Mumbai: Olivier Jean Blanchard, chief economist of the International Monetary Fund (IMF), is optimistic that the global economic scenario will turn around sometime in the second half of the year with an improvement in credit availability and increased spending. Blanchard says India is in a better position to tackle the crisis compared with the rest of the world because it has been exposed to shocks that are not of its own making. India is exposed to export, capital flow and credit shocks, but these shocks are of a lighter magnitude than those faced by some other economies because India’s export sector as well as dependence on foreign capital are much smaller, according to Blanchard.
Managing crisis: Blanchard says the worst is yet to come. Abhijit Bhatlekar / Mint
In an exclusive interview with Mint, his first to any Indian newspaper since he took over his current assignment in September, the 60-year-old Blanchard admitted that India has much less fiscal space than other countries, but said it can do more, particularly moving forward infrastructure projects. A higher fiscal deficit, he said, is acceptable at this stage if it clearly is going to be reduced in the future. With inflation dropping very quickly and economic growth slowing, Blanchard sees room for more interest rate cuts by the Reserve Bank of India (RBI). During his four-day familiarization trip to India, his first, Blanchard met officials of the Indian government and the central bank, made a presentation to the Planning Commission and had lunch with business leaders in Mumbai on Saturday. Edited excerpts:
Is the world economy in a recession or depression?
I think it’s a deep recession. I would like to use the word depression for something which is there for very long. My sense is that the situation is deep but hopefully not too long. There is still hope that next year there will be growth in advanced countries. If our estimate is correct, there are a lot of uncertainties and we may see a year-and-half of negative growth, depending on the country. That’s a deep recession—not a depression.
Listen to Tamal Bandyopadhyay’s conversation with IMF chief economist Olivier Jean Blanchard
How real is the threat of deflation at least in some part of the world?
In many countries, there’s going to be negative inflation for some time, but we think that’s not going to last. It becomes a danger when people start building it in their expectation of inflation. Frankly, when people start expecting deflation, it’s much harder to get rid of and it becomes a very big issue. We have seen this in Japan. We think there is going to be negative inflation for a while. Then, we are going to go back to some positive numbers, but prolonged deflation is something we want to avoid.
Do you see any sign of recovery? Is the worst over?
In terms of numbers, the first and the second quarter of this year will be the worst ones. We think things will turn around sometime in the second half of the year. Why do we believe this? Policy measures are being taken, and if they work, as we think they should, then they will improve the credit situation, bring confidence to people who will in turn increase spending. We think that the policy measures will turn around the situation. But we probably haven’t seen the worst of it. We are probably two quarters away from it.
Worldwide, governments are spending hugely on stimulus packages. What kind of impact do you see on the fiscal side?
We think what is happening in advanced countries is a sharp drop in demand due to a loss of confidence. While the origin of it is in the financial sector, the loss of confidence is adding to it. In this context, the right thing to do is try to prop up demand. Monetary policies in advanced countries don’t have a whole lot of room to play with. Interest rates are close to zero. So we thought that in the countries that could afford it, fiscal policies are tools to increase the demand now and will limit the effects on the financial systems. So, we advocated fiscal deficits in the short run. It’s very important not to run this fiscal deficit forever and avoid debt explosion. We also insist that if measures are to be taken, they should be temporary. They should be reversed and, if possible, they should come along with reforms to indicate that deficits will be under control in few years. These two things are very important. If you do the first and don’t do the second, then financial markets will be wary, rightly. And then you can see an increase in interest rates. So, what we gain through direct effects of spending, we lose in terms of interest rates and reduced spending. So, we advocate fiscal stimulus, not in all countries, but in the countries which can do it. But it must come with a credible re-entry plan.
How do you see the Indian scenario?
India is clearly a country which has much less fiscal space than other countries and, therefore, it cannot do very much. But I still think it can do some. The two fiscal packages are reasonable; if it could do more, it should do more. I was discussing in Delhi the possibility of moving forward infrastructure projects to the extent that they can be done. This is the type of measures that can be done without compromising the medium term, because what you are doing now is something that you would have done later. It doesn’t make the future worse and at the same time makes spending happen earlier. The issue is whether you can increase infrastructure spending quickly enough. My sense is if you can increase spending in the next two years, that’s the way to do it. Because, you are not going to return to full growth anytime soon. Even if the projects can start in 2010 that kind of measures are just right in this context.
