India is a country of 1.2 billion people, but only a small fraction of the population is able to establish its identity through documentation.

The inability to prove one’s identity is a major handicap for the poor, as access to benefits under the government’s anti-poverty program — such as old-age pensions, subsidised food grains and rural employment — are often denied on this basis. Subsidised food grains, for example, can otherwise achieve broad coverage, and are supplied through the Public Distribution System (PDS) to 180 million poor. This occurs through a network of half a million licensed shops at an annual subsidy of Rp400 billion (US$8 billion). But nearly 40–50 per cent of the subsidy gets wasted on undeserving people: ‘non-poor’ people who obtain a card entitling them to subsidised food; poor that inflate the number of members in their family; and through cards in the names of nonexistant people. Such fraudulent entitlement is often obtained by committing acts of bribery.

The Unique Identification Authority of India (UIDAI) was created during 2009–10 to issue a 12-digit unique number (called aadhaar) to residents in the belief that these measures would plug the leakages and eventually strengthen national security. But there are many vocal critics of aadhaar who question the creation of a centralised database which may be open to abuse by police and security agencies. Aadhaar is linked to each individual’s basic demographic and biometric information — a photograph, ten fingerprints and an iris scan — stored in a central database, but the number is not classified by caste, creed, religion or location. Citizens’ identity can be verified using hand-held devices linked to the mobile phone network by sending the aadhaar and a finger print to the central database. The UIDAI then promises to give a ‘yes’ or ‘no’ response to verify the individual’s identity within eight seconds. Though possessing aadhaar is not mandatory, obtaining one does require proof of identity, an address and a date of birth. Individuals without identification documents may obtain aadhaar if they are introduced to the issuing agency by an existing participant of the scheme — and nearly 37 million residents have been issued with aadhaar so far.

Two critical steps will determine the program’s success. First is the enrolment of a significant proportion of India’s population and the collection of error-free information. Duplications will also need to be weeded out. This is a difficult technical task, but it should not prove insurmountable given India’s expertise in software and algorithm development. Second is the use of aadhaar by various government departments to authenticate citizens who request a service — no government agency currently uses it as a basis for delivering services. This will require the front-end to electronically capture basic transactions. For example, half a million shops will need to obtain a finger print and seek authentication from the central database through the PDS alone. Keeping the hand-held devices in working condition and training shop owners to use such a device are challenges that have not been overcome in the past.

Experience of electronic service delivery in India is a mixed bag: a citizen-based assessment of 40 large projects shows that the process has become efficient, but the impact on corruption is marginal. Interestingly, nearly 90 per cent of the approximately 100,000 internet kiosks created in rural areas to deliver certificates and licenses are not delivering any government services, and departments at the back-end, where the basic data is maintained and the issuing of certificates is authorised, have not been enabled with information and communications technology. Any procedural reform that reduces the lower bureaucracy’s capacity to delay or deny services has been resisted. In the case of aadhaar, the departments, too, will resist its use on some pretext. In fact, there has been no pilot testing of aadhaar for end-to-end delivery of any service. Critics wonder whether the many technical and implementation issues will be successfully handled, as the task of collecting 12 billion fingerprints and 2.4 billion iris scans is significantly larger than for any existing biometric database in the world.

Aadhaar was also expected to be widely used for opening bank accounts, so that cash subsidies could be transferred to the poor, instead of distributing subsidised food grains and creating state-supported jobs in rural areas. But such a qualitatively different restructuring of the state’s role in the social sector is unacceptable to many people. Moreover, the Reserve Bank of India has thrown a spanner in the works by declaring that aadhaar would not be a sufficient proof of address — other documents would also be needed. Aadhaar began with the promise of making delivery of government services to the poor efficient, convenient and corruption-free. With so many implementation challenges and turf battles ahead, such a promise may be harder to keep than originally anticipated.

Subhash Bhatnager is an Honorary Adjunct Professor at the Indian Institute of Management in Ahmedabad.

1. India: Labour market’s changing times
2. The old ghosts of India show their faces again
3. Incredible India? Complicated India

In a country like Solomon Islands, with over 60 languages and 150 dialects spread over just under 1000 islands, loyalty to one’s nation often comes a long way behind loyalty to one’s relatives, or wantoks.

Aid donors run here with slogans like ‘tugeta yumi save duim’ – together we can do it – but Solomon Islanders have often recognised the differences rather than the similarities between themselves since independence in 1978.

Richard Irosaea, the Premier of Malaita, has the red white and blue flag of his province draped over his coffee table in his office in Auki, Malaita’s capital. When I spoke with him, the topic quickly turned to independence.

Premier Irosaea clearly believes in Solomon Islands, but not unconditionally.

‘If Solomon Islands becomes a federal state, we will definitely not be part of it. We will become a separate nation.’

Talks on federalism have taken place at a number of leadership conferences in Solomon Islands, including at a recent Premier’s Conference, though the idea is still controversial.

