The Indian government presented its National Manufacturing Policy (NMP) to the nation in early November.

Presumably, the announcement was timed to demonstrate that reform is alive and kicking before parliament reconvenes later this month. With the final text now available on the Department of Industrial Policy and Promotion website, it is possible to take a considered view of the policy’s goals, the means proposed to achieve them and the probability of success. It is also possible to speculate on the unintended consequences and possible collateral damage.

The preface of the NMP refers to ‘concern about the stagnant and low share of the manufacturing sector in India’s GDP’ as providing prima facie justification for policy intervention. In the body of the policy, this goal is further justified by reference to the superior manufacturing performance of other Asian countries, and by the employment challenges that India faces. This is a rather dubious basis for intervention.

On this rationale, the quantitative target is to raise the share of manufacturing value-added in GDP from the current 16 per cent to 25 per cent by 2022, implying that manufacturing needs to grow appreciably faster than overall GDP over the next decade. This will become progressively harder as the share of manufacturing rises in overall GDP. Given the shares of agriculture, services and industry (of which manufacturing is the dominant part) must add up to 100 per cent, it is also not clear from the policy which of the other two sectors is expected to give way within an aggregate growth target of nine per cent. This information will only become available when India’s 12th Five-Year Plan is finalised early next year; presumably, much of the ‘space’ will be ceded by agriculture.

The main positive instrument proposed to achieve this growth acceleration is the creation of national investment and manufacturing zones (NIMZs), to be developed as integrated industrial townships. The policy envisages that ‘the NIMZs would be large areas of developed land, with the requisite ecosystem for promoting world-class manufacturing activity’. In contrast to existing special economic zones, with their focus on exports, such NIMZs are envisaged as industrial townships of a minimum size of 5000 hectares.

Each NIMZ will be managed by a special purpose vehicle (SPV), which will exercise the powers conferred by the policy. The policy specifies that the SPV’s CEO must be a senior central or state government official. So, in principle, these townships are to become publicly run corporations for the benefit of the private sector, free from the political and governance failures that plague India’s existing urban local bodies. The aim is to permit both clustering and concentration of infrastructure. In many ways, this is a return to the past, except these townships are designed to facilitate manufacturing by a cluster of smaller units, rather than being dominated by a single large employer.

Is this a solution in search of a problem? Apart from India’s still stunningly low per capita income compared to all other G20 members, it seems there is no tight linkage between levels of income and a ‘natural’ share of manufacturing when G20 countries are compared. It is true that India’s Asian peers — Indonesia, China and South Korea — have a much higher share of manufacturing than India, but there is little reason to think they represent a ‘norm’ to which India should aspire.

Two conclusions follow. First, there is no analytical reason to conclude that India’s ‘low and stagnant’ share of manufacturing reflects major distortions in its economy. Second, if it is to privilege manufacturing through special, potentially costly, measures, such actions need to be justified for reasons other than merely to raise its share. By the same token, a blanket commitment to raise the share of manufacturing at any cost risks leading India into the same blind alley of interventionist industrial policy from which it so painfully exited.

These concerns emerge from several of the policy’s provisions that are not necessarily linked with the NIMZs. Particularly disturbing is the looseness of the formulation on trade and investment policy and government procurement, and the stress on specific industry verticals. By way of example, paragraph 1.22 contains the extraordinary statement on regional trade agreements that ‘it will be ensured that such agreements will not have a detrimental effect on domestic manufacturing in India’. What on earth is the point of such agreements if not to put competitive pressure on India’s domestic producers?

The policy’s authors will undoubtedly cite the new wave of academic thinking associated with Hausmann, Rodrik, Stiglitz, Ann Harrison and the like to justify a return to activist industrial policy. I would remind them that this literature finds very little reason to favour manufacturing as such, but strongly supports the long-term productivity benefits of outward exposure.

Suman Bery is Country Director, India Central, International Growth Centre. This article first appeared here in the Business Standard.

1. Can India match East Asia as a manufacturing powerhouse?
2. Is India in need of a new investment policy?
3. Reviving India’s manufacturing industry

Following the torpor of the August holidays on both sides of the Atlantic, each September marks the revival of the international diplomatic calendar.

On the political side, the centrepiece is the annual meeting of the United Nations General Assembly in New York; on the economic side, a similar marker is the Annual Meetings of the World Bank and the International Monetary Fund, held in Washington twice every three years.

Amid all these comings and goings, it would be easy to miss an important bilateral event of perhaps greater consequence for India’s economic prospects: the 2011 inaugural India-China Strategic Economic Dialogue. The talks will be held in Beijing, starting today, and led on India’s side by the deputy chairman of the Planning Commission and on China’s side by Zhang Ping, chairman of China’s powerful National Development and Reform Commission. The two countries agreed to institute such a dialogue on the occasion of Chinese Premier Wen Jiabao’s visit to New Delhi in December 2010. At the bilateral level, the two sides already have a great deal to talk about. But as their economic relationship evolves and deepens, it will also grow in significance for the rest of Asia, and, in time, for the global economy.

Taken together, India and China constitute a major growth pole in an otherwise anaemic global economy. Though some analysts might disagree, most economists would judge that the rapid growth of both countries has been substantially driven by their increasing integration with the global economy, most of all in trade (both goods and services) and through direct investment. China’s commitment to such global integration over the last 20 years or so is one of the important factors responsible for its sustained, rapid growth and its now commanding position in the global merchandise trade.

While India’s external liberalisation is successful within its own terms, it has been much more halting and hesitant. On account of its policy choices, India’s economy is today dwarfed in size by China but is arguably better balanced between consumption and investment, and between net exports and domestic demand. There is worry about the size of India’s deficit on merchandise trade, running at about 7 per cent of GDP, but the strong performance of merchandise exports suggests that this does not represent a generalised competitiveness problem; rather it reflects the adjustment of the economy to its underlying comparative advantage, and to the savings–investment balances in the economy, where the government’s fiscal position represents a major distortion.

