World Economic Outlook is not in Spring

Joint note with Prof. Charan Singh, IIM B

The world economy in 2013 is projected to grow by 3.3 percent, a shade lower than 3.5 percent estimated in January 2013 and marginally higher than 3.2 percent in 2012, according to the World Economic Outlook released by the IMF on April 16 at Washington DC. The world is recording a three speed recovery with strong growth in emerging markets, slow growth in the US and negative growth in the euro area. The projections for all major countries except Germany and Japan have been revised downwards. India’s projected growth is now pegged at 5.7 percent, lower by 0.2 percent from the IMF estimates released in January 2013.

The IMF hails the positive trend in growth in 2013 over 2012 and observes that though global prospects have improved, the road to recovery in advanced countries will remain bumpy. The economic activity has already picked up steam in emerging markets and is expected to accelerate gradually in advanced countries in 2013. Interestingly, IMF observes that economic activity in many economies is held back by continued fiscal adjustment (even in the US), competitiveness problems and balance sheet weaknesses.  According to the IMF, two great threats to economy recovery – break-up of Euro area and sharp fiscal contraction in the US - have been defused. But risks still remain in the short and medium term. In the short term risks are mainly from the euro area while in the medium term, the key risks are insufficient institutional reforms, weak balance sheets, broken credit channels and prolonged stagnation in the euro area; and high deficits and debt in the US and Japan. In the medium term, emerging markets need to tighten their monetary policies and strengthen prudential measures for the financial sector in face of sustained rapid growth of credit and high asset prices, if necessary.

The emerging markets have done well on the fiscal front and are expected to continue with neutral fiscal policy in medium term. The WEO observes that the growth in emerging markets may be strong but is less than projected during the last few years. These forecast disappointments are symptomatic of deeper structural problems heralding cutbacks in investments or capital outflows and need to be seriously considered by the policy makers.

The improvement in global economy could again result in substantial capital flows to the emerging economies which would require adjustments in the policy mix. IMF guides that when the capital inflows threaten to destabilize the economy, then the country can adopt capital flow management measures to avoid the buildup of major internal imbalances. Merely tightening of monetary policy could reinforce capital inflows and therefore countries with current account deficits need to consider macro-prudential measures, fiscal tightening and avoiding exchange rate appreciation.

To reduce global imbalances, China needs to have higher consumption and Germany more investment while the US needs to boost national savings through fiscal consolidation. Other deficit economies need to undertake structural reforms to rebuild competitiveness, according to the IMF.

The prices of main commodity groups, including food and oil, are projected to decline in 2013 with improving supply prospects and harvest. However, metal prices are projected to trend upwards, consistent with global recovery.

The WEO contains very interesting discussion in two specific box items. First, the discussion in Box 3.1 under the title Does Inflation Targeting still make sense with a flatter Phillips Curve is certain to gladden the heart of two past Governors of the RBI, amongst many policy makers in India. The researchers in the IMF are now beginning to realize that touting inflation targeting to all countries and in all circumstances was probably not the best policy advice. In Box 1.1, titled The Great Divergence of Policies, an unusual path of global recovery when compared with the three global recoveries is discussed. The ongoing recovery path after the great recession exhibits two types of divergences. First, recovery has been the weakest for advanced countries and strongest for emerging markets in contrast to earlier recoveries where advanced countries were the engines of global recoveries. Second, and more interestingly, monetary and fiscal policies, mainly in advanced countries, have marched in opposite directions in this recovery whereas in the previous episodes, the two policies were always aligned.

For India, a number of concerns emerge. First, the recovery in euro area and the US economy continues to be sluggish which could impact India’s exports. Second, according to the projections by the IMF, India’s CAD is projected to be 4.9 percent in 2013 and 4.6 percent in 2014 and consumer prices nearly 11 percent for both the years. While the real GDP for India is projected to rise from 5.7 percent in 2013 to 7.0 percent in 2018 that of China is projected to rise from 8.0 percent to 8.5 percent, respectively.

A Rahul-X or An Advani-Modi Government?

  This article appeared in TOI, 18/4/13.