Silas Talota, the Minister assisting the Premier, was even more forthright.

‘I think that [Malaitan independence] is the way forward. Malaita should pursue that.’

Talk of provincial independence is common in the Solomons. Western Province, Temotu, and Makira provinces have called for independence at one time or another, and sceptics say that such talk is more about securing funding from the national government than genuine sentiment. Nevertheless, calls for independence tend to rattle national leaders, especially when it comes to Malaita. One out of every three Solomon Islanders is Malaitan. In Honiara, Solomon Islands’ largest city, that figure changes to one in two.

There is an echo of the Tensions in his thinking. He believes Malaitans are discriminated against throughout Solomon Islands, and believes – like many others – that Malaitan immigration to Guadalcanal was the root cause of the Tensions. Irosaea thinks that bringing Malaitans back to their home province could help from a social order standpoint, but he also believes in their labour.

‘I’d like them to (come back). Because of the human resources we have, Malaita would stand to be a successful state. I have no doubt about it.’

Malaita certainly faces challenges. World Bank data for 2010 showed that almost 30 per cent of the population of Malaita is in the bottom 3 income deciles, by far the worst rating for a province. Malaitans leave their province because there are few jobs and opportunities. Their labour in other provinces, and particularly in Guadalcanal, is an important contributor to the fragile Solomon Islands economy. Focusing development on Malaita may be part of the solution, but most aid money in the Solomons is spent in Honiara.

Francis Fukuyama visited Solomon Islands in 2008. During his visit, he called for the political elite in Solomons to lead a push towards nationhood to stop ethnic tensions from surfacing again. At the time, he said that wantok loyalties could be held in check by ‘a national elite that is loyal to a larger concept of nation.’

Compatibilist efforts to work the benefits of wantokism into the civil service have gone some distance since his visit, but many still associate the dense web of relationships in Solomon Islands with split allegiances.

At a Truth and Reconciliation Commission forum recently, participants in a question and answer session were asked to identify where they were from. Almost every questioner identified himself or herself by island. Only one, a government official, said he was from Solomon Islands.

Solomon Islands has some distance to go in gaining a thoroughgoing sense of nation. Hints at secession, particularly within its largest province, make that project even harder.

Charles Prestidge-King is a Masters of Arts (Strategic Studies) student at ANU, currently living and working in Honiara, Solomon Islands. He has written about the Solomon Islands for the Sydney Morning Herald, The Age, Australian Associated Press, and the Lowy Interpreter.

1. The Solomon Islands and Pacific insularity
2. Solomons avoids violent election, but stability uncertain
3. The Solomons’ new leader

A current account deficit widening at a furious pace, high inflation, a tightening monetary cycle, foreign inflows driving stock prices and an appreciating currency — these form an unusual macroeconomic constellation for liberalising the capital account.

Yet these beeps have been ignored, even as fresh pastures are opened for foreign investors. This also comes at a time when Western grasslands remain dry, the US Federal Reserve is poised to unleash a fresh round of liquidity, investors are rebalancing portfolios toward emerging markets, and other Asian nations are contemplating capital controls to stem the global tide of hot money. India is no exception to this flood: Indeed, with its currency yielding the maximum bang for investors’ bucks, the country is the star among emerging markets.

The doubling of foreign investment limits in sovereign debt, topped by a $5 billion raise in the corporate debt cap, comes in the context of ‘…India’s evolving macroeconomic situation, attractiveness as an investment destination, need for additional financial resources for India’s infrastructure sector while balancing its monetary policy,’ according to a 23 September press release from the Finance Ministry.

The ‘evolving macroeconomic situation,’ meanwhile, is a visible matter of concern. The current account deficit — led by a trade deficit — is widening at a rapid pace. The trade gap grew by some 19 per cent in April-June over the preceding quarter. More recent data shows it increased a further $2 billion in July-August — a 21 per cent jump over the previous quarter.

A capital account surplus is increasingly feeding the deficit. The surplus comes from accelerating short-term inflows, i.e., trade credit and rate-sensitive commercial borrowings, and banking capital. Other data show a gush of portfolio equity inflows — $7 billion in September alone — threatening to turn into a deluge.

The price of the domestic currency fully reflects these temporary capital movements. In 2010, year-on-year real exchange rate appreciation, or REER, exceeded 10 per cent every month, and sequentially, an average 1.2 per cent each month. To compare, the six-currency REER index (trade weight, 1993-94=100) reached 2007 — or the previous boom — levels this July. Currency value is thus wholly influenced by capital movements instead of by real economic activity.

In addition, there’s persistent and high inflation, a tightening monetary cycle, and the possibility that the central bank may not have finished increasing interest rates yet.

This knowledge, plus some conservative assumptions, is used to profile an evolving macroeconomic position. This shows the fickle-financing (short-term loans) component rising significantly along with the current account deficit. And this does not factor in the additional debt flows that may come in due to liberalisation: Chances are that foreign investors may not be interested in long-term bonds of a country with high inflation risk; chances also are that they might.