Notwithstanding these asymmetries, deeper integration of the two economies is both inevitable and economically desirable. China is already India’s largest trading partner and India is slowly becoming a significant market for China — not a mean achievement given that China is now the world’s largest exporter. Both countries also agree at the policy level that such integration should proceed for the mutual benefit of the two economies, even as security tensions (border issues, Tibet, Pakistan, the South China Sea and Indian Ocean) persist and even intensify.

More critical than these political issues is the ambivalence felt by both the corporate and official sectors in India towards greater economic engagement with China. This ambivalence has stalled any progress towards a trade agreement at a time when most of India’s large Asian neighbours are negotiating preferential access to the Chinese market. Addressing the issues that underlie this ambivalence will no doubt be a key goal of this and subsequent economic dialogues. Among these issues is the current imbalance in the goods trade where, of a total volume of US$60 billion in two-way trade in 2010, China’s exports to India exceeded India’s exports to China by a wide margin. There is also the commodity composition of trade in each direction, with China’s exports to India representing significantly more sophisticated manufactures than trade in the reverse direction. Finally, there is the global concern with China’s exchange rate regime.

Focus on bilateral trade imbalances with a particular country partner, either in volume or in composition, makes relatively little economic sense. Regarding China, a basic concern for India is that such trade is driven by strategic rather than purely commercial considerations. India points to its globally-competitive pharmaceutical and IT sectors’ lack of success in the Chinese market as an example of ‘hidden’ non-tariff barriers. It may be noted that the US has long complained about similar barriers to the import of foreign cars into otherwise open economies such as Korea and Japan, and it is not immediately clear whether China particularly discriminates against imports from just India. China’s apparent ‘hyper-competitiveness’ in supply of project imports, particularly in the electricity sector, also causes disquiet. Slightly different issues arise in the sourcing of telecommunications equipment from Chinese suppliers, in that there is no existing Indian supplier of comparable equipment. Here the concerns are of embedded security risks in China-sourced equipment, even though the leading manufacturer of this equipment, Huawei, now operates a significant research facility in Bangalore.

Trade issues like these remain the proximate irritants in the economic relationship at present, but there are equally important issues involved in foreign direct investment and other forms of financial cooperation. India has enormous needs and opportunities in the infrastructure sector and China has both skills and finance available in this area. China, in turn, stands to improve its own productivity by benefiting from areas in which India is a competitive supplier, including the sectors mentioned above. Accordingly, an important goal of this first Strategic Economic Dialogue should be to put in place mechanisms to enhance mutual understanding and transparency on these thorny issues between the two sides. This can be done by dialogue, and also through detailed joint research to validate and demonstrate non-discriminatory treatment. In time, the goal should be to develop sufficient interpenetration of the two economies, so that economics tempers insecurity, rather than the other way round.

Suman Bery is Country Director, India Central, at the International Growth Centre, New Delhi.

A version of this article was first published in the Business Standard.

1. The strategic implications of the economic rise of China and India
2. Japan-China Strategic Dialogue enough?
3. India, China and Asian economic integration

The narrative on the economic growth of ‘maritime East Asia’ in the period after the Korean War is well-established, and runs roughly as follows.

Japan’s reconstruction was facilitated by its integration with the US and Europe within the liberal trading and monetary order set up under US leadership at the end of the Second World War. This phase was followed in the 1970s by the rise of the so-called Newly-Industrialised Economies (NIEs): South Korea, Taiwan, Hong Kong and Singapore. These countries followed essentially the same path as Japan, but with a more prominent role accorded to the import of foreign capital. The third wave, in the 1980s, was associated with the rise of the core economies of ASEAN, powered through deeper integration with the still-vibrant Japanese economy.

This third phase lost momentum in the face of the prolonged financial and growth crisis of Japan as well as the Asian financial crisis of 1998, and gave way to the current phase, prominently associated with the sustained, rapid growth of China in the first decade of the new century.

China is following its Asian predecessors in significant and sustained unilateral trade liberalisation. Where it differs in its integration model is in its openness to foreign direct investment. These Chinese policies, further supported by the sheer scale of the Chinese labour force and the quality of Chinese infrastructure, facilitate a continued deepening of already strong intra-regional trade integration, and the development of production networks centred on final assembly in China.

The reshaping of the Asian economy around the rise of China is facilitated by the development of political consultation mechanisms in the ASEAN+3 countries (the ASEAN 10 plus China, Japan and Korea). An important issue facing Asia is whether and how these consultation mechanisms need to be adjusted for the next wave of Asian economic growth.

Several of these developments are already widely commented on. These include the likely shift in China’s own growth strategy away from merchandise exports toward domestic demand, and a corresponding shift in domestic saving-investment imbalances to levels that prevailed a decade ago, even as the country remains a significant capital exporter. Also fairly likely is continued sluggish growth in the advanced countries as their public finances and financial systems rebalance.

All this is the new, post-crisis, conventional wisdom. Less remarked though is another potentially-important trend, which is the scope for much deeper integration between India and China than currently exists. Measured in terms of purchasing power parity, China and India are already the largest and third-largest economies in Asia, with some prospect that India will soon become the second-largest Asian economy. Two-way trade between the two countries is growing rapidly to an estimated $60 billion in 2010, roughly a quarter of the volume of trade between China and all of ASEAN. Investment ties are also developing, though at a slower pace.

Notwithstanding these positive developments, economic engagement between these two fast-growing and large economies is well below potential. While this is partially a matter of weak infrastructure links, a deeper cause is lack of familiarity and trust between official and corporate elites in the two countries. The source of this distrust is primarily military and strategic, dating back to the border conflict between the two countries in 1962, and China’s close military links with Pakistan. But it is also in good measure economic, with the Indian corporate sector delicately poised between greed and fear — wishing to benefit from the scale and productivity of Chinese manufacturing while uneasy about permitting full-throated competition in India’s domestic market. India does not accord China ‘market economy’ status, and believes that China applies significant non-market barriers to access by Indian firms in areas such as pharmaceutical products and IT services where Indian firms are widely accepted as being internationally competitive.

