ET NowIn a chat with ET Now, Dr. Duvvuri Subbarao, Distinguished Visiting Fellow at NUS Business School, shares his macroeconomic outlook. Excerpts:
ET Now: What do you think are the key mega trends that could shape the Indian economy in the next two to three years?
Dr. Duvvuri Subbarao: The first mega trend that is going to shape India’s future is the engineering and manufacturing revolution. PM Modi has been talking about it. We desperately need a big manufacturing sector in order to generate jobs for hundreds of millions of people. Hence, the first mega trend is going to be a manufacturing revolution.
The second one is going to be decentralisation. It has, of course, been with us since the independence. It has taken route since the 73rd and 74th Amendments to the Constitution, but it is going to get much deeper, partly because the second generation of reforms, that this government has to implement, need the active cooperation of State governments. Thus, decentralisation - not just at the state level but also at the sub-state level - is going to be the other key trend.
The final mega trend in my list that would shape India’s future would be globalisation. India has been integrating with the world for the past several years and that integration is going to get deeper - notwithstanding the cost we have had to pay. There will be a realisation that globalisation comes with costs and benefits and those benefits, in the long run, outweigh the costs. Thus, when I say that globalisation is going to deepen, what I mean is that India’s trade will increase and even on the capital account, India will become more open.
ET Now: How do you view the improvement in India’s macroeconomic fundamentals that we are seeing? Are they for real and are they enduring, or are they contrived and temporary?
Dr. Duvvuri Subbarao: Over the last several months, since this government has come to office, we have seen macro indicators stabilising - indeed improving. Growth is in an uptrend, inflation is on a downtrend, and there have been significant adjustments on the current account, fiscal consolidation is on track, investment sentiment is reviving, etc.
All these improved indicators will deliver cyclical upturn in growth from below 5 per cent last year to 5.5 per cent this fiscal year, and to may be 6 to 6.5 per cent in the next couple of years.
But the question is - is that sufficient for India, given the size of its poverty, the aspirations of millions of people, the hundreds of millions of jobs that have to be created? For that we have to grow at 7 to 9 per cent. Hence, the challenge for this government is going to be whether they can shift the economy to a high growth trajectory on a sustainable base by the time they finish the current term in office.
Mythili Bhusnurmath: Is there success in controlling inflation due to monetary policy or is it more due to fortuitous circumstances such as falling oil and commodity prices?
Dr Duvvuri Subbarao: As a former governor of the Reserve Bank of India, I cannot say that the softening of inflation is not due to monetary policy. Monetary policy - especially governor Rajan’s stance - has certainly helped, but I should also add that fortuitous global circumstances that you mentioned have also helped, particularly oil prices that have become lower - much lower than earlier estimated.
The monsoon has been stronger than earlier feared and growth possibly might be weaker than earlier expected. The Reserve Bank is going to see as to what extent these dynamics will sustain. Hence, I would say that the softening of inflation is both due to the Reserve Bank’s credible monetary policy stance as well as fortuitous global circumstances.
Mythili Bhusnurmath: Is inflation-targeting the way to go or has the financial crisis really raised doubts on the wisdom of the central bank focussing only on inflation?
Dr Duvvuri Subbarao: One of the big lessons of the crisis is indeed that strict inflation-targeting does not work. Countries’ central banks must be more flexible in delivering on their inflation target, which is to say that they must deliver on their inflation target but subject to concerns about growth and financial stability. That has been the big shift in policy stance in thinking, post crisis.
In India, of course, we are talking about a new monetary policy framework that will assign inflation target to the Reserve Bank. That is a good move, but what objective the Reserve Bank has been driving at has not been very clear. But having said that, I would also add that it will be difficult for the Reserve Bank of India to deliver on strict inflation target, partly because as much as 50 per cent of inflation is beyond the control of monetary policy.
Hence, I think that in the agreement on monetary policy framework between the government and the Reserve Bank, it would not be a strict inflation target, but an inflation target that is qualified that concerns about growth and financial stability.
