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