Both countries have preferred to address these issues through intensive bilateral contact, as well as contact in various multilateral fora such as the G20 and East Asian Summit (EAS). In a speech delivered earlier this year, India’s former Foreign Secretary (previously an Ambassador to China) noted that between 2005 and 2010, Prime Minister Manmohan Singh and Premier Wen Jiabao had met no less than eleven times. Following Premier Wen’s official visit to New Delhi in December 2010, the two sides agreed to institute a strategic bilateral economic dialogue.

The issue is whether any of these tensions could be better eased through participation in plurilateral groupings rather than purely bilaterally, and, if so, what such a grouping might look like. At the global level, India and China are leading emerging-market members of the G20 and have co-ordinated their positions in areas such as the multilateral trading system, reform of the international financial institutions and climate change finance. The competitive issues are likely to be sharper within Asia, where India has valid concerns of being marginalised by Chinese trade and finance in a dynamic region of historic, cultural and strategic interest to it.

These issues of regional economic architecture are yet to receive sustained attention within the Indian establishment. Much will depend on how an expanded EAS, now to include Russia and the US, begins to function on security issues, and on whether that expanded EAS generates any economic coordination mechanism similar to that provided by ASEAN+3. In my own view India should embrace the EAS process vigorously as a way of complementing bilateral contacts with China that span economic and security issues. Whether this would also be the Chinese preference remains to be seen.

Suman Bery is Country Director for the India Central International Growth Centre and a member of the Economic Advisory Council to the Prime Minister of India.

This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘Asia’s global impact‘.

1. Asian economic integration? Address domestic inequalities
2. The India-China Strategic Economic Dialogue
3. Asian economic integration and cooperation- Challenges and way forward

In the coming decade, Indian cities will grow exponentially. It is essential they are kept healthy.

More by accident than design, India’s Five Year Plans are today well synchronised with its population census. The 12th Five-Year Plan is due to commence in 2012, a year after the population census of 2011 was conducted. Both the caste and poverty-line censuses are also to be conducted in the course of this year. A great deal of fresh, authoritative information will accordingly be available as India’s planners flesh out the prime minister’s directive to aim for growth in the range of 9 to 9.5 per cent over the 12th Five-Year Plan’s period, even while attempting to improve the distributive reach and ecological sustainability of this growth.

Interestingly, China also entered its 12th Five-Year Plan earlier this year. In contrast to the mandate given to India’s planners, China’s already approved plan seeks to slow down rather than increase aggregate growth performance over that achieved in the previous plan period. This is to allow the economy space to address the severe economic and social imbalances that have emerged over the course of the past decade’s rapid growth.

In a recent article in Economic and Political Weekly (‘Prospects and Policy Challenges in the Twelfth Plan’, 21 May 2011), India’s Planning Commission Deputy Chairman Montek Singh Ahluwalia provided his assessment of the 11th Five-Year Plan’s main accomplishments, and the prospects for improving growth performance in the 12th Five-Year Plan, arguing that one of the emerging challenges is managing India’s urban transition.

In this context, the Census 2011 revealed India’s rate of urbanisation increase over the prior decade was slower than projected earlier, both by UN experts and Indian scholars. The Census 2011 figures, once tabulated, will provide a definitive assessment of what happened in the last decade, and what might be expected in the decade to come.

In his article, Mr Ahluwalia reckons the current urban share of the population is at around 30 per cent, not much changed from the Census 2001-estimated share of 27.8. The Planning Commission currently projects this to reach 30 per cent by 2030, implying an increase of 250 million urban dwellers above the current 350 million. China’s latest census puts its urban share at almost 50 per cent, up by 13 per cent since 2000. Indeed, for the first time in history, the world now has more than 50 per cent of its population living in urban areas.

A broad range of factors influence the growth of the urban population, notably differentials between average household incomes in urban and rural areas. The Chinese experience suggests if India succeeds in achieving its ambitious growth objectives, the rate of urbanisation could increase even more rapidly than currently expected.

Increased urbanisation should be welcomed. Most modern economic activity takes place in cities, and growth in productivity and income is easier in an urban context. Well-designed cities are also efficient users of energy compared with dispersed habitations, and efficiently functioning cities are a key element in the competitiveness of a modern economy.

The Indian government has been primarily seized by two aspects of the urbanisation challenge: the financing of urban infrastructure and the energy needs of India’s emerging cities. The first was comprehensively discussed in the recent Report of the High Powered Expert Group Estimating the Investment Requirements of Urban Infrastructure (Chair Dr I J Ahluwalia) by the Ministry of Urban Development, while the second is being addressed under the Action Plan for Climate Change.

However, systematic attention is needed for a third important element of the urban challenge: the health status of urban citizens. These challenges were the focus of a workshop at Oxford in January. The workshop, with which I was involved, was organised under the aegis of the Emerging Markets Symposium, bringing together public health experts, economists and practitioners from cities in emerging markets from around the globe.

Several reasons make focused discussion of urban health issues in emerging markets important. For one, the growth and scale of emerging market cities over the next few decades will be unprecedented in human history. And the level of urbanisation will take place at comparatively lower levels of per capita income, compared to the now-rich countries, affecting the resources available to governments and the degree of inequality in urban populations.

Perhaps most importantly, health outcomes in cities have relatively little to do with healthcare expenditures and much more to do with broader elements of urban design and public health: water, air, transportation, recreational facilities and the like. As at the national level, these issues are typically seen in isolation, and resource allocation is determined within each ‘silo’, rather than optimising expenditure across functions. Yet health outcomes are critical not only for the welfare of the citizens but also for the urban workforce’s productivity.

Each urban conurbation is distinctive, and solutions will need to be found locally, as has been done in Latin American cities like Bogota and Curitiba. Three things seem essential to make progress: effective and politically-empowered mayors (or chief ministers); a well-developed tracking and information system that helps monitor and analyse trends in health status; and flexibility in resource-allocation at the city level, irrespective of where those resources ultimately originate.