Mythili Bhusnurmath: What is the ideal structure of the Financial Stability and Development Council (FSDC), and the monetary policy committee? Who all should comprise these committees?
Dr. Duvvuri Subbarao: Firstly, on FSDC, the structure as it is constituted now is okay, with the Finance Minister chairing it, the Governor of the Reserve Bank chairing the FSDC subcommittee and all the regulators and the finance secretary senior officers including all secretaries represented there.
What is of greater importance is the FSDC meetings, their agenda, the decisions taken, how they are implemented and how active the FSDC is. It, in particular, is very intrusive - so intrusive that it eats into the autonomy of the regulators that it keeps itself to financial stability functions and develops financial development functions.
My own view has been that the FSDC must play a more active role during crisis times, and that it must relegate itself to the background in normal times.
When it comes to the monetary policy committee, the governor must have a decisive say on the members of the monetary policy. They will of course be individuals who will enjoy reputation for credibility and intellectual honesty, but on specific purpose and the composition, the governor must be consulted.
Mythili Bhusnurmath: In a recent interview to ET Now, the FM Arun Jaitley had said that poor credit offtake is something that has really worried him. Do you expect an improvement in the credit offtake? How much is that linked to interest rates?
Dr. Duvvuri Subbarao: Credit offtake has certainly been poor - it has been uncomfortably low. It is difficult to say how much of this is due to the Reserve Bank’s monetary policy stance, in particular to what extent interest rates setting by the Reserve Bank has been a binding constraint and to what extent other factors are at play. But credit offtake is important for investment revival, both for generating sentiment in the short term as well as for generating productive capacity for sustainable growth in the medium to long term.
Mythili Bhusnurmath: The recent World Bank India report says that India’s potential rate of growth is 6 to 7 per cent and the fiscal balance is also improving. What is your view? Do you see India in a better position than other EMEs in terms of the macros?
Dr. Duvvuri Subbarao: Firstly, I must say that I am quite heartened by the number that the World Bank has put out because during my time at the Reserve Bank, we were rather uncomfortable with how low the potential growth rate had come down to. We were talking about potential growth having come down to below 6 per cent. Thus, if the World Bank has put out a number that is in the range of 6 to 7 per cent, that is certainly good.
I think compared to other emerging markets, India is in a relatively better shape because of the adjustment that it has made on the current account, foreign exchange reserves have been built up, fiscal consolidation is on track , etc. But the important thing is to use the current breathing space provided by easing global pressures to institute big ticket reforms. That is important also because the government enjoys enormous amount of political capital now. So they must get on with reforms early on so that sustainable results come in by the time they finish their term in office four-and-a-half years from now.
ET Now: What are you expecting to hear from the FOMC on Thursday morning Indian time? Is there a risk of funds flow reversal? Do you see India ready for any eventuality, perhaps the US interest rates going up?
Dr. Duvvuri Subbarao: First of all, I should say that I am not expecting anything. But I can give you my own view, which is that now they are going to stop QE, which means that they are going to stop expansion and at some time in the future, they are going to have to reverse both the QE as well as raise interest rates.
How soon this will happen, is a big question. They are going to look at how robust the recovery is, they are going to look at inflation concerns on the way forward and importantly, they are also going to be concerned about any threat to financial stability as a consequence of keeping interest rates low for an extended period.
But my own view is that the reversal of QE and the raising of interest rates are going to be later than what most people currently think them to be. As far as its impact on emerging markets - particularly India - is concerned, India has made an adjustment since last year. When QE is reversed, there will be some capital outflow, some adjustment, but that will be nothing compared to the taper tantrums we had last year. There will be a quick adjustment through a fairly stable equilibrium.
ET Now: A number of steps have been taken - monetary as well as fiscal - and these have helped India move out of that fragile five. But what, according to you, is necessary for India to get into a growth five, rather than be part of the fragile five?
Dr. Duvvuri Subbarao: India has to generate investment. The big task for Prime Minister Modi and his government will be to revive investment, particularly investment in infrastructure. We need reforms - both structural as well as governance - and it requires a very healthy financial sector also. Hence, moving on with reforms and getting the financial sector, particularly banks, through relative confidence about lending will be quite important.
