India in a Globalizing World
Some Policy Dilemmas
Distinguished Speaker Series
Cornell University
Ithaca, New York
August 28, 2012
Dr. Duvvuri Subbarao
Governor
Reserve Bank of India
1
India
Macroeconomic Situation
Cause for Concern?
2
India - Macroeconomic Situation
Long Term Trends in Growth Rate
10.0
8.7
9.0
8.0
Per cent
7.0
6.0
7.5
6.2
5.6
5.0
4.0
3.0
2.0
1.0
0.0
3
India Growth Story
What drove India’s growth in
the pre-crisis period?
4
India Growth Story
Started fraying, beginning
with the global financial
crisis of 2008/09
5
From One Crisis to Another
• Just as we were recovering from
2008/09 crisis, the eurozone crisis
hit us.
• Policy space to respond to the crisis
is much less now than in 2008/09.
6
India
Current Macroeconomic Situation
• Growth has moderated
• Inflation is high and persistent
• Balance of Payments under stress
• Twin deficits (fiscal deficit, current account
deficit)
• Investment has decelerated
• No policy space for stimulus
7
Three Policy Dilemmas
1. How do we manage the growthinflation dynamics?
2. External Sector - how do we manage
the short-term trade-offs without
compromising long-term
sustainability?
3. Fiscal Consolidation - how to manage
the political economy constraints?
8
Dilemma - 1
How do we manage the
growth-inflation dynamics?
9
Why has growth slowed?
Recent Trend
10.0
9.5
9.6
9.0
8.5
Percent
8.0
7.5
7.0
6.5
6.5
6.0
5.5
5.0
10
12
-2
Oct-09
Nov-09
Dec-09
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
Dec-10
Jan-11
Feb-11
Mar-11
Apr-11
May-11
Jun-11
Jul-11
Aug-11
Sep-11
Oct-11
Nov-11
Dec-11
Jan-12
Feb-12
Mar-12
Apr-12
May-12
Jun-12
Jul-12
per cent
What is the inflation story?
Year-on-year Inflation Rates
10
Headline Inflation
8
6
4
Core Inflation
2
0
WPI-Headline
WPI-Non Food Manufactured Products
11
What is driving Inflation?
• Food (cyclical + structural)
• Global commodity prices +
depreciation
• Fiscal deficit
• Demand pressures
12
Inflation and RBI
• What has RBI done to control
inflation?
• Has RBI succeeded in controlling
inflation?
13
Growth - Inflation Risks
• Global Uncertainty
• Commodity Prices
• Fiscal Deficit
• Monsoon Performance
• Supply Response
14
Dilemma - 1
How do we manage the
growth-inflation dynamics?
15
Dilemma - 2
External Sector - how do we
manage the short-term tradeoffs without compromising
long term sustainability?
16
What is the external
sector problem?
• Large current account deficit (CAD)
• Financing the CAD with stable flows
17
India - Balance of Payments
Current and Capital Accounts
10
9
As a percentage of GDP
8
7
6
5
4
3
2
1
0
2007-08
2008-09
2009-10
Current Account Deficit
2010-11
2011-12
Net Capital Flows
18
External Sector Problem
• Why has current account deficit
(CAD) increased?
• Why have capital flows thinned?
• What has been the result of this?
19
How much has the rupee
depreciated and why?
Month-wise Trend in Rupee-dollar Exchange Rate
and REER 6 Currency
30
120
118
116
114
40
45
110
REER
112
108
50
106
104
55
102
Rs/US$
June 2012 (so far)
May-12
Apr-12
Mar-12
Feb-12
Jan-12
Dec-11
Nov-11
Oct-11
Sep-11
Aug-11
Jul-11
Jun-11
100
May-11
60
Apr-11
Rs per US$
Nominal Exchange Rate
35
REER 6 Currency (RHS)
20
Rupee Depreciation?
What is the impact of rupee
depreciation?
21
What has RBI done to
contain volatility in the
exchange rate?
22
What is the ‘Capital Flows’ problem?
• We want capital flows just equal to
CAD
• But they are invariably either too
much or too little
• And they are volatile
23
Capital Flows - How volatile?
Quickly Reversing Trends
Pre-Crisis (2005/08)
- Great Moderation - Volatile Inflows
Crisis (2008/09)
- Safe Haven - Outflows - Sudden exit
Post-Crisis (2010/11) - Volatile inflows - ‘Currency Wars’
Eurozone Crisis (2011)- Confidence Effect - Outflows
24
Managing Capital Flows
Change in world view on
capital controls from precrisis to post-crisis
25
Managing Capital Flows
• Two options
- Capital Controls
- Exchange Rate Management
• No option is totally benign
26
Managing Capital Flows
No Benign Options
Capital inflows
Do not intervene
Currency appreciation
Intervene but
but do not sterilize
Inflationary pressure
Intervene and
sterilize
Upward pressure on
interest rates
27
External Sector Management
What is RBI’s policy
- on capital account?
- on exchange rate?
28
External Sector Management
Sustainable Solution
• Reducing CAD in the medium term
• Financing CAD in the short-term
29
Policy Dilemma - 3
How to manage the political
economy of fiscal consolidation?
30
Fiscal Deficit
Why is fiscal deficit a
problem?
31
India’s Fiscal Deficit
• What is India’s fiscal deficit
problem?
• What are the challenges in
fiscal consolidation?
32
Why 2012 is not 1991?
33
India and China
34
Is the “India Growth
Story” still credible?
35