The governor of the Bank of Israel since May 2005, Stanley Fischer has been one of the most influential policymakers and economists, as vice-chairman of Citigroup Inc., first deputy managing director of the International Monetary Fund, chief economist of the World Bank, and head of the department of economics at the Massachusetts Institute of Technology. In India on an invite from the Reserve Bank of India, Fischer spoke to Mint on the likely impact of the subprime crisis on the global economy, growth, capital flows and “of course, the perennial problem of the exchange rate”. Edited excerpts:
In 2004, speaking of the “period of extraordinary stability”, you said “many a trader wishes the world were a little more volatile”. That has come to pass.
It was an extraordinary period of four-five years and lasted longer than expected. The Indian take-off has been gradual. The rate at which it has taken off now is phenomenal. I think we’ll date it to this period. We also had phenomenal growth all over the world, including Latin America and Africa, especially regions that had been left behind. We hope we can go over this period of relative instability very quickly and we can go back to this nice period of sustained growth.
So, how deep will be the impact of the US subprime crisis on the world and India? Will the stimulus package be enough?
There is no question that it’s having an impact in the US. The actions of the Fed (the US Federal Reserve) were a result of a series of negative numbers, so it was clear that at a minimum there would be a significant slowdown, probably happening already, certainly in the first quarter. How much farther it would go is not clear. But it is hard to believe that it won’t have an impact on the rest of the world, in terms of the exports from other countries which will also affect their domestic growth. We won’t have decoupling in the sense that what happens in Asia is independent of what happens in the US. But we will have decoupling in the sense that Asia will grow at somewhat lower rates than it would have grown had the US continued to flourish. But this will have an impact on everyone, I am pretty sure.
Influential policymaker: Stanley Fischer, governor of the Bank of Israel. (Photo: Sanjay Sharma/Mint)
(US President George W. Bush’s) package is about 1% of the GDP which will have an impact on growth. The big issue about the US economy is the link between the short run and the long run. The short run needs stimulus while the long run needs tightening. If the stimulus comes entirely without dealing with any action or commitment for dealing with the long run, it’s not going to be easy. The dream package is one that gives a stimulus now but also...reaches an agreement on the future burgeoning of the fiscal deficit.
Where and how will investments flow, now that the financial sector is hit?
Financial sector is hit but a lot of capital is flowing into it, so it may recover relatively quickly. Investment is now going into hi-tech sectors. A lot of it is going to fairly traditional sectors where one sees potential, as in automobiles in India, which is very promising. Even in Israel, which is known as a hi-tech centre, the biggest investments have come in the traditional manufacturing sector of machine tools. Basically, people want to buy into China, India. Financial investments of course are another matter, they could slow down. It would be no doubt helpful to your monetary policy if they would.
So, capital flows into India will continue to bug the exchange rate?
In Israel, which is now facing a massive appreciation, we talk more about the weakness of the dollar and not the strength of the sheqel. And a large part of that would be true of India too. We (the two currencies) move largely closely, too. So what we are seeing is a worldwide strengthening of currencies against the dollar. Everybody who speaks English has strengthened, except the British. In addition, you have begun to grow so fast, you are an attraction for foreign investment, so you’re dealing with two phenomena here.
Do you see India’s economic growth continuing or are there structural constraints yet?
There is a set of reforms that still has to be done. The optimistic view is, given that you’ve been able to grow so rapidly without having done so means there’s a lot more growth in the pipeline. The other is that if we don’t deal with these issues, we’ll hit a brick wall. I’m more impressed by the flexibility of your economy despite all its many complications than by the capacity to hit brick walls.
Is there any special sector for policymakers to focus on, something that’s neglected?
Let me put it this way. Let me talk about the Israeli economy. We’re having now another committee for financial sector reforms. But if you look at international competitive reports, they focus more on problems of excessive bureaucracy. So my inclination now is to look what these reports say about us than to focus on what’s convenient to deal with. Financial sector reforms is easy, you tell the banks what to do. Fixing a bureaucracy is more difficult because you have to deal with your own problems.
The fact that India is a democracy means you can’t do things the way they’ve been done in, say, China. And it also lends a stability to your system that is lacking in other countries. One knows in India if things don’t go well, the political system will react, and governments may change.
So what are the major differences between the Israeli and Indian economies?
We’re very small compared to you. But neither society is enthusiastic about inflation, we’re both integrating into the global world, our businessmen are also turning out to be good like yours. But you’re gigantic, you can develop through your domestic market; we have no hope unless we integrate and globalize.
We also have much higher inflation...
It’s good that we’ve gotten used to lower inflation. There are no easy choices here. You can’t have low inflation rate, high growth and low interest rates all at the same time. The policy of flexible inflation targeting rate has worked well for us. But you don’t have that. You have been intervening very heavily, still you have an appreciation. So you have to decide if you have to intervene probably on a Chinese scale; then it becomes expensive and complicated.
How will the slowdown impact global commodity prices?
Reduced demand will reduce the rate of growth of food prices. Oil prices will possibly go down. But wealthy Asia is moving from eating grains to eating meat. We must remember that the relative prices of agricultural goods went down in the US over a very long period. We also have to consider agricultural innovations.
How does the next two years look for the global economy in terms of growth and equality?
This looks like a year of growth slowdown for everybody though Asia is where the growth is going to be focused. I don’t see this (the subprime crisis) as a fundamental challenge to the open global economy, more as a fundamental challenge to financial regulators and central bankers. I hope we’ll go back to what we were two years ago.
Inequality has been rising, but the number of poor in absolute terms has been declining. The former is undesirable, but less devastating than the latter. An Israeli economist had said, if we want to reduce social gaps, we should close down the hi-tech sector. That’s where the income rise has been the maximum. But we won’t do it because that is where the dynamism of the economy comes from.