My recent visit to New Delhi coincided with the annual NCAER-Brookings India Policy Forum conference, now in its ninth year. In addition to the usual working sessions, the conference each year features a public lecture before an invited audience. This year the speaker was Dr Y V Reddy, formerly governor of the Reserve Bank of India and now at the University of Hyderabad. His topic was “India: New Strategies for Economic Development”.
His remarks were wide-ranging and his line of argument dense and closely reasoned. Unfortunately no prepared text was circulated, so what I will cover here is based on personal notes and recollection. I apologise if I have missed important nuances. What he had to say was of sufficient current importance that I would encourage NCAER to publish quickly an approved summary of both his remarks and the very illuminating questions and responses that followed.
Dr Reddy’s broad argument was that the shift in global economic power and the crisis in global finance implied both greater volatility and lower net availability of external finance for the foreseeable future. This was taking place at a time when many macro indicators for the Indian economy were flashing amber if not red: inflation, the current account deficit and public debt and the fiscal deficit.
India was accordingly exposed and vulnerable in a hostile global environment. India’s already fragile domestic politics could be stressed to breaking point if it were to suffer the kind of speculative attack that had felled Latin America in the 1980s, its Asian peers 15 years ago or peripheral Europe today. In order to bulletproof the economy it was therefore necessary to rethink the macroeconomic “rules of the road” that had guided India over the last 20 years, and also to re-examine the drivers of growth on the supply side of the economy.
Dr Reddy made three bold and controversial proposals. First, he urged Indian policy makers to moderate their growth ambitions, and put aside fantasies of a return to GDP growth of 9 per cent. In this regard he cited I G Patel (whose collected papers he had recently edited) who early in the previous decade had urged Indian policymakers to calibrate their ambitions to the political and social circumstances of India. Second, he urged that Indian macro policy henceforth target an average current account deficit of zero per cent of GDP over the business cycle, rather than the rough guide of 2.5 per cent which has been considered “safe” since the work of the Rangarajan committee in the early 1990s, with which Dr Reddy had been associated as member-secretary. Third, to achieve and to complement this current account goal, Dr Reddy urged that the government henceforth target an average revenue deficit of zero over the cycle as its de facto fiscal rule.
If Dr Reddy is indeed appointed chair of the Fourteenth Finance Commission, as has been recently trailed in this newspaper, it is likely that these rather severe views will find expression in the work of that body. In contrast to this forceful expression of the normative framework for fiscal policy, I do not recall his articulating any equally emphatic doctrine for monetary policy. His main lament was that in recent years Indian inflation had moved from being on average below that of other emerging markets to on average being at the top of the heap. Unkind observers might argue that this is what happens when a central bank is given unlimited discretion and is not bound by a formal commitment to the government or to Parliament. We know that both Dr Reddy and his successor have spurned inflation targeting as inappropriate for India, including its less formal version, the “low inflation goal” proposed by the Raghuram Rajan committee’s report on the financial sector. The lack of an explicit nominal anchor may also have complicated the Reserve Bank’s efforts to guide the exchange rate in an orderly way in recent weeks.
In many ways the greater and more interesting part of Dr Reddy’s address had to do with the supply side of the economy. Space does not permit me here to go into his many specific proposals, but there were two broad themes that ran through his talk. The first was that sustainable, long-term growth was fundamentally about growth in productivity. The goal of policy should be to use competition and liberalisation to generate economic actors able to succeed in a global economy where increasingly India’s emerging market peers, notably China, will dominate as both markets and as suppliers. Policies had to be market-friendly, not necessarily business-friendly. Second, he pleaded for much greater fiscal decentralisation, arguing that the present structure of fiscal federalism was failing to deliver critical public goods. He noted ironically that under the cloak of Centrally-sponsored schemes the largest ministries in the Union government were in areas reserved for the states under the constitution. Among other inefficiencies, this impeded valuable experimentation in the states on alternative delivery mechanisms in social and economic infrastructure.
Given Dr Reddy’s experience as an economic administrator in both domestic and international spheres and the rigour and clarity of his thought, I found myself in agreement with much of what he had to say. I was particularly pleased by his concurrence (in a question put by me to him) that Indian industry must seize the opportunity represented by a fast-growing Chinese domestic market rather than retreat into the comfort of an inefficient fortress India.
On his proposed fiscal rule my quibble is a minor one: where sovereign debt is an issue, it is more sensible to target the primary deficit than the revenue deficit. I would also have liked him to take a more forceful position on the appropriation of revenues from asset sales into current revenues. Where I was least convinced and comfortable was in accepting that India should curb its growth ambitions, largely to reduce its dependence on foreign financing. Like the proverbial bicycle, I would argue that India’s stability and attractiveness would be enhanced, not retarded by going for growth, and that success would bring its own financing. Despite the travails in the world economy, this is not the time to lose our nerve.
The writer is Chief Economist, Shell. These views are personal