It is hoped that those involved in preparing the 12th Plan will give this dimension of India’s urbanisation the attention it deserves. Not doing so at this critical juncture could trap millions of Indians in avoidable misery.

Suman Bery is a country director at the International Growth Centre and member of the Prime Minister’s Economic Advisory Council.

An earlier version of this article was published here by the Business Standard.

1. Urbanisation: the driving force behind India’s growth
2. The route of urbanisation in China
3. The myth of China’s urbanisation

The earthquake, tsunami and nuclear disaster in Japan and the global financial crisis centred on the US and Britain suggest that decision makers in even the most advanced societies experience difficulty in acknowledging, let alone managing, worst-case scenarios in modern, complex systems.

In each case, the underlying ‘failures’ were more political than technical. In the US, both the Clinton and Bush administrations believed that market discipline was superior to regulatory oversight in achieving an appropriate balance between innovation and safety. This view was strengthened by the apparent ease with which the US financial markets handled earlier crises, such as the Black Friday stock market crash of 1987, the Long-Term Capital Management crisis a couple of years later, and the succession of emerging market crises, including Asia, Brazil, Argentina and Russia around the turn of the century.

Though this success undoubtedly led to complacency, there was little reason to expect that a widely-expected correction in the US mortgage market would lead to the systemic upheaval that ensued. However, in retrospect, one can find prescient voices, such as Raghuram Rajan and Nouriel Roubini, who warned of the build-up of systemic risks.

Similarly, in the case of the Japanese catastrophe, the tsunami experienced, though massive, was not unprecedented for the area. The decision to site the reactors there, and to store spent fuel rods also on site, represented a gamble by decision makers and regulators in the face of opposition from more affluent areas.

It is important to draw the right lessons from these landmark episodes, but it is difficult to know what those lessons are. This was clear from a fascinating conference at the Lauder Institute at the Wharton School, University of Pennsylvania on new perspectives on global risk following the financial crisis. What was unusual about the conference was that it attempted to bring perspectives from various disciplines — sociology, history, business and economics — to reflect on the nature of the global economic and business risk in the wake of the financial crisis. The Japanese disaster was obviously unanticipated at the time when the conference was organised, but many of the insights drawn from the financial crisis are, in principle, transferable to the Japanese crisis.

Some of these insights had to do with the sociology of knowledge elites, and echoed the points I made last month citing the International Monetary Fund’s own internal evaluation of the tendency for ‘group think’ within similarly trained cadres. Within such an ‘established paradigm,’ dissenting voices find it hard to be heard until and unless they are ‘certified’ by an accepted authority.

Who exactly should and can perform this legitimising role is a somewhat mysterious process. Clearly, the IMF and much of academia failed to acknowledge these views in the build-up to the crisis. By contrast, since the crisis the IMF has been furiously pedalling to discard one former dogma after the other. Capital controls! Low inflation! Fiscal restraint! All of these old arks of the covenant now lie in ribbons, and it is not clear what will replace them and when, although it is also true that the old rules of thumb did not anticipate that large parts of the world would be caught in a liquidity trap.

It was also important to be reminded of Frank Knight’s distinction between risk and uncertainty, as also the fallacies of composition, which failed to take into account systemic consequences of behaviour that is rational for each individual actor.

For me, however, the more intriguing issues raised by the conference have to do with the implications for India’s own development strategy. It seems more than likely that the global economic environment will remain turbulent in a number of important respects for some time to come, quite apart from enhanced geopolitical security risks. Exchange rates, capital flows and commodity prices are all likely to fluctuate within wide ranges. The question is: how should the society be equipped to deal with this volatility?

A useful start would be to distinguish between the impact at three levels of the nation, businesses and households. A possible extension would be to examine the impact at the level of the individual states as well. In the recent crisis, the national level fared relatively well, essentially because a reasonable amount of fiscal and monetary space had been created. In addition, despite its high debt level, India was protected because its public debt is denominated in rupees and is largely forcibly held by public financial institutions. There was less protection available for businesses and households, however, and some businesses were themselves sources of vulnerability by taking on unhedged foreign exchange exposure. The solution is clear, if difficult to implement: tighter monitoring of corporate borrowers by their banks, and continuing the drive to expand the range of hedging instruments.

The most difficult issues, both analytically and in terms of policy, arise at the household level. As the recent crisis has shown, there is great injustice involved in vulnerable workers being the hapless victims of international forces over which they have no control. Yet I, for one, have no doubt that as a group India’s workers (and farmers, for that matter) are better off integrating with the global economy, and taking on board the additional volatility that this implies, as compared to the alternative of disengaging from global involvement. It is clear from the recent experience with food and fuel subsidies that the attempts by government to act as a shock absorber are not sustainable in the long run.

There are two more complications. First, as the recent crises have revealed, with complex systems it is difficult to anticipate the speed and ramifications of any crisis. Second, for a fast-growing country like India, it is important to facilitate, and not impede, adjustment and also to put safety nets in place that are consistent with longer-term competitiveness and flexibility.

What does this imply for planning? It suggests that our planning increasingly should be about scenarios and gaming rather than point predictions, and that the focus should be on contingency planning as much as the base case. It also raises profound questions about the division of labour between government and the household in bearing risks, which will need to be the subject of a future article.

Suman Bery is Country Advisor, International Growth Centre and Member, Prime Minister’s Economic Advisory Council.

This piece was originally published here in The Business Standard.

1. Managing the risk of inflation during economic recovery – the case of Vietnam
2. Capital controls: The way forward for India
3. The values dimension of Southeast Asian development and the rise of China

On November 3, shortly before US President Barack Obama’s arrival in India, the Federal Open Market Committee (FOMC) of the US Federal Reserve announced that it intended to undertake a fresh round of purchases of longer-term treasury securities in an aggregate amount of US$600 billion until the second quarter of 2011, at a pace of approximately US$75 billion per month.

Even though Fed Chairman Ben Bernanke had done his best to ‘trail’ (that is, anticipate) this decision, starting with a speech at Jackson Hole, Wyoming in late August, the formal announcement of this move (so called QE2, denoting the second round of quantitative easing) has unleashed a firestorm of criticism both within the US and internationally.

