Central bankers usually prefer to speak in riddles.
The role comes with the job: an outspoken central banker is an oxymoron. Their grey demeanour is a perfect contrast to the wild mood swings in the financial markets, which every now and then struggle to see through the fog of obfuscation that central bankers like to generate. Gone are the days when Montagu Norman of the Bank of England could write to his French counterpart, in 1931, in a letter that made its way into the newspapers: “Unless drastic measures are taken to save it, the capitalist system throughout the civilized world will be wrecked within a year.” His modern avatars speak in a more guarded manner in good times and bad.
So, it is strange that these same men have a definite talent for attention-grabbing phrases that soon enter everyday language. The financial markets and the media are quick to ignore the profusion of careful analysis and latch on to the one evocative phrase that they feel captures the essence of a central banker’s statement. Think of William McChesney Martin Jr (the job of a central bank is “to take away the punchbowl just as the party gets going”), Alan Greenspan (“irrational exuberance”, a phrase he borrowed from Robert Shiller) and Rakesh Mohan (“lazy banking”).
The most recent example is “green shoots”, a phrase used by US Federal Reserve chairman Ben Bernanke to describe some early and tentative signs that the global economy could be recovering from the steep fall it took after September. All you need to do is check the timeline on how frequently the phrase was searched on Google. There is a sharp spike in search traffic after January.
The green shoots phrase has since been chewed out of shape by those who think that what was till recently described as the worst global recession since the 1930s has quickly been defeated by six months of higher government spending and cheap money. They prefer to ignore the fact that American households have lost some $14 trillion of wealth because of the collapse in housing and equity prices; that Europe continues to be in free fall; that unemployment is climbing in most economies; or that large structural issues, such as low savings in the US and repressed consumption in China, have not yet been addressed.
The world economy seems to be stabilizing slowly, but there is little reason to jump to the conclusion that economic growth will soon rebound to its recent highs. It is in this context that another analogy by another central banker makes sense. “We are reaching the valley, but we have to walk through the valley,” Yves Mersch, European Central Bank governing council member and head of the Luxembourg central bank, told The Wall Street Journal on 8 June.
The question then is: How deep is the valley and how long will it take for us to trudge out of it?
In his first speech in the new Lok Sabha on 9 June, Prime Minister Manmohan Singh seemed to suggest that the valley is neither too deep nor too long, at least in the case of India. “… we can achieve a growth rate of 8-9% even if the world economy does not do well,” he said.
The interesting thing is that the Prime Minister quite rightly linked the potential growth rate to the fact that India has a high savings rate. While a host of preconditions need to be met for a country to move to and stay on a high-growth path, there is little doubt that high rates of savings and investments are one key factor in any growth story.
India currently saves around 35% of its gross domestic product, as Manmohan Singh pointed out in his speech. That is a good 10 percentage points more than what it was at the beginning of this decade. The sharp rise in the savings rate is one of the big reasons why growth accelerated after 2003.
But can the current savings rate be sustained? My guess is that the savings rate has already peaked and could actually decline in the next few years. That’s because the fiscal deficit has ballooned and corporate balance sheets have deteriorated. The rise in India’s savings rate in the current decade was because the government was saving more (or dissaving less) and corporate savings shot up during the economic boom. Both these trends seem to be reversing.
At around 7% a year, India’s growth rate in the previous fiscal year and its expected growth during this year are far higher than what most other countries will be able to manage. But it is still a good two percentage points below the recent peaks that were scaled before the economic crisis struck like a bolt of lightning.
Getting back to those old heights will require strong corporate savings and a lower fiscal deficit, especially the latter. In other words, the savings rate will be the key.
The Indian valley promises to be a relatively shallow one. But it is a valley nevertheless.
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