ET Now: What do you think are the key mega trends that could shape the Indian economy in the next two to three years?
Dr. Duvvuri Subbarao: The first mega trend that is going to shape India’s future is the engineering and manufacturing revolution. PM Modi has been talking about it. We desperately need a big manufacturing sector in order to generate jobs for hundreds of millions of people. Hence, the first mega trend is going to be a manufacturing revolution.
The second one is going to be decentralisation. It has, of course, been with us since the independence. It has taken route since the 73rd and 74th Amendments to the Constitution, but it is going to get much deeper, partly because the second generation of reforms, that this government has to implement, need the active cooperation of State governments. Thus, decentralisation - not just at the state level but also at the sub-state level - is going to be the other key trend.
The final mega trend in my list that would shape India’s future would be globalisation. India has been integrating with the world for the past several years and that integration is going to get deeper - notwithstanding the cost we have had to pay. There will be a realisation that globalisation comes with costs and benefits and those benefits, in the long run, outweigh the costs. Thus, when I say that globalisation is going to deepen, what I mean is that India’s trade will increase and even on the capital account, India will become more open.
ET Now: How do you view the improvement in India’s macroeconomic fundamentals that we are seeing? Are they for real and are they enduring, or are they contrived and temporary?
Dr. Duvvuri Subbarao: Over the last several months, since this government has come to office, we have seen macro indicators stabilising - indeed improving. Growth is in an uptrend, inflation is on a downtrend, and there have been significant adjustments on the current account, fiscal consolidation is on track, investment sentiment is reviving, etc.
All these improved indicators will deliver cyclical upturn in growth from below 5 per cent last year to 5.5 per cent this fiscal year, and to may be 6 to 6.5 per cent in the next couple of years.
But the question is - is that sufficient for India, given the size of its poverty, the aspirations of millions of people, the hundreds of millions of jobs that have to be created? For that we have to grow at 7 to 9 per cent. Hence, the challenge for this government is going to be whether they can shift the economy to a high growth trajectory on a sustainable base by the time they finish the current term in office.
Mythili Bhusnurmath: Is there success in controlling inflation due to monetary policy or is it more due to fortuitous circumstances such as falling oil and commodity prices?
Dr Duvvuri Subbarao: As a former governor of the Reserve Bank of India, I cannot say that the softening of inflation is not due to monetary policy. Monetary policy - especially governor Rajan’s stance - has certainly helped, but I should also add that fortuitous global circumstances that you mentioned have also helped, particularly oil prices that have become lower - much lower than earlier estimated.
The monsoon has been stronger than earlier feared and growth possibly might be weaker than earlier expected. The Reserve Bank is going to see as to what extent these dynamics will sustain. Hence, I would say that the softening of inflation is both due to the Reserve Bank’s credible monetary policy stance as well as fortuitous global circumstances.
Mythili Bhusnurmath: Is inflation-targeting the way to go or has the financial crisis really raised doubts on the wisdom of the central bank focussing only on inflation?
Dr Duvvuri Subbarao: One of the big lessons of the crisis is indeed that strict inflation-targeting does not work. Countries’ central banks must be more flexible in delivering on their inflation target, which is to say that they must deliver on their inflation target but subject to concerns about growth and financial stability. That has been the big shift in policy stance in thinking, post crisis.
In India, of course, we are talking about a new monetary policy framework that will assign inflation target to the Reserve Bank. That is a good move, but what objective the Reserve Bank has been driving at has not been very clear. But having said that, I would also add that it will be difficult for the Reserve Bank of India to deliver on strict inflation target, partly because as much as 50 per cent of inflation is beyond the control of monetary policy.
Hence, I think that in the agreement on monetary policy framework between the government and the Reserve Bank, it would not be a strict inflation target, but an inflation target that is qualified that concerns about growth and financial stability.
Mythili Bhusnurmath: What is the ideal structure of the Financial Stability and Development Council (FSDC), and the monetary policy committee? Who all should comprise these committees?