 In an earlier note I had forecast that the 2014 election campaign would be fought between a Rahul led Congress and a Modi led BJP.  Rahul Gandhi’s speech has given us the first hint of the Rahul-Congress election platform and strategy. The election platform is basically the congress development strategy of “Inclusive growth” developed over the last 8 years, modified/tweaked by the need to restore growth to its 8% potential and leavened with Shri Rahul Gandhi’s personal experience of reaching out to the common people and reviving the Congress party. By leaving the issue of a post-election Congress PM open, the strategy is also designed to keep the election from becoming a Presidential style Rahul vs. Modi election.  Similarly, Narendra Modi’s speeches and the reaction of the JD(U) and other potential NDA partners to his rise is also giving us a picture of the election platform of the Modi led BJP: (i) Faster economic growth & job creation, (ii) Better Public Goods & Services, (iii) More focused and better governance, (iv) Public Security.  At the same time Hindutva issues are likely to be downplayed in an effort to pacify the JDU and other potential NDA partners, and more emphasis on the inclusive programs of BJP governments in M.P., Chhattisgarh etc.

      Consider a grading based on the each parties program (Cong/BJP) and the ability of the potential leader (Rahul/Modi) to achieve results (positive & negative).  Three dimensions are likely to figure in the election discourse: Social inclusion, Economic Growth & Development and Domestic & National security (plus a net/overall grade).  Putting oneself into the hypothetical persona of neutral analyst with a nationalist, liberal perspective, the tentative scores for the two national parties are, (i) Rahul led Congress: A, B+ and B on the three dimensions with a net score of  B+ and (ii) Modi led BJP: C+, A and A- with a net of B+.  Any ranking can be disputed by committed supporters, particularly as it relates to likely future performance. Our purpose is however the very limited one of analyzing potential election strategies.  Two points emerge from this exercise: One that on basis of net score it may be difficult for voters to choose between the two National parties, so traditional supporters of each are likely to vote for their historically favored party, even if they had drifted away in the last two elections. Two that new, independent, undecided voters are likely to vote for the party whose score is higher on the dimension that is more important to them.  Those who care very strongly about social liberalism are likely to gravitate to the Rahul Congress, while those who care strongly about liberal economic policy outcomes are likely to drift to the BJP.  Those who care more about caste and region, will likely vote for the State parties.  On balance the urban vote is likely to shift back from Congress to BJP, while the rural vote share of the Congress could increase to partially offset this.  The challenge for both parties will be to win back the younger, more mobile voters from among those whose families switched to the State parties during the last 10-15 years. 

        The National party which gets significantly higher number of seats along with its limited pre-election partners will have a better chance of forming the government. Analysts have said that an ambiguous result will favor the Congress, given that parties like JD(U), BJD and TDP may not join a government with Modi as PM.   At this point, analysis suggests four potential outcomes: (a) Clear win for Congress – Rahul Gandhi becomes PM, (b) Clear win for BJP – Narendra Modi becomes PM, (c) Uncertain win for Congress with UPA III the largest pre-pol group. Rahul takes over party president ship and names a non-political PM, (d) Uncertain win for BJP, with NDA- the largest pre-pol group.  L. K. Advani becomes PM, with Narendra Modi as DPM (Economy) and Nitish Kumar as DPM (social inclusion).  One may well question how L K Advani of Yath Yatra fame could be an acceptable compromise.  The most important reason is he was almost drummed out of the BJP by the RSS for his positive remarks about Jinnah while on a visit to Pakistan and has therefore in a sense paid his dues to the JD(U) secularists. Despite this he may be preferred by the RSS (to “dictatorial” NaMo), as also by the next-gen BJP leaders, who can keep their leadership hopes alive.

     Does this new post-election scenario, require new thinking on the part of the Rahul Congress?  For one it requires a complete extirpation of any residual complacency in the Congress with respect to economic reforms and economic growth.  The government, fully and whole heartedly supported by the party, must get down in the trenches to carry out every possible governance and economic reform that can revive economic growth within the next twelve months(this will benefit whoever comes to power). The achievements of Narendra Modi in sustaining growth in a relatively high per capita income State can only be countered by restoring national growth to reasonable levels.  It also requires some re-balancing of “social inclusiveness” away from Rawlsian abstractions, approved by Nobel prize winning philosophers towards more practical maximization of benefit-cost ratios and a greater focus on the issue of law and order and public safety & security.