When fundamental indicators suggest a weakening currency (and monetary tightening), but market forces are such that speculative, short-term capital flows dominate the capital account, it is critical to pay attention to the current account and exchange rate movements. Instead, a ‘hands-off’ exchange rate policy and a pro-cyclical liberalisation to invite more capital is the policy choice.

This strategy is exacerbating the imbalance. Not preserving external competitiveness in an environment of depressed demand and currency depreciations abroad hurts exports and discourages foreign direct investment in this sector. From a macro policy point of view, too, the impact of strong versus weaker currency needs to be judged in terms of expenditure shares: If the Reserve Bank of India’s own estimates show 72 per cent of manufacturing output is exported, how is growth supported by merely increasing the availability of capital? This capital must eventually finance economic activity to produce growth.

Higher investments in exporting industries contributed significantly in raising the investment rate to nearly 40 per cent in 2003-07; so, the impact of competitiveness loss is far higher than the directly observed 20 per cent output share of exports. Plus, a falling investment-GDP ratio, with no sign of recovery in private investment, means a sharper decline in the savings rate.

If exports are steadily losing out while the increased supply of finance is used to make money out of money, it leads to an unsustainable situation. Opening up to more foreign capital when ‘push’ factors (low interest rates abroad, high global liquidity) are potently interlocked with ‘pull’ ones within, is courting instability. It increases external vulnerability through the risk of sudden reversal of foreign capital; a slight shift in market views — unsustainable stock prices or a bubble — could trigger this as investors remain wary.

One would have thought that the 2006-07 dalliance — an ill-timed liberalisation of debt caps amid a boom, much against the central bank’s wishes — would have served a lesson. This exacerbated the surge, destabilising monetary conditions with severe real appreciation pressures, eventually leading to curbs on overseas borrowings to break the carry-trade arbitrage-rupee appreciation-money supply expansion spiral.

It is crucial that capital account liberalisation is synchronised with the macroeconomic situation so that positive and negative shocks are well absorbed. A wiser strategy would be to narrow the current account deficit, incentivise exports and reduce dependence on short-term capital flows.

Renu Kohli is an economist and a former staff member at the International Monetary Fund and the Reserve Bank of India.

This article first appeared here on LiveMint.

1. India’s exchange rate conundrum
2. India’s controlled appetite for foreign capital
3. China’s current account surplus and inflation

The recent flare-up over the Diaoyu Islands—a Chinese fishing boat captain was arrested by the Japanese Coast Guard—has followed a well-worn script. An international incident, say, the publication of a Japanese textbook, the bombing of a Chinese Embassy or pro-Tibet protests in France or even a disputed football match, quickly leads to protests in China, which are quickly defined as ‘nationalist’.

The international press duly reports on outraged citizens shouting slogans, bearing flags, threatening boycotts and some form of retaliation against those who have dared to offend China (The New York Times article of September 19, 2010 features a photograph of a bellicose bare-chested man with a tattoo of the national flag). Government spokespersons tell the world that the ‘feelings of the Chinese people’ have been offended. But, generally speaking, within a week or so the protesters are gone and the causes for which their fury ascended like a whirling dervish become mild breezes. To wit: for all the bluster of Chinese ‘nationalists,’ French products and stores were not boycotted after the pro-Tibet protests, Japanese cars and electronic products remain highly prized, and applications to American colleges and universities have not declined because of dissatisfaction with American policies or actions. When observing the contemporary China scene a gambling man would never lose by betting long on economic self-interest over any contemporary ‘ism’.

I raise these issues to make a larger point about how we empirically evaluate any sentiment or ideology in China, whether it is nationalism or Marxism. Now is a particularly opportune time to think about this given the widespread acceptance of the notion that ‘nationalism’ replaced Marxism-Leninism-Mao Zedong Thought as China’s reigning ideology in the reform period.

What is the evidence for this?

Yes, it is true that the government has promoted ‘patriotic education’—but it is not clear that this campaign—which began, not coincidently, after the 1989 legitimacy crisis—has worked, that people who are otherwise quite cynical about corruption, the education system and rampant materialism would suspend their disbelief and become ‘patriots’. What about all of those ‘nationalists’ who stage colorful street protests and shout slogans, vent on the web or hack foreign websites? They are, overall, a tiny sliver of the Chinese population, and unrepresentative at that. The American Tea Party has a flair for the dramatic, but one could hardly conclude that ‘Americans’ share their sentiments about the government.

I would suggest that it is critical to examine long term behaviors and commitments as a more accurate measure of patriotism in China, or anywhere else. Are Chinese economic nationalists? By the measure of calls for boycotts and statements of outrage at ‘x’ (take your pick: the US, Japan, France), yes; by a sustained boycott that requires sacrifice? Not really. There is no evidence that Chinese consumers prefer ‘Made in China’ products because they are manufactured in China and support Chinese workers.

