New Delhi: India’s chief economic adviser, Arvind Virmani, is one of the key members of the team driving economic policy in the government. Though a hot seat at the moment, given the sharp deterioration in the macroeconomic outlook, the job also provides the 59-year-old economist a bird’s-eye view of the Indian economy. On the eve of his departure for the Fall meetings of the International Monetary Fund and the World Bank in Washington, DC, Virmani spoke to Mint on the current prospects of the Indian economy, even while it braces for the second-round impact of the ongoing global financial crisis, as well as the immediate policy imperatives for the next Indian government. Edited excerpts:
We are seeing some macroeconomic changes that are under way, beginning from Monday’s Reserve Bank of India’s (RBI) policy response. It seems a piquant problem, fighting inflation or saving the rupee. What would you propose?
Two months ago, I said given the measures that have been taken and the management by the RBI, I expect inflation to come down to the 5-6% level within 12 months. When I was asked what happens to inflation this year, I had said I cannot say because there is large uncertainty on oil prices. But nobody was willing to go on record saying what would be the price of oil by December-end or any other month. But now the uncertainty is over for whatever reasons. I call it collateral benefit of global financial crisis. So, for the time being, oil prices have peaked around $147 (Rs7,056 today) per barrel. So one can say inflation would be down to single digit by (the) end of the fiscal year.
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You would recall our analysis that much of the inflation had come from global cost push. Two-thirds of this inflation in the first half of the year was due to three sets of commodities: edible oil, oilseeds; iron, steel and related products; and oil and refinery products. So, all these things now look good. There is a question that given this trend in oil prices, what would be the effect. I am very clear the oil price... will have a positive effect on balance of trade, on current account, on inflation and on growth. It was exactly the problem that was causing me great worry, (and) it is a problem that has been reversed. Therefore, this is a source of positive effect on the Indian economy.
But simultaneously, just like the collateral benefit of the oil price falling, the collateral damage is that liquidity is sucked out internationally, which is why the rupee is coming under pressure for the past few months. How to tackle this situation?
The major negative of the financial crisis is the equity drawdown is due to two reasons — the big increase in risk-aversion globally and the huge uncertainty from the crisis — which are basically prolonging the crisis in a sense as the uncertainty is not getting resolved. So clearly the collateral negative, so to say, of the global crisis in emerging markets is the investors of the countries that are affected by the global crisis are selling out equity in those countries, which are not necessarily affected — which are the emerging market economies — to gain this liquidity. That has clearly become the major negative effect as financial elements always appear first.
Ringside view: Arvind Virmani, chief economic adviser. Harikrishna Katragadda / Mint
What is the effect on the equity side is obvious, because people are selling equity and taking money out of the economy that has certain effects. It has a negative effect on the exchange rate. So that is the initial impact, but what is (the) final effect on the economy depends on policy response.
So given the circumstances, are the policy responses adequate or we need more of this?
Liquidity adjustment is what central banks do, that is really their job, (and) nobody should be second-guessing that. They have to do it to the best of their ability.
But the FDI (foreign direct investment) has been doing reasonably well. The growth in first quarter was higher than one is projecting for the year as a whole from the beginning. One can assume it would be more or less on track.
So when we evaluated BoP (balance of payments) earlier this year, we had anticipated that for the first half, FII (foreign institutional investment) inflows would be negative and they would reverse at some point and become positive for the year as a whole. But I have no doubt when the uncertainty is resolved, the FII flows will reverse. But much of this FII money is institutional, so it depends on their liquidity.
But isn’t a 3.6% current account deficit by the end of the first quarter disturbing?
Not at all. That is because of the oil price rise. The April-August growth rate of exports is 36%. What more can you expect? That is almost (the) first half of the year. Growth may slow down, but compare this: It is 20% for China over more or less the same period. So there is a clear and immediate effect of oil prices on the import side, which will start appearing from the September statistics. As far as exports to the US are concerned, this has been affected for the past 18 months. The oil producers or oil exporters have a surplus. That is not going to be affected until oil goes down to less than $80, because the average per barrel cost for India is $80.
The basic balance of payments has turned negative after quite a long time in the first quarter. Does not it indicate some kind of structural problem?
Not at all.
It is oil and commodity prices, particularly oil. Another fact I have been pointing out, the net exports, in analysing the past five years’ growth, looking at the medium-term scenario, average growth was 8.9% per annum. On the demand side, 60% of the increment in demand was from investment. But the net exports had a negative contribution, minus 14%. The only time they have had a positive contribution was in the five years preceding that. Because the oil price went down to $20 a barrel.
So, the basic balance is going to improve. Right now we are not seeing a slowdown even. On the basis of whatever evidence is available one can be very confident the balance is going to be good. I am confident the overall balance will turn out to be much better than anybody had anticipated.
What do you think is the single biggest risk to the Indian economy at this stage?
One thing I am unable to discuss — because it has to be put in Parliament — is the fiscal situation. As you know many people have been speculating.
So, is the overall growth projection on course?
I had said 8.25% earlier. I would now say 8% plus-minus is a safer projection given this uncertainty. It will affect those companies which were dependent on equity flows. This crisis doesn’t look like it is going to end in six months.
That means the real sector is getting affected.
I had also said next year I expect the economy to return to the long-term growth path, which, I said was 9%. It seems to me that as soon the new government comes to power, it must much more seriously now...we will have less flexibility given the global crisis may last for a year or more, to think more seriously about reform issues. I am saying that we have to look more seriously at other issues, which are not currently on the table.
It is very easy to fall into extremes. To say we will return automatically we don’t need to do anything. That is just not true. When I say we are going to return, I am assuming some level of reforms. Sometimes you can go the other way and say if we don’t do this reform the economy will tank. That is also not true. One has to find the right balance.
With major drivers of inflation, particularly oil, on the wane, is it time to relax monetary policy?
How will the RBI act? Well, it has acted to some extent (a reduction in cash reserve ratio on 6 October). You have to see now. I can’t discuss the RBI’s actions. There are certain implications of that. Till two months ago, I refused to say what will happen. Now, I am telling you. I expect inflation to be down to single digit by the end of this fiscal year. That has certain implications.
If we look back over the past six months, incrementally the finance ministry has been able to push reforms such as currency derivatives. You are able to move the blueprint for financial sector reforms forward incrementally?
There’s a general philosophical point there. This is once-in-a-generation type of crisis (global financial crisis). In that sense, certain amount of conservatism in the previous five years has also paid off. What that also means is we are in a much better position and once all this dust settles, we can actually move faster. It is once-in-a-generation crisis, it won’t happen in the next 20 years because every central bank is carefully going over the lessons. Of course, after 20, 30 years people will get careless.
You expect the growth rate to pick up next year...
You have a huge increase in (the) investment rate and saving rate; they may fluctuate, they are not going to reverse. There is a fundamental change in the Indian economy. That is the source of my confidence. We have to refocus on policy and institutional reforms.