New Delhi:Guillermo A. Calvo, professor of economics, and international and public affairs at Columbia University, cautions India against high reliance on fiscal policy to tide over the economic downturn. In an interview, Calvo—described as “one of the most influential macroeconomists” of the last 30 years by the International Monetary Fund (IMF)—also says this may not be the right time for India to push aggressive financial sector reforms. Edited excerpts:
What are your broad views on the current financial and economic crisis?
First and foremost, we have a crisis associated with distraction of liquidity. We are dealing with a situation where we have these shadow banks which went bankrupt. And what the central banks have been trying to do is to replenish that liquidity. The problem is the central banks do not have the responsibility of doing that. They are essentially the lenders of last resort to the regular banks. But beyond that, they don’t have the authority (to provide liquidity support), although they have done some. So what we have done is like giving the patient a tranquillizer, we are not curing (thepatient).
Cautious note: Calvo says he would encourage Indian policymakers to continue discussing reforms in a very active way. But they need to wait until the global financial system normalizes, he says. Ramesh Pathania / Mint
So you are not happy about the way developed nations have handled the situation.
No, no. They have done a lot, given their limitations. What this has indicated is that looking forward, we need an institution that is capable of sustaining a globalized economy. We have institutions which are good for individual countries. We have central banks, we have supervision, but there was very little coordination across countries. That was the fault.
You have been advocating a global lender of last resort. Do you think IMF is ready for this job in its present form?
It is moving in that direction but is still very far away. First of all, you have to come to a global agreement. IMF does not operate as a lender of last resort. I have been talking about that as an idea. IMF needs to be given more authority, more funding, more freedom, but you also must give the fund the authority to supervise.
You have preferred increasing credit to the private sector over fiscal stimulus. Why do you think fiscal stimulus is not such a good idea?
Going back to what I said, it is a liquidity problem. You do not necessarily solve liquidity problem by spending more. You spend more when people are not willing to lend more to the private sector. Here, you are replacing the private sector. Would it not be better to give the private sector the resources through credit?
But the financial crisis was followed by an economic crisis characterized by contraction in consumer demand. Don’t you think governments were right to spend more to stimulate demand and only providing more liquidity to companies may not be sufficient?
It is likely not to be sufficient. But the fiscal stimulus could be ineffective in the first place, because all I am doing is spending on what people wanted to spend before the crisis. So they are likely to spend less, because now you are providing the services. So there could be crowding out of the private sector.
Secondly, you don’t usually spend on the same things that the consumers do, so how efficient could the government spending be? Thirdly, in the case of India, the government has already a very high debt to GDP (gross domestic product) ratio. So even if one accepts the fiscal stimulus in the short run, that could not be a policy that the government would be able to sustain in the medium term, because then other problems will start showing up.
I am not against fiscal stimulus, but I am afraid many of us (economists) who favour such a solution remember the simple multiplier model, which is very misleading. It was a simplification by (economist John Maynard) Keynes to make a point. In the first place, Keynes was thinking of a situation where there is excess capacity. But if you have a shock by the credit market or, in the case of India, a contraction in exports, that’s a real shock. You cannot offset that by spending more.
But how will providing more liquidity to companies solve that problem?
It’s not simply liquidity. What some people have suggested is nationalize the banks, make them work and then sell them back to the private sector. Like what they have done in Sweden and Chile very successfully.
Initially it was thought that the developed world would lead a recovery in the emerging economies, but now it seems Asian economies such as China and India are recovering before the OECD (Organization for Economic Cooperation and Development) countries. Does that mean the decoupling theory has some weight?
Only partially. I think there has been some kind of recovery. But I find it hard to imagine a world where China and India could grow at rates they did before the crisis with a stagnant US economy.
What are the takeaways for countries such as India and China from this crisis?
I think the big risk here is to think that by fiscal policy you can solve all the bad things that have happened. You may alleviate the impact. I am not an India expert, but the policy followed by the central bank is commendable. So I would say continue with the very sensible monetary policy that the central bank is conducting and be very wary about trying to use fiscal policy. I keep saying that because the message from Washington is spend, spend, spend. But once the crisis would be over, they will come back to India and say, “Oh, you have such high debts.”
Even now people have started screaming at the top of their voice about the Indian government’s fiscal deficit. Do you think it is alarmingly high?
Given the level of debt, that is bad enough. Really, you cannot sustain those levels of deficit. You already have a current account deficit. Higher fiscal deficit means widening of current account deficit.
In order not to generate a crowding-out effect in other parts of the economy, the central bank would be under pressure to draw down from its international reserves. It makes sense in general to provide fiscal stimulus to prevent output from falling very sharply rather than to increase output.
Should India now be cautious in going ahead with financial sector reforms after the crisis? There are proposals pending to allow more foreign investment in banking, insurance and pension sectors. Should India go ahead with those at this moment?
No, this is not the right time. The idea earlier was to anchor your financial system to the global system. Now we don’t have a global system. There are very serious complications. You can become much more vulnerable to capital flight. It is very risky. I don’t want to delay reforms, I would encourage policymakers to continue discussing this in a very active way. But they need to wait until the global financial system normalizes, so that you know what you are anchoring to.