Your take on the growing fiscal deficit?
Eventually, the fiscal deficit has to be reduced. At this stage, there is a fire that has to be fought and so the fiscal deficit is acceptable if it clearly is going to be reduced in future. Some of the measures that have been taken have to be undone later.
Is there any scope for bringing down the rates further?
Looking back, I think, what the (Indian) central bank has done—which is decreasing interest rates by 350 basis points —is a good thing. The central bank has also increased liquidity. These are good measures. (One basis point is one-hundredth of a percentage point.) Is there more to be done? I think there is more to be done because inflation is dropping very quickly and economic activities are slowing down. I think there is room for more interest rate cuts in future.
You have any number in mind?
I think it could go down fairly quickly. I think cuts of 50-100 basis points in the near future will be a reasonable step. I hope it’s done.
Do you advocate creation of a market stabilization fund by the government? Should it buy stocks at low levels to protect the market and in the process try to make money?
These are all emergency measures. I don’t think creating such a fund is a priority in India. Buying stocks is not something the government should be in the business of doing. There are exceptions to the rule. Hong Kong did it once and it worked for them. But in general I think it is a very dangerous measure to take.
How is the Indian situation different from what you see in the US and the UK?
I think it is very different. In the US and the UK, the banks have many bad assets. Many of them are obviously under-capitalised and some of them may be insolvent—even some of the big ones. We shall know more by looking at the balance sheets under the Geithner plan. (US treasury secretary Timothy Geithner, under the Barack Obama administration, called for a “consistent review of banks’ balance sheets” and urged tighter oversight and more accountability for pumping in $700 billion under the Troubled Asset Relief Program, or TARP, to bail out struggling banks.) That’s not true of India. Banks are still well-capitalized. They are not exposed to many of the bad assets as the US banks were. It doesn’t mean that all the assets are good but in general, the assets held by the Indian banking system are much better than they have in the US system.
One way of tackling the global liquidity problem could be to increase SDR (special drawing rights) allocations by IMF to various countries. Why aren’t you doing it?
Various countries have been protecting themselves by creating very large amount of reserves which is costly. One way of addressing the liquidity problem could be accessing some of the swap lines. But that’s not an ideal system as some countries don’t have the reserves and don’t have the swap lines. We think it would be much better for them to have a multilateral system in which countries could come and draw liquidity when there is capital outflow of the type that we have seen. We are working on creating a new window in the IMF which will provide liquidity, but to avail of that the countries will have to qualify by showing us that they have a responsible past. This will give you access to a line of credit. Whether some of them is through SDR or some other ways don’t matter much, but we hope to create a window in the future where countries which have liquidity need and are responsible come and borrow and repay later. When do we see this happening? We are doing the technical work within the institution. After this, there will be a decision by the shareholders of the IMF. We will go to the board sometimes in the next month or two months with a proposal and we hope they will endorse it.
Do you see a repositioning of the IMF against the background of the crisis?
It has been shown that institutions like the IMF can be useful. This being a global crisis, there’s a need for discussions, if not coordination, of policies. We are a very natural place to organise it and do it – coordination of reforms. We are also a good place to have discussions. The crisis has shown that somebody has to look at the world over time and make sure that there is no systemic risk being held there. But probably that has to be done by some global institution and we are probably in the best position to do it. The crisis has shown that there is a need for provision of drawing liquidity. That’s a natural role of the IMF.
Do you see a larger role for India in the global financial architecture?
India should have a large role the same way as China and other big countries that count in representing on the global scene. I think there’s a role in the future for India and China and other countries.
What is your overall assessment of the Indian situation?
You have been exposed to shocks which is not of your own doing. You have these export shocks which come from the advanced countries. You have been exposed to capital flow shocks and credit shocks which are again not of your own doing. The shocks are less large than some of the countries because your export sector is smaller and your dependence on foreign capital is smaller. I think you have been hit by shocks which are smaller than some of the other countries. In general, policies which have been followed— fiscal and monetary—are good ones.
You were fairly optimistic about the world economy in September. Are you still as optimistic as you were?
A lot of bad things have happened since then. It’s clear that I was too optimistic and I am still optimistic, in the sense that yes, I do think that this is not going to be a depression. We think to a large extent it is a crisis of confidence that can revert itself. We still think that next year we will see growth in advanced countries. In that sense, when some people predict that there will be a long depression, I don’t agree.