This article appeared on the editorial page of the Times of India, on April 18, 2013: Can be accessed at,

http://timesofindia.indiatimes.com/home/opinion/edit-page/Heres-the-electoral-math-to-predict-who-will-form-the-next-government/articleshow/19602360.cms

Now For something completely different: Election Strategy

Introduction      

 In an earlier note[1] I had forecast that the 2014 election campaign would be fought between a Rahul led Congress and a Modi led BJP.  Rahul Gandhi’s speech has given us the first hint of the Rahul-Congress election platform and strategy. The election platform is basically the congress development strategy of “Inclusive growth” developed over the last 8 years, modified (tweaked?) by the need to restore growth to its 8% potential and leavened with Shri Rahul Gandhi’s personal experience of reaching out to the common people and reviving the Congress party. By leaving the issue of a future Congress PM open (Rahul-? diarchy), the strategy is also designed to keep the election from becoming a Presidential style Rahul vs. Modi election.  

     The election platform of the Modi led BJP is also reasonably clear, based as it is on governance and his experience of maintaining fast economic growth and job creation in Gujarat and the provision of Public Goods and services through his administrative abilities.  At the same time he is likely to leave it to his social critics to arouse the BJP’s Hindutva base by criticizing his leadership of Gujarat during the 2002 riots, with perhaps some help from RSS affiliates.  These strategies will be designed to subtly polarize the voters and attract them towards the two National parties and away from State parties that depend heavily on cast, creed and regionalism.

Election Strategy

      Consider a grading based on the each parties program (Cong/BJP) and the ability of the potential leader (Rahul/Modi) to achieve results (positive & negative).  Three dimensions are likely to figure in the election discourse: Social inclusion, Economic Growth & Development and Domestic & National security (plus a net/overall grade).  Putting oneself into the hypothetical persona of neutral analyst with a nationalist, liberal perspective, the tentative scores for the two national parties are, (i) Rahul led Congress: A, B+ and B on the three dimensions with a net score of  B+ and (ii) Modi led BJP: C+, A and A- with a net of B+.  Any ranking can be disputed by committed supporters, particularly as it relates to likely future performance. Our purpose is however the very limited one of analyzing potential election strategies.  Two points emerge from this exercise: One that on basis of net score it may be difficult for voters to choose between the two National parties, so traditional supporters of each are likely to vote for their historically favored party, even if they had drifted away in the last two elections. Two that new, independent, undecided voters are likely to vote for the party whose score is higher on the dimension that is more important to them.  Those who care very strongly about social liberalism are likely to gravitate to the Rahul Congress, while those who care strongly about liberal economic policy outcomes are likely to drift to the BJP.  Those who care more about caste and region, will likely vote for the State parties.  On balance the urban vote is likely to shift back from Congress to BJP, while the rural vote share of the Congress could increase to partially offset this.  The challenge for both parties will be to win back the younger, more mobile voters from among those whose families switched to the State parties during the last 10-15 years.

Post-Poll BJP

        The National party which gets significantly higher number of seats along with its limited pre-election partners will have a better chance of forming the government.  Analysts have said that an ambiguous result will favor the Congress, given the reluctance of parties like JD(U), BJD and TDP to join a government with Modi as PM.  My analysis suggests that the BJP-NDA may solve this conundrum by making L K Advani PM, Narendra Modi as Deputy PM in charge of the economy and perhaps Nitish Kumar as DPM for social policy.  This may have the collateral benefit of allaying fears within the BJP and the RSS of Modi’s “dictatorial” tendencies.

Pre-Poll Congress

     Does this new post-election scenario, require new thinking on the part of the Rahul Congress?  For one it requires a complete extirpation of any residual complacency in the Congress with respect to economic reforms and economic growth.  The government, fully and whole heartedly supported by the party, must get down in the trenches to carry out every possible governance and economic reform that can revive economic growth within the next twelve months.  Two, they must move to the center on social laws, expenditures and programs.  There is an impression among the Urban middle class that social policy has been driven to an extreme by philosophers, poets and dreamers, without regard to scientific analysis and much understanding of the severe limitations imposed by the overburdened, broken and corrupt bureaucratic system that has to implement this policy.  The emerging middle class is unlikely to vote on the basis of promises and programs that transfer 70% to 85% of money to administrators and politicians.

Conclusion

       The economic growth achievements of Narendra Modi can only be countered by the growth achievements of the Congress-UPA government.  The Congress cannot assume that even if it wins fewer seats than the BJP, most potential post-pol allies of the BJP can be persuaded to abandon the Modi led BJP.  They may flock to an Advani-Modi led NDA government.