The same can be said about military matters, both historically and in the present. During the Korean War, for example, the Chinese government mounted a propaganda campaign to mobilise support for the war (‘Resist American, Support Korea’). Unsurprisingly, the state media produced evidence of ‘rising nationalism’: protests, citizens happily contributing money to buy bullets for the army and the like. Many Western analysts concluded that Chinese supported the war, and the government enjoyed heightened legitimacy as a result, despite the high costs and stalemate.

But what happens if we shift the spotlight away from easily mobilise-able populations, like students, government workers and the press? Materials in archives, unlike newspapers and film clips, reveal that many ordinary citizens in Shanghai objected to the war, were confused about its objectives and admired the United States for its high standard of living; fear of reprisal should they not contribute to the war effort led many to hand over their money; peasants were often forced into the army and recruiting officers resorted to lies to recruit them; landlords and other ‘class enemies’ were sent to the front to fight the CCP’s war. When soldiers returned from the war, they were not treated well by employers or their fellow citizens, even those who were supposedly most exposed to state propaganda in cities.

The same sorry story repeated itself after China’s brief war with Vietnam in 1979: ballyhoo in the press and expressions of outrage against Vietnam, but archival documents show that veterans had a very difficult time taking advantage of their patriotic status when they sought better employment. Wives of military personnel soldiers could not easily capitalise in their status either. During the Cultural Revolution, when urban youth were parading around the county wearing military uniforms, investigations by the Shanghai Supreme Court revealed dozens of cases involving the rape of real soldiers’ wives, and soldiers who went AWOL seeking to avenge the crime. In fact, there is little conventional wisdom in Chinese politics that can survive the test of archival data unscathed.

Nationalism is a convenient concept for Western analysts to use—it ‘fits’ the way Westerners understand their own history and seems to explain various protests. But there is little documentary evidence that nationalism, Marxism or even hatred of Japan motivated millions of peasants to support the CCP in its rise to power. Nationalism did not prevent the bloodletting of the Cultural Revolution or contribute to better treatment of those who served their country in wartime or peacetime. At the moment, and until more archives are opened, we do not know how many current day ‘nationalists’ or ‘patriotic hackers’ are on the government payroll and directed by the party.

In the meantime, I would rather take the long-term view and ask: do the speeches and online chat result in meaningful, long-term action, and are they even authentic? Does evidence about actual behavior match the evidence from orations and comments to reporters? As with anything that we deem significant, the proof has to be in the data pudding.

Neil J. Diamant is an Associate Professor of Asian Law and Society at Dickinson College, Pennsylvania.

1. Chinese nationalism and where it might lead
2. The anniversary of the 1999 Chinese embassy bombing
3. Territorial disputes in East Asia: Proxies for China-US strategic competition?

The recession now present in advanced economies seems set to continue for a while yet.

The annual Neemrana conferences on the Indian economy provide a valuable opportunity to take stock of the state of the US and world economies, and the implications of global developments for the Indian economy.

The conferences are held annually at the Neemrana Fort Palace hotel in Rajasthan. They are co-hosted by NCAER and ICRIER. International (primarily US) participation is organised by the NBER, arguably America’s most respected network of academics engaged in research on issues of economic policy. The format is designed to encourage informal, off-the-record discussion on a range of current issues in economic policy.

This year marked the tenth anniversary of the conference, amidst the most challenging environment the global economy has faced in that decade. Despite the roaring boom of the past few years, past conferences had repeatedly warned of the unsustainability of two structural trends, namely the size of the US current account deficit and the decline in the US household savings rate that lay behind it. However, the depth of the crisis in the US financial system and economy, and its global impact was difficult to anticipate even as recently as a year ago.

Prior to the conference, my initial assumption was that the worst was probably behind us as far as the slowdown in the major economies was concerned. The discussion at the conference, particularly with regard to the US and European economies, suggested that this was no more than wishful thinking, and that considerable pain lies ahead. (There was relatively little discussion of the prospects for the Japanese and Chinese economies, but these are unlikely to improve the picture.)

Quite apart from the overall assessment of the short-term outlook, however, was the nature of the analysis that led to these sombre conclusions. In the case of the US, the underlying mechanism at work is a massive re-pricing of risk by financial institutions following the unexpectedly high default rates on sub-prime mortgages that began to be evident some two years ago.

This repricing of risk has led to the destruction of household financial wealth in the two principal assets held by American households, residential real estate and equities. Between these two, the estimated reduction in overall household wealth is of the order of ten trillion dollars.

Historical estimates suggest that this would lead households to cut back their consumption by around 4 per cent of their reduced wealth, just as the past enhancement of this wealth led to major increases in consumption during the boom. The estimated cutback in consumption alone represents a negative ‘demand shock’ of approximately 2.5 per cent of US GDP, or $400 billion.