In the run-up to the G20 Leaders’ meeting in Seoul (where Prime Minister Manmohan Singh and President Obama were both present) China, Brazil and Germany were among the most vocal critics of this monetary expansion. These countries have portrayed it, in my view incorrectly, as an ill-disguised attempt by the US to depreciate the US dollar as part of a feared circle of competitive devaluations across the major economies.

As widely noted in the international press, India has been more supportive. At his joint press conference with President Obama, Prime Minister Singh observed, ‘A strong, robust, fast-growing United States is in the interests of the world … and therefore, anything that would stimulate the underlying growth and policies of entrepreneurship in the United States would help the cause of global prosperity.’ While some of this may just have been the courtesy of a polite host in the presence of an honoured guest, it also seems to imply a more mature and relaxed attitude towards exchange rate flexibility on the part of the government. This interpretation is also consistent with both the relatively limited intervention in the exchange markets by the Reserve Bank of India in recent times, despite strong capital flows, as well as statements by Finance Minister Pranab Mukherjee that India was not contemplating limiting foreign flows into its equity markets.

Nevertheless, this episode has served to crystallise the issues and tensions in the present international monetary system. If anything, these issues are likely to gain even greater prominence now that the meeting in Seoul has concluded, because France has taken over as the chair of the G20. President Sarkozy has already signalled that he intends to make review and reform of the international monetary system (IMS) a core agenda item of that Presidency, and is bound to raise these issues when he visits here early in December.

India has in general been relatively passive on these aspects of the global financial architecture, showing more interest in the governance reforms of the International Monetary Fund (IMF). Yet, as happened over the previous decade in the area of multilateral trade negotiations, India could easily be asked to play a central role in the redesign of certain aspects of that regime. Accordingly, it is important that there be a more robust domestic debate on the key issues, so as to help our officials better articulate our core concerns and interests.

What, then, are the important issues that might arise in an agenda for international monetary reform? Unfortunately, the public debate on these issues is rather confusing, combining as it does elements connected with what one might call the ‘real’ economy (savings and investment; current account deficits; global imbalances) with the monetary system. As Ted Truman of the Peterson Institute in Washington has observed, the enormous expansion of global finance over the last decade now means that the latter increasingly sets the rules for the former, at least until and unless there is a fundamental roll-back of private cross-border finance, of the type that took place during the great Depression.

Within the more narrowly defined monetary area, the key issues have to do with the exchange rate regime, the accumulation of reserves, the supply of reserve assets, volatility in exchange rates and volatility in private capital flows. While under the post-war Bretton Woods system, fixed exchange rates against the dollar were the norm, the vogue today is for ‘market-determined’ flexible exchange rates, at least for systemically important countries, even though ‘clean’ floats are more the exception than the norm in most emerging markets, India included.

At the same time, exchange market intervention has crept back into the financial armoury of even the advanced countries, such as Switzerland and Japan, with the clear objective of influencing (the polite word is ‘stabilising’) the nominal exchange rate. The challenge here will be to devise rules that are appropriate for both the advanced countries and for large emerging markets such as China, Brazil and India. India will need to be vigilant to ensure that these rules strike the right balance between policy flexibility and harmful mercantilism.

Equally difficult judgments arise on the appropriate stock of reserves. The bulk of reserves accumulation over the past decade has been by major emerging markets, primarily as a form of insurance against volatile capital flows and possible speculative attacks. Despite their high cost, such reserves did demonstrate their worth as a protective device in the crisis. At the same time, it is these reserves that have been cited as one cause of the financial crisis.

Finally, there is the role of the dollar as the central reserve asset. It is being argued again now as in the 1960s, that the reserve role of the dollar has encouraged unsustainable policies, and that a range of alternatives is needed. But a move to a multi-currency reserve system (or to a synthetic unit such as the IMF’s SDR) needs careful management to avoid destabilising flows.

Emerging markets have now become systemically important, China most of all, but India and Brazil in due course. Yet they remain ‘emerging’ and will be for a considerable time to come. At the same time, the negotiating skills and power of the advanced countries way exceed those of the emerging markets. As monetary reform approaches centre stage, we must be careful not to throw the baby out with the bathwater.

Suman Bery is Director-General, National Council of Applied Economic Research.

This piece originally appeared in the Business Standard and may be found here.

1. Global reform: Fixing interest rates trumps fixing exchange rates
2. Will Asia have common interests in global monetary system reforms at the G20?
3. India: Monetary policy dilemmas

The East Asian countries responded with coherence and vigour to the weaknesses in their financial systems revealed by the crisis in 1997-98. This raises two issues. First, how important does that earlier agenda remain? Second, is it is reasonable to expect comparable alignment among the Asian members of the G20, particularly on the inter- related issues of global imbalances and the reform of the international monetary system?

Among the ASEAN+3 group of countries (the ASEAN 10, Japan, Korea and China), there is a well-established narrative on the 1997-98 financial crisis. The crisis had its roots in an excessive reliance on short-term foreign debt, stimulated by fixed exchange rates and inconsistent monetary policies, intermediated through fragile and poorly supervised banks.  By contrast, fiscal policies were not to be blamed. There was also extreme anger at the high-handed treatment countries received from the International Monetary Fund.

Based on this assessment, the regional policy response was two-fold. One pillar was the Asian bond market initiative (ABMI), designed to deepen local currency bond markets in the major emerging markets of the region, so as to provide an alternative to bank financing. The second was the Chiang Mai Initiative (CMI). While this originally consisted of bilateral swap lines among regional central banks, it has now been expanded in scale and has also been multilateralised to provide a regional source of liquidity to complement support from the IMF.

The third element of the region’s response was the massive resort to ‘self-insurance’ through the accumulation of foreign exchange reserves in a number of countries. This has triggered fierce controversy, particularly between China and the US, on the role of this Asian ‘savings glut’ as an underlying driver of loose monetary conditions.