Dr. Duvvuri Subbarao: Firstly, on FSDC, the structure as it is constituted now is okay, with the Finance Minister chairing it, the Governor of the Reserve Bank chairing the FSDC subcommittee and all the regulators and the finance secretary senior officers including all secretaries represented there.
What is of greater importance is the FSDC meetings, their agenda, the decisions taken, how they are implemented and how active the FSDC is. It, in particular, is very intrusive - so intrusive that it eats into the autonomy of the regulators that it keeps itself to financial stability functions and develops financial development functions.
My own view has been that the FSDC must play a more active role during crisis times, and that it must relegate itself to the background in normal times.
When it comes to the monetary policy committee, the governor must have a decisive say on the members of the monetary policy. They will of course be individuals who will enjoy reputation for credibility and intellectual honesty, but on specific purpose and the composition, the governor must be consulted.
Mythili Bhusnurmath: In a recent interview to ET Now, the FM Arun Jaitley had said that poor credit offtake is something that has really worried him. Do you expect an improvement in the credit offtake? How much is that linked to interest rates?
Dr. Duvvuri Subbarao: Credit offtake has certainly been poor - it has been uncomfortably low. It is difficult to say how much of this is due to the Reserve Bank’s monetary policy stance, in particular to what extent interest rates setting by the Reserve Bank has been a binding constraint and to what extent other factors are at play. But credit offtake is important for investment revival, both for generating sentiment in the short term as well as for generating productive capacity for sustainable growth in the medium to long term.
Mythili Bhusnurmath: The recent World Bank India report says that India’s potential rate of growth is 6 to 7 per cent and the fiscal balance is also improving. What is your view? Do you see India in a better position than other EMEs in terms of the macros?
Dr. Duvvuri Subbarao: Firstly, I must say that I am quite heartened by the number that the World Bank has put out because during my time at the Reserve Bank, we were rather uncomfortable with how low the potential growth rate had come down to. We were talking about potential growth having come down to below 6 per cent. Thus, if the World Bank has put out a number that is in the range of 6 to 7 per cent, that is certainly good.
I think compared to other emerging markets, India is in a relatively better shape because of the adjustment that it has made on the current account, foreign exchange reserves have been built up, fiscal consolidation is on track , etc. But the important thing is to use the current breathing space provided by easing global pressures to institute big ticket reforms. That is important also because the government enjoys enormous amount of political capital now. So they must get on with reforms early on so that sustainable results come in by the time they finish their term in office four-and-a-half years from now.
ET Now: What are you expecting to hear from the FOMC on Thursday morning Indian time? Is there a risk of funds flow reversal? Do you see India ready for any eventuality, perhaps the US interest rates going up?
Dr. Duvvuri Subbarao: First of all, I should say that I am not expecting anything. But I can give you my own view, which is that now they are going to stop QE, which means that they are going to stop expansion and at some time in the future, they are going to have to reverse both the QE as well as raise interest rates.
How soon this will happen, is a big question. They are going to look at how robust the recovery is, they are going to look at inflation concerns on the way forward and importantly, they are also going to be concerned about any threat to financial stability as a consequence of keeping interest rates low for an extended period.
But my own view is that the reversal of QE and the raising of interest rates are going to be later than what most people currently think them to be. As far as its impact on emerging markets - particularly India - is concerned, India has made an adjustment since last year. When QE is reversed, there will be some capital outflow, some adjustment, but that will be nothing compared to the taper tantrums we had last year. There will be a quick adjustment through a fairly stable equilibrium.
ET Now: A number of steps have been taken - monetary as well as fiscal - and these have helped India move out of that fragile five. But what, according to you, is necessary for India to get into a growth five, rather than be part of the fragile five?
Dr. Duvvuri Subbarao: India has to generate investment. The big task for Prime Minister Modi and his government will be to revive investment, particularly investment in infrastructure. We need reforms - both structural as well as governance - and it requires a very healthy financial sector also. Hence, moving on with reforms and getting the financial sector, particularly banks, through relative confidence about lending will be quite important.
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