Compounding this withdrawal of demand is the slowdown in housing construction: a million fewer housing starts represents a further withdrawal of some $200 billion in demand. So the ‘demand gap’ that needs to be filled just to replace these two sources is in the order of $600 billion on an annual basis, without taking into account other destruction from demand either in terms of (net) exports or reduced corporate investment, both of which are likely under present conditions. The only silver lining is the relief household budgets will receive as a result of lower fuel prices.

Under normal circumstances, both monetary and fiscal policy would be available to offset such sharp ‘autonomous’ decreases in final demand. Unfortunately, despite Herculean efforts by the Federal Reserve, monetary policy is not generating any traction because of the seizure in the credit markets, itself largely related to uncertainties on the valuation of housing-related securities.

No effective floor has so far been placed under house prices, despite several proposals to do so. The impact of house price declines on the balance sheets of financial institutions is enhanced in the case of the US by the fact that, in most states (and unlike the situation in other advanced countries), mortgage loans are ‘non-recourse’: that is to say, they are only secured by the value of the house, and are not secured by other assets of the borrower. Approximately 25 per cent of all houses with mortgages are now worth less than the value of the mortgage that they bear, encouraging homeowners to surrender their homes and walk away from the loan. This additional supply further depresses prices. So there is no immediate reason to see a return to normality in US credit markets, at least not until a floor is found, or is placed, under housing and equity markets.

The past and likely future inefficacy of monetary policy therefore puts the entire burden for replacing the ‘missing demand’ on fiscal policy. Yet the prospective design of the Obama fiscal stimulus package came in for criticism both as to its scale and as to its composition. If the advertised figure of $775 billion over two years is accurate, then on an annual basis the injection of demand is only half as large as is needed. To the extent that a portion of the relief is in the form of temporary cuts in income taxes, recent evidence suggests that such cuts tend to be saved rather than spent, particularly in an environment where households are busy rebuilding their balance sheets. If the demand ‘hole’ is not adequately plugged, then second-round multiplier effects could worsen the downturn.

The US remains central to the global recovery. The story from Europe is gloomy for many of the same reasons but also for two additional ones. Several of the smaller countries have very high levels of debt already and are likely to be penalised by the markets for expansionary fiscal policy. And members of the Eurozone lack the instrument of exchange rate adjustment. There is the additional factor that the leading European economy, Germany, which does have fiscal space, remains unconvinced of the efficacy of fiscal stimulus.

Finally, despite G-20 protestations to the contrary, there is considerable expectation that protectionist tendencies are likely to intensify in this global climate. All in all it is an an ugly environment for India to face as it struggles with its own issues of internal security, corporate governance and general elections. Welcome to 2009!

–

Suman Bery is the Director General of the National Council of Applied Economic Research, New Delhi. He serves on the Central Board of the State Bank of India, India’s largest bank and has been a member of several government committees and task forces.

This is part of the special feature: Reflections on developments in Asia in 2008 and the year ahead

1. India faces the harsh reality
2. The old ghosts of India show their faces again
3. Malaysia’s progress in a gloomy global economy and contested political environment

Vietnam began the year 2008 with high expectations. There was exuberance at the admission to the WTO and record growth of 8.5 per cent was recorded in 2007. The government set an even higher target in 2008, aiming for growth at 8.5-9 per cent.

Events took a seemingly unexpected turn. Signs of overheating, already evident at the end of 2007 amidst the asset bubble and rising inflation, became more and more visible towards the end of the first quarter.

The VN index lost almost 45 per cent of its value in just the first three months. The CPI was already running at 9.2 per cent for the first quarter, corresponding to a year-on-year rate of nearly 20 per cent, much higher than in neighbouring countries. Inflation rose from month to month and peaked in August, when the year-on-year rate reached 28.3 per cent.

To some extent, the price hike resulted from the surge of world prices, especially food and fuel prices. With a very open economy and a stable exchange rate, price rises in international markets were transmitted directly to domestic prices. Vietnam still maintains controls over prices of some essential goods and services, but the evidence shows that there were close correlations between the movements of international and domestic prices in controlled commodities.

The overall increase of world prices aside, the macro turbulence in Vietnam in the fist half of 2008 was essentially home-made. Policy responses were slow and not directed at the factors behind the price hike in 2007. Of particular concern were the large inflows of foreign indirect investment and the extraordinary (and related) high rate of credit growth.

In March 2008, the year-on-year rate of credit growth reached 63 per cent, driven largely by excess liquidity and speculative investment in the stock market and the real estate sector. Massive capital inflows caused upward pressure on the Vietnamese Dong, which threatened to reduce the competitiveness of exports. In response, the State Bank of Vietnam (SBV) bought more than 10 billion U.S. dollars in a single year and consequently injected large amount of cash into the economy.