So what should be done now? And is it likely that the other Asian members of the G20 (India, Indonesia and Australia) will feel able to make common cause with Japan, Korea and China for a distinctive Asian view on international monetary and financial reform?

All G20 countries clearly desire a monetary order that supports orderly, non-inflationary  global growth. however, of the six Asian members of the G20, only China and Japan seem likely to have chronic saving surpluses into the indefinite future. The remaining four will have an interest in a global monetary order which remains conducive to vibrant flows of cross-border capital.

China has been most aggressive in condemning  the post-Bretton Woods reserves ‘system’ (or non-system) as providing the United States an unacceptable ‘exorbitant privilege’ as reflected in the scale of its current account deficits.

While there can be legitimate criticism of the conduct of US monetary and fiscal policies over the last two decades, these have relatively little to do with the role of the US as the supplier of reserves. Indeed, one could just as well argue that China has enjoyed an equivalent privilege in its ability to become the workshop of the world while maintaining a depreciated real exchange rate. It seems to me unlikely therefore that Chinese efforts to replace the dollar will, by themselves enjoy much support.

As pointed out by Barry Eichengreen, any displacement of the dollar is likely to be a market-driven response, based on global perceptions of the quality of economic management in the US. There is also a logical fallacy at the heart of the Chinese critique. Supplying the world with dollar reserves does not oblige the US to run a deficit on its current account, merely a deficit on its basic balance.

The recent resort by Japan to currency intervention suggests that even the advanced countries are beginning to feel the burden of major swings in nominal exchange rates. Yet it is difficult to believe that the genie of mobile capital will easily be put back in the bottle. One should not forget that, for all its imperfections, it is under the post-Bretton Woods non-system that Asia has prospered.

It is unlikely that there will be a common ‘Asian’ view on international monetary reform at the G20. China apart, most of the other members remain at ease with a US anchored monetary system, with the comfort of alternatives, initially the euro, and in due course the renminbi. What is desirable is to strengthen the safety net available to emerging markets so they feel less need to accumulate reserves. This initiative, being pushed by Korea, probably represents the limits of what is feasible, and perhaps even what is desirable. And as for the earlier Asia-specific reform agenda, it is no longer where the action is likely to be.

Suman Bery is director-general, National Council of Applied Economic Research, and member of the Prime Minister’s Economic Advisory Council.

This is an article from the most recent edition of the East Asia Forum Quarterly: ‘Asia and the G20’.

1. India and global monetary disorder
2. China’s monetary and exchange rate policy and the global economy
3. Reshaping global economic governance and the role of Asia in the G20

On the reasonable assumption that India’s current UPA government will complete its full term, the Twelfth Five-Year Plan (2012-2017) will be prepared on its watch.  But is the idea of state planning in India still relevant?

Professor T N Srinivasan of Yale University, feels that the whole business of planning is an embarrassing relic of an earlier era. He argues that planning as we know it should be abolished, and the Planning Commission itself wound up. This seems unlikely to happen; instead, according to press reports, the Commission is currently engaged in an internal effort to rethink its role and purpose.

One important achievement of the Commission in the six years since the UPA first came to power has been its branding of the government’s economic strategy as ‘inclusive growth’ and the deepening of that idea in the 11th Plan document, prepared in 2007. This is a slogan that has been politically astute and has resonated in popular discourse. But all slogans need refreshing, and it is not too early to start thinking on possible themes for the next Plan.

In my view, the Commission would perform a valuable service by shaping a broad national debate on the issue of economic security. At one level, this would not be anything new. Led by activists in the National Advisory Council, a rights-based approach to economic security has, in many ways, been the hallmark of this government. The prototype for this approach was the Mahatma Gandhi National Rural Employment Guarantee Program, followed more recently by the Right to Education Act and the Food Security Bill currently under consideration.

These landmark pieces of legislation have been accompanied by other important national social protection schemes in the areas of rural health insurance and rural old age pensions, and the hugely ambitious Aadhar program of the Unique Identification Authority of India. These initiatives are over and above the various existing sectoral schemes for such groups as self-employed workers in the handloom and bidi sectors. Not to be outdone, some of the more affluent states, notably Tamil Nadu and Andhra Pradesh, have also developed their own health insurance schemes.

What is developing, accordingly, is an expensive patchwork of activist-led initiatives, largely focused on the rural areas (where poverty is concentrated, agriculture is stumbling and people vote) without a coherent articulation of the reasonable, affordable and sustainable division of labour between the state and the individual in dealing with risk.

Given its political nature, it is perhaps unreasonable to expect the Planning Commission to provide an objective assessment of the strengths and weaknesses of the edifice that is being constructed, yet it also seems a pity that the formidable talents of the deputy chairman and the chief economic adviser, both world-respected authorities on issues of poverty and social protection, cannot be deployed for a sophisticated discussion of what is needed, and where we should be headed.

What issues should such a discussion include?

It is worth distinguishing between issues of economic security at the level of the nation, and issues of economic security at lower levels, down to the household and even the individual, highlighting the links between these levels. In common with virtually all nations, the Indian state has accepted the responsibility to ensure adequate aggregate supply of food and energy to the country. Security has tended to be interpreted as self-sufficiency wherever this is a realistic prospect; where trade is unavoidable, as with hydrocarbons, there is a pronounced preference for such trade to be controlled by the public sector.

While there is no denying the complexity of the issues, both these premises need to be re-examined. This is important particularly given the undesirable (and inefficient) precedent being set by Chinese state-dominated companies in buying up land and raw material assets around the world, at relatively rich valuations, at the peak of the commodity cycle.

It is not my case that ordinary mergers and acquisitions between Indian firms and their suppliers abroad should be discouraged; far from it. My point rather is that India’s long-term interests are almost certainly better served through increased reliance on market mechanisms and company-to-company transactions rather than through state-led actions, with the government playing at best a facilitating role through its diplomatic activities. In particular, the idea that India should emulate China and create a sovereign wealth fund to acquire overseas energy assets strikes me as particularly dubious and risky, even as the Chinese presence undoubtedly complicates life for our private sector.