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[1] http://dravirmani.blogspot.in/2013/03/let-party-begin-election-2014.html

Problem is Not in the Implementation

       In this note I want to address some dangerous myths that underlie public discourse and Civil society participation in public policy discussion and lobbying for their pet concerns.  There is an illusion, bordering on delusion, that the source of all our problems is the Central Government in Delhi and if only it had the intelligence and the moral fiber to pass the right laws, all our problems would be solved.  The problem is the opposite: there are myriads of laws, rules regulations programs and projects on every conceivable problem and issue under the sun and we keep adding to them every year, without putting in the hard work of studying and changing them.  On the other side, the bureaucracy, which stretches from State capitals (including Delhi as a State distinct from the central govt) down to the village, is completely in adequate to implementing the plethora of laws, rules regulations and of carrying out programs and projects with any degree of rationality.  The few intelligent and sincere people who still try to do their job to the best of their ability, are completely outnumbered by those who make little pretense of serving public purpose and are there merely to further their own welfare.  Unlike in a business, there is no metric to alert the public of the performance of any government office.
      As I wrote over a decade ago,"The power to do good has been severely reduced while the power to do harm has increased." As the proportion of the corrupt increases the constraints on corruption decline. The bureaucracy, from the pettiest official at the bottom of the pyramid to the top, has little positive incentive for doing good, while the risk of going against the prevailing culture of self-aggrandizement is grave. So it is advisable to keep your head low and do the basic tasks with a minimum of effort.

      Is there a way out of this negative spiral.  In the same paper (which incidentally was presented at RGIDS, published in 2 journals and reprinted in 3 books) I suggested that Government must focus its limited resources (financial, human, attention span, time) on those problems and issues only it can do well and others cannot do.  Business and Non-Government organizations must not only be freed to do what they are good at, but be encouraged and supported. 

     "Inclusive Growth" is a very nice phrase that captures the philosophy and poetry of what the government must try to do, but unless backed by hard scientific analysis of problems solutions and priorities, it results in a further diffusion of focus to more and more problems, and less and less solutions.  It adds to the burden of the 150 odd programs that a typical district magistrate/collector is required to run in a district -- One has to be totally delusional to believe that the DM/DC can actually run so many programs or that he even bothers to try.  

     A law, rule, policy or regulation that is made without understanding the system that will be required to implement it, is a bad law, rule, policy regulation.  Those who propose it, cannot later deny culpability, by saying that "the problem was in the implementation,"or that "It is the failure of the system."  If you claim the right to determine policy, people have the right to expect you to learn about the system that will implement it!

      An understanding of systemic limitations leads to two different but complementary approaches: One, keep trying to reform the system, even though this is a long and frustrating process. Two, in the immediate future try to minimize/reduce the demands on the government system by creating a policy and regulatory environment that makes it possible for business, non-government organizations and civil society to solve the problem more effectively.  In the decades since I understood the system, I have applied this approach to policy reform.  Focus on essentials, prioritize, compare solutions and suggest only those that have a higher probability of success (there are no perfect solutions only better or worse). 

     If you want to get a flavor of these policy reform suggestions in different areas & sub-sectors, see www.chintanlive.org. When you are ready to dig deeper see https://sites.google.com/site/drarvindvirmani/ .

Fixing India’s Current Account Deficit

Joint Note with Prof. Charan Singh 

Dual Deficit Problem 

  The country is in the midst of twin deficits of gross fiscal deficit (GFD) and current account deficit (CAD). The GFD, though high, has been on a declining trend, while the CAD continues its uptrend and is expected to record a new high in the current year after 4.2% of GDP in 2011-12. According to the latest data released by RBI on March 28, the CAD for April-December 2012 was 5.4% of GDP (and 6.7% in Q3). Earlier, the highest recorded CAD of 3% in 1990-91 was followed by a major BoP crisis soon after. This is a worrisome situation

Sustainable Level?