Vietnam was thus confronted with the ‘impossible trinity’ of simultaneously trying to maintain a virtually fixed exchange rate, an open capital account, and an independent monetary policy. Attempts to sterilize interventions in the foreign exchange market did not succeed and the accumulation of reserves led to an expansion in the monetary base.

A potential adverse impact of high inflation in the presence of stable nominal exchange rate is the loss of competitiveness for the Vietnamese economy against its trading partners. As inflation in Vietnam was much higher than in its main trading partners, there was a significant appreciation the Vietnamese Dong in real terms. There was also the threat of a widening trade deficit, already at 15 per cent of GDP in 2007, and weaker export growth.

High inflation and the resulting instability prompted the government of Vietnam to act and, in March 2008, a stabilization package was launched. The package saw a switch in priority from high growth to stability and included credit tightening, spending cuts and above all, a reduction in the growth target to 7 per cent, much lower than the initial figure set at the end of 2007. Credit growth was to be brought down to 30 per cent in 2008 by a number of measures, notably the sharp increase in the benchmark interest rate, from 8.75 to 12 per cent in May, then 14 per cent in early June. Greater flexibility was also imposed on the exchange rate.

The package also included contractionary fiscal policy measures such as cutting government spending, cancelling inefficient public investment projects and postponing new projects. By May 28, ministries, provinces and the state economic groups had reportedly decided to postpone, delay or stop nearly 1000 projects, equivalent to 7.8 per cent of the total investment budget.

The stabilization package seemingly worked well in dampening the overheated economy. Credit growth was brought under control. The three month moving average of CPI declined rapidly after May and the consumer price index declined after October.

Yet as Vietnam barely struggled out of the home-made turbulence, the world financial crisis caused the broader economic environment to deteriorate dramatically. Like many other open developing economies, Vietnam was inexorably engulfed by the crisis. The adverse effects of the global downturn were visible in the last few months of 2008. Exports declined in 3 consecutive months after September 2008, and only increased slightly in December. Although FDI commitments reached a record of US$ 64 billion, three times those of 2007, FDI disbursement has slowed in recent months. Perhaps the most visible effect has been seen in manufacturing employment. Reports from a sample of 461 firms in Ho Chi Minh City showed that more than 20 per cent of the workers of these firms have already lost their jobs. Nonetheless, the number of reported strikes increased rapidly in 2008.

Against the backdrop of a global recession, an expansionary package was introduced at the end of 2008. Loosening monetary policy saw interest rates cut to 8.5 per cent over a short period of time. A stimulus package of US$6 billion was proposed that includes substantial tax reductions and investment in infrastructure. Important social protection measures, including introduction of unemployment benefits and a 50 per cent increase in the poverty line, were part of the package. The consensus, however, was that appropriate intervention should have economic stability as the first priority. Inflation remained high at 23 per cent in 2008, and the stimulus package should avoid causing another wave of price surges.

Overall, Vietnam performed relatively well in 2008. GDP grew at 6.23 per cent and registered FDI reached a record high. Exports grew much better than those of neighbouring countries, at nearly 30 per cent, even though the increase in world prices played an important role in this achievement.

This year will be more challenging for Vietnam.

The crisis in 2008 revealed serious structural weaknesses in the economy. Vietnam is an economy in which growth is still highly dependent on external demand and external financing. With high levels of current budget deficits, trade deficit and inflation, and decreasing oil revenues, the room for manoeuvring aggregate demand is likely to be limited. The hotly debated stimulus package barely touches upon these structural weaknesses, and is likely to foster inefficiency and waste public resources if not properly designed and implemented. Above all, the delayed and ad-hoc responses to overheating and price overshooting, and conflicting stimulus package proposals are all evidence that Vietnam still lacks an effective mechanism for informed and systematic policy-making.

–

Quang Doan is Senior Economist at the World Bank and was formerly Senior Research Fellow at the Vietnam Academy of Social Sciences, Hanoi.

This is part of the special feature: Reflections on developments in Asia in 2008 and the year ahead

1. Vietnam: Balancing growth and stability in a more market-oriented economy
2. Vietnam sails through the crisis but needs reform to sustain the growth
3. Managing the risk of inflation during economic recovery – the case of Vietnam

With India’s state elections out of the way (and with a surprisingly favourable outcome for Congress revealed by Monday’s results), the central government was free to proceed with its two-part economic stimulus package.

Monetary policy measures (including fairly significant acts of regulatory forbearance) were announced on December 7, and ‘real’ side measures, primarily fiscal, on December 8. These measures were taken against the background of a deteriorating growth picture in the advanced industrial economies, and a sharp slowdown in certain key sectors of the Indian economy, such as labour-intensive exports, automotive and real estate.

