Roberto Rigobon, Society of Sloan Fellows Professor of Management and professor of applied economics at MIT Sloan School of Management, finds parallels in the present Indian economy and what happened in Brazil back in 1980s. He has seen these situations arising in various Latin American countries as well. He talks about what problems are ailing the Indian economy and offers his prescription for growth.
From the monetary point of view, should the central bank ease rates given the slow pace of growth?
India is in a difficult place. It has a relatively large fiscal deficit. It has a very large current account deficit, low growth rate and high inflation rate. However, this is not unique of India. If you look at the Latin American economies of 1980s, they were in a similar space. In these situations, central banks have little option and whatever they do is bad for the economy. If they lower the interest rates to produce a little bit of growth, then the current account becomes worse, fiscal deficit becomes worse and interest rates actually don’t fall. If they do the opposite—that is collect money to protect inflation—the interest rate increases and this may not be considered responsible. And that is why they do nothing. So how do you solve this? Well, the government starts what is called a fiscal adjustment programme. By correcting fiscal deficit and current account, it leaves room for the central bank to act.
If doing something on the fiscal side leads to lower growth, which means lower revenue and rising fiscal deficit, won’t it be a difficult choice for the government?
That is why this is called an adjustment programme and not let’s-have-a-party programme. Yes it is very costly and that is why very unlikely to happen in an election year. But one needs to realize that the situation in India is asking for that and there is little choice. Emerging markets need to act much faster than developed nations. The reason is that for developed nations, external finances are in good shape and everybody is ready to lend at lower interest rate. But that is not the case for emerging economies. And so you need to make the central bank relax and fiscal adjustment is required for that. This can be done by keeping interest rates low and do the adjustment so that the pain is not much. So the government and central bank need to work in a coordinated way.
Globally, everyone wants to devalue their currency. If money is printed, it will go somewhere—maybe emerging market stocks or bonds or anywhere. And since countries such as India have a large current account deficit and need money, is it good to collect cheap money like this?
No, this is not at all good. It may be cheap now, but will not be 30 years from now. The whole world is devaluing money but India is on the other side along with Brazil, Australia and Chile. However, India has several advantages. First, according to me, India has a large internal demand and so it can be used more to sustain the economy. Say by simplifying taxes on goods and services. This will help tremendously in the current environment. Because here taxes are not reduced but just simplified. This may actually lead to higher tax collection. Here the demand is stabilized by basing it on internal demand rather than external demand. Second, use cheap money only for FDI (foreign direct investment) and not for portfolio. Capital flows can fund current account and there are a few ways. It can enter as a loan to the government which is a no-no. Next can be a loan to the private sector as a portfolio investment. But this too is not good because it can leave anytime. But there is a third way. Allow FDI for building infrastructure, say a greenfield corridor. This is what was done in Latin America.
India does not have a robust method of collecting data. What are the options in this situation?
Countries having income levels like that of India do not spend much on statistical offices. So the poorer a country is, poorer is the quality of data and the only option you have to play by your guts, unfortunately. So I would say in such situations, countries should be conservative and go by the worst possible interpretation of the data.
What three things should India do to grow at a faster rate?
First would be to simplify taxes and regulations, and simplify to infinity. That will also help in eliminating corruption. Maybe flat taxes and eliminating permits will work. Second, India needs to change its mentality towards FDI. Foreign companies need to be allowed to enter as they will bring capital, infrastructure, technology and a lot of gains in terms of efficiency. The third is about macroeconomic stability. That means balance between the fiscal expenditures and taxes with the central bank, but this one is much harder to achieve. But even the first two will make a country gain a lot, and it can be done really faster.