     On the CAD, at the outset, it needs to be mentioned that the sustainable level varies over time. According to the High Level Committee on Balance of Payments (1993), CAD should be 1.6% of GDP which could be met through sustainable level of net capital receipts. According to the Committee on Capital account Convertibility (1997), growing degree of integration of the Indian economy with the global economy would imply variability in the size of the CAD and recommended a CAD of 2% of GDP, while the Committee on Fuller Capital Account Convertibility (2006) recommended a CAD of 3% of GDP. The parameters considered by the latter Committee and some more generally do not show a steady performance, especially rise in debt reflecting a weaker international investment position (table 1). This should be a matter of concern. 

Table 1: Select Indicators of External

Year	Total External Debt to GDP	Short term Debt to Total Debt	CAD/GDP	CR/CP	DSR	CR/GDP	Import cover of Reserves (months)
1995-96	27.0	5.4	-1.6	88.8	26.2	14.0	6.0
2005-06	16.8	14.0	-1.2	94.8	10.1	24.0	11.6
2011-12	20.0	22.6	-4.2	87.0	6.0	28.6	7.1
2012-13 End-Sep	20.7	23.1*	-5.4	na	5.8*	na	7.2

CR - Current Receipts; CP - Current Payments; DSR – Debt Service Ratio.

Source: RBI and GoI.

     The experience of other countries also shows that India’s CAD is not the only outlier in the global economy (table 2). An IMF study published in February 2013 mentions that a CAD of 4% for India in 2012 corresponds to a cyclically-adjusted 2.7% of GDP. However, as argued by Freund and Warnock (NBER WP 11823), high CAD is a cause of concern and should be addressed. 

Table 2: Current Account Balance as percent of GDP

Country	1996	2006	2012 Estimates	2013 Estimates
Australia	-3.36	-5.33	-4.08	-5.50
Chile	-3.98	4.60	-3.20	-3.00
Indonesia	-3.21	2.98	-2.11	-2.38
New Zealand	-5.86	-8.28	-5.37	-5.87
South Africa	-1.15	-5.31	-5.47	-5.85
Turkey	-1.00	-6.09	-7.54	-7.13
United Kingdom	-0.56	-2.93	-3.31	-2.71
United States	-1.59	-5.99	-3.11	-3.08

                   Source: IMF.

Trade and Exchange Rate

      The finance minister has argued that the CAD continues to be high mainly because of high oil, coal and gold imports, and slowdown in exports. The scheme to raise the limit of duty free import of gold jewellery is expected to raise the supply of gold and can also be expected to reduce the demand pressure reflected in rising imports and ballooning the CAD. It may be recollected that, in November 2009, RBI had purchased 200 metric tonnes of gold from the IMF. Since then, taking the cue, probably to hedge against numerous risks, gold imports have increased significantly from $21 billion in 2008-09 to $29 billion in 2009-10, and further to $56 billion in 2011-12

     The government could consider some more bold measures similar to those initiated in the latter period of the last year, including the politically-sensitive issue of oil subsidy. Similarly, the direct measure to correct the CAD would be to allow the exchange rate to be determined by medium term market forces that drive the CAD.

       It has been argued by many learned pundits that given the differences in inflation between the US and India, amongst many other variables, the current level of exchange rate would need a correction. As economic theory suggests that market-determined exchange rate, in this case implying a depreciation of the rupee, would boost exports and restrict imports. As commodity imports, consisting of essential commodities like fuel and fertilisers, which were highly subsidised, are relatively inelastic in the short run, the demand for these responds relatively slowly to exchange rates. But now, given that the subsidy on petroleum, oil and lubricants (POL) is being phased out, higher oil prices would lead to rationalisation of consumption by the public, private and household sector. The demand by households for other major imports like gold and silver, and electronic goods can be expected to be moderated by exchange rate adjustment. On the export front, manufactures and mineral fuels can be expected to respond to exchange rates.

      A number of econometric studies have shown that exports respond to exchange rates and external demand. Illustratively, exports responded to depreciation in exchange rates in 2008-09 and 2011-12. Though global demand was muted in some of the traditional export markets of India in 2012-13 because of the global slowdown, it is expected to improve in the next year. However, India needs to explore how it can make a dent in China’s labour-intensive exports, given that wage rates are finally being allowed to rise in China. Exchange rates driven by short-term capital flow movements also distort prices and preferences in the economy, though the impact is difficult to quantify. Therefore, a bold decision to let the exchange rate be determined by medium-term market forces will help lower the CAD

A version of this article appeared as an Op Ed in the Financial Express of March 29, 2013, under the banner,"Fixing India's current account."