If a rising tide lifts all boats, a falling tide brings out all lobbies. There have been plenty of voices arguing that what has been presented is ‘too little, too late’, in respect of both monetary and fiscal policy. Many of these critics cite the US; there, the emerging professional consensus is that policy has been irresolute and reactive, and that well-timed anticipatory action would have significantly reduced the growth and fiscal costs of financial deleveraging. Others cite the resolution passed by the heads of government of the G-20 in Washington last month, where all countries pledged to stimulate domestic demand (and to avoid protection). Here, the poster-child is the dramatic package announced by China well before the G-20 meetings, followed closely by the public works program announced recently by the Obama administration.

Professional opinion In India is more sharply divided: Govinda Rao (ex ANU) and Shankar Acharya have cautioned against excessive fiscal adventurism. Based on the supplementary budget recently passed by Parliament, they argue that substantial incremental fiscal stimulus has already been applied. In contrast, Abheek Baruah and Surjit Bhalla are of the view that matters are sufficiently dire, even in India, that no restraint is called for, and that, as in the case of the United States, forceful pre-emptive action now will actually prove cost-effective in the medium run. While these observations primarily apply to fiscal policy, voices from industry are arguing for continued aggressive monetary easing, in line, once again, with what we are seeing in the advanced economies.

These are extraordinary times for the global economy. But as I argued last month, [LINK] there are significant risks involved in developing policy ‘on the hoof’, without a clearly articulated framework. These risks are of at least two kinds: first, as already mentioned, the risk that government will be pressured by special interests; and second, that poor communication in  the present environment could lead to unnecessary panic, uncertainty, or even a speculative attack.

For all the imperfections in its implementation, the macro framework in place until the Budget in February 2008 was a stool with three legs. These were the targets of the Fiscal Responsibility and Budget Management (FRBM) Act; a flexible but managed nominal exchange rate with a medium-term target for some measure of the real exchange rate; and sterilised intervention designed to deliver steady growth in some composite measure of monetary conditions.

Over the past two years this framework was used to accommodate two major, partially offsetting shocks to the economy. These shocks were, first, the large and rising inflow of capital (until the end of last year); and second the large terms of trade shock symbolised by the rise in the price of many commodities, particularly oil. These shocks were in effect accommodated by the twin mechanisms of an appreciation of the real exchange rate, and its counterpart on the “real” side, namely a widening current account deficit.

Today, these shocks are being reversed. While capital is certainly exiting, it is more difficult to be sure what is happening to the terms of trade. While commodity prices are sharply down, the deep deterioration in foreign demand for labour-intensive tradable goods will undoubtedly have an impact on their world price. Perhaps the best assumption would be that the terms of trade might improve slightly, if at all. The question for macroeconomic policy is what elements of the above framework, if any, now need modification, to what degree and through what mix of policies.

This is where the local and the global can and should fit together.  Policy over the next twelve months needs to be driven by the goal of targeting a pre-announced level of the current account deficit on the balance of payments, somewhere in the range of 2-3 per cent of targeted GDP. This would help India make an explicit commitment to sustaining global demand, without prejudging whether this contribution is to be made by boosting public investment or supporting private investment. It would also be a target sufficiently concrete to reassure those concerned about India’s financing risk, while being flexible enough to allow public investment to replace private investment should the need arise, without taking actions (such as excessive fiscal stimulus) which might crowd out private investment, by flooding the banks with too many safe government bonds.

Judged by this yardstick how might one assess the adequacy of last weekend’s measures, and whether there is likely to be a need for additional action? It is clear that the government is right to give primacy to easing monetary policy, as that is the tool most likely to stimulate investment and to help households and corporations build up liquidity. Here, the question is whether we need to be worried about any lower limit in terms of the speed or amount of easing. Our approach so far, once the inflation threat had receded, has been to ‘cross the river by feeling the stones’. The main reason for taking incremental steps is to leave some reserve for future shocks. But in general the risks of more rapid easing seem to me to be relatively low, despite the high measured inflation rate.

As against this, I find myself siding with those who urge caution on the fiscal side. This not just because of our high debt stock and concerns of debt sustainability at the lower growth rates that now seem more probable, nor particularly because our government spends less well than the private sector. It is mainly because there is greater risk of crowding out than crowding in private investment through aggressive public investment, and maintaining a helpful climate for private investment remains the highest priority.

1. Why the world needs fiscal stimulus
2. Reviewing the arguments against fiscal stimulus
3. China’s health care and the fiscal stimulus

India had a dream run of five years during 2003-08 as the GDP growth averaged nearly 9 per cent annually, the best run over five years ever! The economy began to slow from the middle of 2007-08. A 9 per cent growth apparently could not be sustained: India’s potential rate of growth has been estimated by more than one agency to be around 8.5 per cent. As the economy overheated, the central bank tightened credit gently initially but more sharply since 2006-07. The economy began to slow down. Some of us had argued that the tightening was going too far and was an over-reaction to global inflationary pressures. No one foresaw the external shock arising from the global crisis which began with the financial meltdown in the US.

Now the interesting question is what would India’s growth rate have been in response to the policy measures without the global crisis as compared to what it is likely to be in the context of the on-going global crisis.

