have occurred without India's past economic success and the prospect of even more growth in the Indian market over the foreseeable future.

In turn, by securing access to the best civilian nuclear technology, the agreement, if implemented, should help to ease the energy constraint on that growth and to diversify our energy resources.

These expanded opportunities carry both risks and responsibilities. I do not believe our public discourse has been adequately prepared for these. India will be thrust into roles beyond those expected of other countries at similar income levels, simply because of its size.

One example is the role India is expected to play in the current Doha round of trade negotiations. In the eyes of many members India is a central figure in this round, and is expected to provide leadership. Such leadership involves negotiating widened, multilateral access to other markets in exchange for expanded access to its own, including in agriculture.

While India's position has certainly matured since the round was launched (including through its participation in the G-20), our official position clings to the need for special and differential treatment. This is the notion that, by virtue of being poor, we can expect widened market access without giving anything in return.

I am reminded of an advertisement for training in negotiation skills in the US, which blared: "You don't get what you deserve, you get what you negotiate!"

Another, rather different set of responsibilities was articulated in a lecture delivered in New Delhi, also in July, by John Williamson of the Institute for International Economics in Washington D.C. The lecture was given under the auspices of the India Policy Forum sponsored by the NCAER and the Brookings Institution of Washington D.C.

Entitled "What Follows the USA as the World's Growth Engine?" the lecture pointed out the enormous contribution made by the US to demand outside its own borders in the period 1997-2004 (see Table). This is, of course, the mirror image of a phenomenon that is often remarked on negatively, which is the redirection of global savings to the US economy over the same period.

The largest economy in the world, the United States, has met approximately 20 per cent of its increase in domestic demand through running current account deficits over the last seven years.

The domestic counterpart of this phenomenon has been a collapse in household savings in the US, together with some recent deterioration in the US fiscal position. But the net effect has been to keep the world economy humming despite a series of emerging market crises, and the travails of Japan and Europe.

American demand, largely reflecting growth-oriented policies of both the Democrats and the Republicans over the various stages of the business cycle, has been a source of net stimulus to all regions of the world save Europe. The impact on both Japan and Latin America is particularly striking. By contrast, both China and India have shared in this party less than might be expected.

Like all good things, this American expansion must, sooner or later, come to an end. Williamson did not believe that a US current account deficit of this magnitude could be sustained for another seven years.

America's medium-term adjustment will require compensating adjustments elsewhere in the global economy if the world is not to suffer recession. The issue is who can replace the US as an expansive source of cross-border demand.

Candidate countries (and regions) must satisfy two criteria: they must be able and willing to stimulate domestic demand, and they must have a relatively strong external position. While Europe and Japan are the logical candidates by virtue of their relative size and their creditworthiness, both areas will continue to have difficulty in expanding domestic demand in the future. The rapid ageing of both regions, in particular, creates an imperative for increasing saving rather than consumption.

By elimination, therefore, Williamson targets East Asia (of which he considers India to be an honorary member) to be the candidate of choice to pick up the slack as the US draws back. Here the key player is clearly China, but India's role could also be useful.

What is needed is for the policy mix to generate moderate account deficits rather than surpluses. In turn this will entail real exchange rate appreciation, brought about by some combination of looser fiscal and monetary policy.

What specifically does this diagnosis imply for India? Our policy mix since the Asian crisis of 1997 has been driven by the desire to bullet-proof India against a similar financial crisis here.

Given the weakness of the international machinery for supporting developing countries in crisis (noted by Dr Bimal Jalan at the lecture), we have chosen to self-insure by accumulating reserves. This policy has been further reinforced by the link between the yuan and the dollar and the weakening of the dollar against other major currencies.

In these columns and elsewhere, I have argued we should accept some exchange rate appreciation as a way of increasing competition in the economy, and perhaps even stimulating investment (by reducing the domestic cost of imported capital goods).

Since our fiscal position is parlous, this implies easing monetary policy. It is noteworthy that, contrary to market expectations but following close upon the Chinese move on the yuan, the RBI chose to leave interest rates unchanged. This was the correct thing to do.

At Indian independence, and for the decade thereafter India was an important voice in the conduct of international economic affairs. Since then we have lost both the confidence and the stature to be more than a bit-player. The developments of the past month suggest that the world once again is prepared to accord us an important role. Let us hope we are up to the challenge.