New Delhi: Before taking up his assignment as executive director on the board of the International Monetary Fund (IMF), Arvind Virmani held several jobs in the government. In those posts, including a stint as chief economic adviser in the ministry of finance, he dealt with macroeconomic policy. After the conclusion of the annual meetings of IMF and the World Bank in Washington DC in end-September, Virmani took time off to speak to Mint. While he admitted there are concerns about the global economy, Virmani argued that the way out was to eschew political partisanship and to press the accelerator on domestic reforms. Edited excerpts:
Is the global economy on the brink once again?
The way to put it is that the risks are higher than they have been since 2008—which was higher than many decades before that. But I am not sure I would use the word brink because, in many ways, this is what I call stage II of the 2008 crisis. We never really got out of it; of course, we got out of the huge dip immediately, and that created a sense of complacency that it would be business-as-usual. It is clear that many policy advisers, academics and certainly most politicians in the developed countries did not understand, appreciate or want to appreciate…In the US, there was a lack of political will.
Distinct policy: Virmani sees a revival in global economic growth if each country focuses on its domestic levers. (Photo: India Today)
When you mean political will, you mean the polarization that has led to a policy freeze?
That’s right: polarization between the (two political) parties (in the US). The second side of the problem, the euro zone, is that the flexibility is not there. So, in some sense, it was even more important to deal with the solvency and sovereign debt issue in the insolvent countries—whether you say three or four were insolvent, that is a matter of detail. But the basic point being that the solvency issue had not been fully solved; enough was done to keep it from blowing up. And that is where this new thing, what you might say, the markets have caught up with that; you could keep doing a little bit and stopping the crisis as long as markets thought it was credible. The problem is that markets no longer thought it was credible; and that, in a way, has brought the genie out of the bottle. It is solvable though; so I won’t despair.
Could you elaborate on the political problem in the euro zone?
There the problem is a little different. It is not that within a nation political parties are fighting about their own country. They are fighting about the euro area; that is a different order of a political problem. The public in the four or five highly solvent countries, like Germany and Finland, are saying “why should we want to spend the money to save the public in other countries”. There, the difficulty is that they don’t realize that a part of the reason they are strong is that they benefited from the euro. So it is, perhaps, in their own interest to save the euro and so something about the solvency about some of the member countries.
The two-step recovery, wherein the emerging markets are less affected, implies that they have a lesser stake in the intra-Europe problem. Are they really de-linked?
If the problem is not sorted out by Europe, let us say, in the next three months, which I am hopeful they will, then you could have a real bad event; something that will definitely affect all of us—there is no question (of being insulated). All emerging markets like China, India, Brazil, you name it, will be affected. It is a kind of a two-level thing: we are less affected by the slight slowdown of Europe, US; but, if there is a major shock, everybody will be affected—the whole financial system, as it happened in 2008, gets disrupted.
Then why are emerging markets reluctant to take a greater initiative in resolving the current crisis?
No, I don’t think so. The communiqué (after the annual IMF-World Bank meetings) specifically refers to surplus economies.
By that you mean China?
They have the greater strength and, therefore, they have to contribute. You can’t ask, let’s say, a low-income country to contribute; you can’t ask India, which has the second highest (current account) deficit in the world in absolute amount, to do more…According to the communique, they (China) have accepted—though not specifically named. Some of the oil economies, too, have huge surpluses and, therefore, have an obligation to contribute.
Recovering from the 2008 crisis means the world economy has exhausted a lot of its firepower. It means that, one: you are vulnerable; and second: it means that you are not well-equipped. So does the world, emerging markets in particular, have the firepower to take on another contagion?
The constraint is that the first stage of the crisis has used up so many of the policy levers, particularly on the fiscal and monetary side; so, in some sense, your tools are blunter. But what we have not used is the structural tools. You still have those: if each country focuses on its domestic levers and focuses on growth, that will be another way for global growth to revive. So, if the emerging market economies want to insulate themselves further, they must accelerate their domestic reforms. If we don’t, we will slow along with them (developed economies). There is no magic (wand).
Interestingly, in the last two years and more, you have seen a policy rigor mortis. In the context of what you just said, where does India go from here?
Here is another political lesson. Look at the US, and it has parallels, perhaps, in India. In the US, you had problems within the President’s (Barack Obama’s) party; they were not willing to go along with the President who wanted to do some good things. (At the same time) there were conflicts within the other party. And, then you had a huge conflict between the President’s party and the opposition. In some ways there is a parallel in India.
Part of the reason was that they always thought the US economy would come out of recession. Well, it will come out; but three years will be seven years. Same thing you could apply to India. One, give up complacency; there is no natural rider that the economy will continue growing at 8.5-9%; or if it goes down, it will automatically come up. No, there is no such automaticity. The lesson of high-growth economies in a crisis is absolutely clear: whenever you have a crisis, you have to do policy reform. And what you do is pick out of an agenda that is already there; pick the one that will have maximum impact given the crisis. And we know what these are.
Second, all political parties have to say it is in the nation’s interest: We can’t always be partisan. So the two lessons are clear and we have to learn it as much as the US has to.
India’s burgeoning current account deficit problem is a case of excess domestic demand, largely through the mismanagement of the fiscal situation, spilling over.
Let me put it a bit differently. Some of the emerging market economies are facing price pressures, partly because commodity pressures have not declined as much as one would have hoped and, partly, because we may need to relook at our fiscal-monetary mix. In some ways, the fiscal balance was restored a little faster than it has; then you would have had more scope for monetary policy…we would have been able to do much better on inflation if we had that space.
Is that why the government is not getting a handle on inflation?
There are three aspects. One is global commodity prices. Second is what I just said above. And third is the supply chain; for 40 years, we used to talk about the supply side and say that demand is not everything—somehow, we seem to have forgotten it. That is still important. There are supply-side constraints and, hence, there is a need to get back to structural reforms—not only for (stimulating) growth, but also moderating inflation.
But these, like say foreign direct investment (FDI) in multi-brand retail, are politically difficult initiatives to push.
If you don’t do anything, you have to face the consequences. There is nothing for me to add then. As a policy adviser, I will always tell you what needs to be done and why. Take FDI in multi-brand retail, for example. The rate of growth of per capita GDP has doubled since 2002. The small-scale systems are not able to cope. They just cannot supply the stuff efficiently. Just imagine that they have to grow at twice the rate; the small-scale sector can never do it—it is a new world. We are no longer a low-income country, we have moved to a middle-income country (range) and, hence, need a bigger scale.