The recent lurches in the rupee have served to remind Indians of their economy's increased global integration. It also coincides with an apparent shift in the global recovery five years after the economic plunge of 2008, as emerging markets slow while growth in the advanced countries picks up.
Over the last decade, growth of world output (measured at purchasing power parity) has gone through three phases. The first, from 2003 to 2007, was the era of the global boom. This was driven by the build-up of excessive indebtedness by households and financial institutions as global real interest rates remained low. It was also driven by China's accession to the World Trade Organisation following a decade of intense internal reform. The advanced world grew steadily, but the emerging markets accelerated, which led to global growth rising from 3.7 per cent in 2003 to 5.4 per cent in 2007.
This was followed by the savage dip of 2008-09, when the advanced economies shrank, some dramatically (Japan by almost 10 per cent), and overall global growth stagnated. After a strong rebound in 2010, largely on account of co-ordinated stimulus in both the advanced and emerging markets, the global economy has gradually slowed. This has primarily been because of weak demand in the advanced countries, but also because of the need in emerging markets - India most of all, but also China - to deal with the inflationary consequences of their 2009 stimulus.
Since 2010 the advanced countries have primarily focused on stabilising their financial systems and to varying degrees have worked off excess indebtedness in their household sectors. They have, however, taken very different approaches to fiscal policy. In contrast to the United States, both the United Kingdom and the euro zone have given more immediate priority to fiscal consolidation. The euro zone has faced the additional technical and political challenge of repairing a damaged cross-border banking system still subject to national regulation and the additional constraint of operating within a monetary union.
Advanced country monetary policy has been notoriously loose in this period, but this has not so far resulted in credit bubbles: indeed, the problem in most advanced countries has been to get credit expansion going again. The main impact of quantitative easing in the advanced countries has, by design, been on asset markets, particularly bonds, and to a lesser extent on capital flows to the faster-growing emerging markets.
This second phase in the recovery, which has lasted about two and a half years, now seems to be ending. The major achievement of this phase has been the avoidance of deflation despite high unemployment. While there is now a widespread belief that monetary conditions are set to tighten, it bears noting that the only advanced country central bank that has so far signalled its intention to reduce expansion of its balance sheet is the US Federal Reserve. Both the Bank of England and the European Central Bank have signalled that they intend to maintain loose policies for a while yet, while the Bank of Japan, late to the party, has only just opened its innings.
This new phase in the global recovery carries risks, but should be welcomed by India. First, a return to trend growth in the advanced countries is good for India even if it results in some repatriation of short-term capital to their home markets and a generally firmer tone for global interest rates. Second, as the smoke has cleared on the exchange rate front, there has been a significant realignment in the cross rate between the rupee and the Chinese yuan. Using the back pages of The Economist magazine, one learns that over the past year the Indian rupee has moved from 8.75 to 10.9 per Chinese renminbi, a depreciation of approximately 25 per cent. As a supporter of flexible exchange rates, I do not believe that nominal exchange rates are the drivers of long-term trade success. But at this juncture, with slack demand in the manufacturing sector, a nominal depreciation could be helpful in stimulating production in the tradable goods sector - particularly when supported by the fiscal tightening currently underway.
Global developments could also help. I defer to the superior insight of my fellow columnist Shyam Saran in his recent comment on the Chinese economy ("China's flawed rebalancing", September 11, 2013, Business Standard). My personal judgement is that the new Chinese leadership is serious about addressing the considerable imbalances in its economy, arguably even more severe than those that currently assail India. As part of this rebalancing effort, Chinese wages are expected to continue rising. In 2011 Justin Lin, then the World Bank's chief economist, estimated that up to 85 million jobs could be up for relocation away from the Chinese coast, where costs are now too high to sustain low-cost manufacturing. Since global demand for these products remains strong, their production could either move inland in China or move offshore. These jobs are potentially available to India, provided the country manages to solve problems in its power and ports sectors.
Finally, while communication could certainly have been handled with greater finesse, I am personally not too discouraged by the way India has muddled its way through the recent rupee wobble, with market forces prevailing and limited expenditure of reserves. It is far too early to declare victory, particularly when a stormy political season lies ahead. Nor do we know the damage that slow growth and a depreciated exchange rate might yet wreak on our financial system. But increased exchange rate volatility is an unavoidable fact of today's system of global finance. Corporate risk officers, independent directors and bankers as well as the investment analyst community should now be more inclined to ask tough questions about foreign exchange exposure.
India has paid a significant price for its casual approach to fiscal control at the Centre. Hopefully, this is on the way to being fixed. And financial integration with the global economy will go more smoothly if India's inflation is no longer significantly above that of its emerging market peers. The next six months will be tough. Despite the jeremiads from overseas analysts, for now I am inclined to agree with the prime minister that India can, in time, return to the growth rates of the last decade.
The writer is chief economist at Shell international.
These views are his own
These views are his own
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