Turning next to the household level, there is now an enormous body of work by academic scholars and within international organisations about life-cycle, livelihood and income risks to which households in developing countries are exposed, and the optimal design of government interventions and financial instruments to help households cope with these risks while containing the fiscal burden.

Wherever possible, it is preferable to provide households with financial instruments to pool and manage their risks rather than budgetary transfers, and to prefer general income support to allow the household to decide on its own expenditure priorities. A common, and to some extent valid, criticism of the preference for cash transfer schemes is that they risk being misused by the head of the household; hence the increasing tendency, particularly in Latin America, to channel funds to the mother.

The fiscal constraint does matter, not just to avoid inflation, but because unless targeting is accurate (which in India it seldom is), such transfers can be regressive, as a significant portion of tax revenues still come from indirect taxes.

The final point has to do with globalisation, growth and labour mobility. As the recent crisis has shown, globalisation adds a layer of volatility, even as it helps raise the base of income. It also adds pressure to reallocate labour from low to higher productivity activities, which is the main route for increased income. Efforts to provide cyclical unemployment insurance should not impede this reallocation.

Suman Bery is director-general, National Council of Applied Economic Research, and member of the Prime Minister’s Economic Advisory Council.

The original version of this article was published here at the Business Standard.

1. Targeting by social background vs. economic status in anti-poverty programs in rural India
2. Coping with unprecedented urbanisation in India
3. Obama visit to India: East Asia’s emerging security multilateralism

The Business Standard editorial ‘The IMF gets more upbeat’ noted that the IMF has had a patchy record in charting the evolution of the present crisis, following developments more than anticipating them. Despite this performance, and its poor performance in predicting the crisis, each update of its forecast for the global economy (the World Economic Outlook, or WEO) receives considerable international press attention and commentary.

While the Fund’s full analysis of the global economy is undertaken twice a year — in April and September at the time of the meetings of the governors (i.e. finance ministers) of the IMF and the World Bank — the organisation also undertakes summary intermediate revisions. One such forecast was unveiled in the World Economic Outlook Update, July 8, 2010. Before examining the implications of this forecast for Indian policy, particularly the quarterly monetary policy update due at the end of July, it is worth reflecting briefly on the context in which this latest forecast has been prepared.

Unusually, the release occurred in Hong Kong, China. It was timed for the eve of a major gathering of Asian policy-makers to take place in Seoul, Korea on the joint invitation of the Korean government and the IMF. Both events signal the increased importance of Asia in the global economy. They also indicate the desire of the IMF to reconnect with a group of countries which it alienated through its response to the Asian crisis of 1997.

With the notable exception of Pakistan, these Asian countries (ASEAN, China, India, and the ‘old’ newly industrialised economies of Singapore, Taiwan and South Korea) are unlikely to return to the Fund for resources any time soon. Instead they have spent the past decade ‘self-insuring’ against an unpredictable global financial system through a large build-up of foreign exchange reserves. Under Chinese and Japanese leadership, within the framework of a mechanism of swap arrangements referred to as the Chiang Mai Initiative (CMI), the underlying agenda has, in fact, been to develop alternatives to an IMF seen as subservient to American and European interests.

The alacrity with which the Fund has rushed to support countries and banks in Europe in the present crisis, even as the reform of voting power and board representation in the Fund proceeded at a glacial pace, would perhaps have done little to assuage these concerns. Yet the Fund wishes to remain at the heart of the reform of the international monetary order (exchange rate regimes, capital movements, liquidity provision, safety nets) and the rebalancing of the global economy. For this, it badly needs Asian engagement, particularly from the Asian emerging market members of the G20 (South Korea, Indonesia, China and India).

As widely reported in the Indian press, global growth in 2010, weighted by purchasing power parity, is now forecast at 4.6 per cent as against 4.2 per cent as recently as late April. Despite the turmoil in European sovereign debt markets, almost all parts of the globe have been upgraded. In addition, the charts supplied in the document clearly indicate that the world is experiencing a classic ‘V’-shaped rebound in output, of the kind associated with an extreme inventory cycle.

Within this generally positive global picture, as might be expected, both the absolute levels and the upgrade are strongest for Developing Asia: China, India and the ‘ASEAN-5’ (Indonesia, Malaysia, the Philippines, Thailand and Vietnam). The April projection of 8.8 per cent for calendar 2010 has been further boosted to 9.4 per cent. I would surmise that the main difference to the usual forecast of 8-8.5 per cent for fiscal 2010-11, is the very strong growth performance of the first quarter of this calendar year. Given the very weak performance in early 2009, this can have a big effect on the calculation of the change in average level of GDP for 2010 over 2009.

What does this comparatively buoyant picture imply for Indian policy? While the usual caveats about forecasts are in order, and for many parts of the world, notably the US, the jobs picture remains dismal; it now seems safe to say that the global recovery is well established. This was not my view at the time of the April monetary policy. My earlier concern was that simultaneous tightening of both fiscal and monetary policy was risky at a time when the global prospect was uncertain and domestic private investment was still shaky; but now, equity market developments, the continuing good news on the manufacturing front (the index of industrial production) and indirect tax receipts are reassuring.

This then leaves the external sector: trade, capital movements and the external price of the rupee. There have been a number of developments in this space in recent days. These include the release of the preliminary balance of payments data by RBI (Reserve Bank of India) for the full fiscal year 2009-10; the simultaneous release, also by RBI, of data on external debt of India; recent numbers on merchandise exports; the announced return to a gradual crawl of the Chinese yuan (RMB) against the US dollar; and the general recovery in world trade.

As I’ve noted, eminent Business Standard columnists have expressed concern on the real effective appreciation of the Indian rupee. In speeches delivered in Washington and Zurich, RBI Governor Subbarao has also expressed concern on volatile capital flows and their impact both on asset markets and on managing the nominal exchange rate. The balance of payments data for the last quarter of FY10, and for the full fiscal year, would seem to give some credence to these concerns, with the current account deficit estimated at 2.9 per cent of GDP by RBI. This is certainly a level that deserves watching, but given the big difference between the trade data reported by the Directorate General of Commercial Intelligence and Statistics and that reported by RBI, as well as the healthy growth of overall exports, it may make more sense to adjust the current account through fiscal consolidation, rather than through aggressive intervention in the exchange market.