Our analysis suggests a sharp collapse in Indian growth this year. India would have grown 7.5 per cent (a slowdown from 9 per cent in 2007-08), had the global crisis not occurred. The global crisis is likely to bring India’s growth rate to below 6 per cent in 2008-09.

ICRIER forecasts India’s GDP growth rate using ‘leading Indicators’. Leading economic indicators (LEI) are variables considered to have significant influence on the future level of economic activity in the country. They give advance signals about the likely growth rate and allow us to forecast GDP growth five quarters ahead of the value of leading indicators. The predictive quality of LEIs has earned them the name ‘leading’ indicators. They predicted growth of GDP at 9.2 per cent for 2007-08 in November 2007, while most agencies had predicted a lower growth rate of 8.5 per cent or below that year, as against the actual growth rate of 9 per cent. ICRIER was first to predict a growth rate (before the crisis erupted) of 7.8 percent for 2008-09 in July this year, an estimate that was thereafter adopted by others, including both the Reserve Bank of India (RBI)and the finance minister.

The leading indicators index relies on ten key indicators: 1) production of machinery and equipment, 2) sales of heavy commercial vehicles, 3) non-food credit, 4) railway freight traffic; 5) cement sales, 6) sales of the corporate sector, 7) fuel and metal prices, 8 ) real rate of interest, 9) BSE sensex and 10) GDP growth rates of the US and Europe.

A composite index for the leading economic indicators has been constructed for the period 1997-2008 with the quarterly series of growth of these variables (except for the real rate of interest where the level, and not the growth, has been used) using the ‘principal component index’ (PCI) method. The PCI method assigns weights to each leading indicator component by a process of iteration based on its contribution to total variation in the composite index.
Leading indicators can predict future growth based on what has already happened in the past but cannot capture the impact of sudden external shocks which may have an immediate impact on the economy. Examples of such shocks in the past have been the bursting of the IT boom in 2000-01 (Q3 2000-01 to Q2 2001-02), crop failure in 2002-03 (Q2 to Q4 2002-03) and the recent US financial meltdown (starting with Q3 2008-09 and say, up to Q2 2009-10). The leading economic indicator index (LEI) with a 5-quarter lag and the shock represented by a dummy variable (equal to 1 with shock and 0 without) are used to forecast India’s future GDP growth. The growth equation builds in the previous shocks of the dotcom bust and agricultural failure and its estimates track actual GDP performance very closely as shown in the chart below. For projecting the GDP growth for 2008-09 and the next year, the LEI index incorporates the expected shock from the current global financial meltdown.

The estimated equation for GDP growth forecast is satisfactory with adjusted R-square value of 0.58 and t-values for the regression coefficients of 3.24 for LEI (-5) and -5.95 for the shock variable, both significant at the 99 per cent level of confidence. The GDP forecast for 2008-09 and for the first half 2009-10 is tabulated below alternatively for both with the shock and without the shock.

GDP Forecast for 2008-09 and H1 2009-10

No shock With shock

2008-09 7.5 5.8

2009-10 H1 6.8 3.9

As the chart shows, India would have grown 7.5 per cent this year (a slowdown from 9 per cent in 2007-08), had the global crisis not occurred. The global crisis is likely to bring India’s growth rate to below 6 per cent in 2008-09. With the first half GDP growth rate already known, this implies a sharp slowdown in the next two quarters. In the first half of next year, the economy would have grown below 7 per cent in the absence of the external crisis. The global crisis may reduce Indian growth rate to less than 4 per cent in 2009-10 [It may, however, be noted that we have not calibrated the intensity of the different shocks and the impact on growth is treated similarly for all shocks. If the current shock is more serious than the previous ones the growth may fall even further].

The implications are significant. For starters, the Eleventh Five Year Plan targets should be recalibrated immediately if that exercise is to remain credible. We should prepare the people for slowdown in employment generation and plan for counter cyclical measures urgently. This implies the need for an immediate reduction in interest rates to bring down the cost of capital and a quick and thorough review of government procedures that vitiate the investment environment and hike up transactions costs.

Rather than throw more money at the problem, it is important that the government identify infrastructure projects, like the highway program, where some additional resources but a lot of attention to implementation and execution can generate additional capacities and help raise growth. But some counter-cyclical fiscal measures will surely have to be taken. Perhaps one that needs to be considered seriously is a cut in central excise duties as this will lower prices and bring forth new demand. That would also add weight to the Finance Minister’s demand for industrialists to reduce prices.

Policy makers now have to deploy all tools at their command to boost business sentiment and consumer confidence both of which are badly shaken. It is an extraordinary situation seeking extraordinary measures.

The authors are Director & Chief Executive, Senior Consultant and Consultant at ICRIER, New Delhi.

1. FDI and Indian growth: the new paradigm
2. India: a tough year ahead
3. India’s exchange rate conundrum