Suman Bery is director-general, National Council of Applied Economic Research, and member, Prime Minister’s Economic Advisory Council.

This article first appeared here in the Business Standard.

1. India: a tough year ahead
2. The long and rocky road to global recovery
3. India-ASEAN FTA Agreement: Challenges Ahead

What is at the heart of the Greek crisis? What are the important lessons for India? Based on a fairly close reading of the international press, it has been surprisingly hard to answer the first of these questions, in a way that helps address the second.

The crisis first erupted in late 2009, when the incoming socialist government revealed that its predecessor had understated the country’s fiscal deficit. As jittery financial markets took fright, attention shifted to other areas: the overall size of the country’s sovereign debt and the rigidity of its nominal exchange rate given its membership of the Eurozone.

As a coordinated policy response has been fashioned, including exceptional access to the resources of the International Monetary Fund (IMF), there has been considerable criticism (for example by Arvind Subramanian in these columns) of the burden-sharing between the official and the private sector envisaged in the programme. Banks holding Greek debt are not being asked to suffer write-downs; indeed, Greece is expected to emerge from its three-year programme with the IMF with an even higher ratio of public debt to GDP.

There is criticism that the fiscal adjustment being imposed on Greece condemns it to unsustainable economic stagnation, and is merely postponing an unavoidable restructuring of its sovereign debt. There is also criticism of the asymmetry of the adjustment being imposed on Greece, particularly by Germany which is unable or unwilling to alter a growth model that depends on its running substantial export surpluses.

Many of these critiques, however, lack conviction. As has been frequently pointed out, Japan has systematically sustained much higher sovereign debt levels than Greece, with a decade of slow growth. Yet it has not (yet) suffered a sovereign debt crisis. Both Belgium and Italy, which are also countries with chronically high stocks of sovereign debt, too have managed to soldier on for decades.

More recently, in response to the global financial crisis, and still within the eurozone, Ireland has voluntarily committed itself to a severe fiscal adjustment with consequent implications for its growth prospects. It was on the way to regaining credibility and being rewarded by the financial markets before it was hit by the contagion spreading from Greece. Outside the eurozone, Latvia chose to impose a punitive deflation upon itself in order to avoid breaking its link with the euro.

One needs to remind oneself that the essence of the Bretton Woods arrangements that served the world economy so well in the two decades after the Second World War, was to maintain agreed par values (exchange rates) as far as possible, as an anchor of both domestic and international monetary stability. There is no ‘ideal’ nominal exchange rate regime. One important reason for Greece’s travails is the conviction in the financial markets that its political system does not have the same capacity as Ireland to force through the necessary economic adjustment.

The lessons for India of this Greek drama are more prosaic, but nonetheless important. Although it has not been particularly remarked upon, there seems to have been a basic failure of both public and external debt management, one that also seems to have caught the ratings agencies unawares. Greece suffered the misfortune of needing to roll over large amounts of its sovereign debt at a time when the private markets closed down for it. This is the phenomenon of the so-called ‘sudden stop’ which has been extensively analysed for emerging markets. As a member of the euro area, Greece apparently believed that it was immune from this risk. As T N Ninan has observed, this view was shared by the ratings agencies, which continued to classify the country’s debt as investment grade not long before declaring it as junk.

Out of long experience, India has developed multiple instruments and defences to guard against these debt management risks of particular importance given its relatively high stock of public debt. (External debt remains manageable in aggregate, although maturity management requires continued vigilance). These measures include restricting sovereign market borrowing to rupee instruments; capping the access of foreign institutional investors to the local debt market; imposing heavy portfolio requirements on a broad range of financial institutions (banks, provident funds) to ensure a market for government debt; restrictions on amount and maturity of overseas borrowings by corporate entities and financial institutions via the regulations covering external commercial borrowing (ECB); regulation of outward capital movements; and finally the accumulation of a large stock of foreign exchange reserves.

The Greek crisis serves as a salutary reminder of why these controls were instituted and the care that is needed as we exit from them as part of financial liberalisation. It is fervently to be hoped that this body of experience transfers intact when debt management moves from the Reserve Bank of India (RBI) to the Ministry of Finance.

A second lesson is the importance of avoiding default. India gained huge credibility in the markets in 1991 when it went to the extreme step of pledging its gold reserves rather than call a moratorium on its debt service. India’s aversion to inflation and its relatively high domestic interest rates have equally meant that domestic holders of government debt have also not been dispossessed. As Ken Rogoff of Harvard has noted (based on extensive research on sovereign defaults jointly with Carmen Reinhart of the University of Maryland), it can take up to a century to establish confidence and credit as a sovereign borrower. Accordingly, I find the calls for debt restructuring glib and short-sighted, even if a serial defaulter like Argentina appears not to have paid a high price in the short run for its misbehaviour.

The third lesson is that, when the chips are down, there seems to be little alternative to austerity. Smarting from the criticisms it encountered at the time of the Asian crisis in 1997, the IMF has attempted to tone down the harshness of its conditionality, particularly on fiscal adjustment. Yet in the Greek case, the judgment seems once again to be that there is no prospect of restoring financial market access without a Draconian fiscal programme.

Finally, the crisis does support the caution exercised by the RBI Governor in his April policy statement. As I remarked in ‘Monetary policy: The new normal’, the world economy is not out of the woods. External demand is likely to remain sluggish. Concerns about overheating, therefore, remain premature, despite the headline inflation numbers.

Suman Bery is director-general of India’s National Council of Applied Economic Research and a member of the Prime Minister’s Economic Advisory Council.

This article was first published here at the Business Standard.

1. The Greek tragedy: Global debt crisis and balance sheets
2. How should Asia read the Greek tragedy? – Weekly editorial
3. Greece and the vulnerability of the European Monetary Union