80th Annual General Meeting
February 15-16, 2008

Address by Dr Ila Patnaik, Consulting Editor, Indian Express & senior Fellow, NIPFP

Thank you for inviting me here.

Usually it is very difficult to be the third speaker but since the topic is very complex , I am actually grateful to Naina and Subir to make my job little easier because they have focused on, like an economist one would say, on the one hand, this might happen and, on the other, this might happen and with Naina being a little more pessimistic, then Subir you have heard the one hand and the other hand. So may be I can step back a little and look at something that in this really concerns me. That is how is our policy framework responding to the fact that there might be slow down, how is our policy frame work responding to business being much more exposed to the global economy, are we prepared, I am sure business is far more prepared than the policy framework and I will explain what I mean by this. But are we prepared to take on the world and be part of the globalised economy, as we are expected to be today.

While Indian business has changed a lot in the last 15 years, the same cannot be said about Indian Government and policy framework that we have here today. There are 2-3 new things that have emerged, just stepping back and looking at what is different in India today compared to earlier and the framework is not so different, is something that Subir kept referring to the business cycle in the US and the business cycle in the world. Today we are exposed to the business cycle in the world. The level of financial globalisation and real world globalisation through the trade economy that we see today is far far bigger than what India has ever seen in the past. The two figures that I would like to point you to, the first that if you look at gross inflows on the current and capital account, then last year they were 110% of GDP. Inflows + outflows on the current + capital account for 110% of GDP. This is increasing at a very fast pace. In fact, if you look at the second quarter data, net capital inflows into India were 14% of GDP, completely unprecedented. The first observation that we are far more globalized economy and even though India and China are contributing a lot to world trade, the linkages to the US are very deep. While I agree that on the IT sector it can go up and go down, depending on how firms use or cut down on the use of India, the IT sector performance can go up and down. However, the point is we are very integrated far more than we were ever before.

The second point to note is something that policy makers have more or less been ignoring is that the Indian economy has been witnessing business cycles. Business cycles of the kind of not of the monsoon cycles that used to be there in the pre-liberalization period but the investment inventory cycles and today in a gathering like this we take it as given that yes that is the case that we saw 5% growth in the last 10 years, we have seen growth ranging from 5-9%, what we have is a growth cycle, it goes up or down. The combination of these two factors, the fact that we have business cycle and the fact that we are exposed to the global economy actually can exacerbate some of the cycles and the business cycles that we witnessed. It has been observed that net capital flows in most countries and we are seeing today that in India as well are pro-cyclical that when we are doing well more capital comes in and when we are doing badly either less capital comes in or capital tends to flow out and these flows actually exacerbate business cycle. Then what does this mean for policy framework? How should macro policies have changed responding to this new situation? Should macro policies in India be as in other or at least moving in the direction where they are in other market economies which are more globalised i.e. should they try to be counter cyclical and are they counter cyclical, what does the evidence suggest?

Let's take the monetary policy. If we accept the fact that we are in globalised economy and there may be even a slowdown in the world economy which might also face, whether you go with Subir or Naina it is up to you, but the extent might differ but nobody here is saying that we are completely immune to global slowdown. If we also accept the fact that we can no longer control capital flows the way we could earlier because the very large current account, the very large remittances, very large capital flows that are coming into through various ways, they are not something that you can control when money comes in through other ways, you can control ECBs a little coming through FI flows or it can come in through what came in in the second quarter, other ca[ital flows which you really do not know what it is, you can't really control these. Should policy have been keeping interest rates where they are ? Should the fact that you have large interest differential which is going to put pressure on the rupee to appreciate because you can't really be realistic and you can't really control the capital that is coming in or the money that is coming in and that is going to put pressure on the rupee to appreciate even more than it is already appreciating. In a situation when exports would be facing slow down given that world income is slowing down, do we need that pressure on the rupee to appreciate or should we have thought about our interest rate policy or monetary policy in the framework of open economy and in the context of India, as an economy, which is open to witnessing business cycles, should that have been the policy framework? There can be many aspects to this and in the discussion time we can go back and look how in the past also when the Indian economy was slowing down, instead of lowering interest rates we were some time hiking them. For example, in 1998, when the Asian crisis was happening, we tried to defend the rupee by raising interest rate by 200 basis points at a time when the economy was slowing down and that was not the need of economy. In other words, there is a clear case that our policymakers have not woken up to the fact that policy needs to be counter cyclical. The same can be said of fiscal policy, we have seen good years when we were on the high of a cycle and this was not a time when fiscal consolidation took place by putting things off budget, putting oil bonds, fertilizer bonds and things like that. You pretended as if you were doing fiscal consolidation, even the FRBM does not satisfy because they have a fixed deficit, aim is to get 3% fiscal deficit, regardless of whether the economies on the high of a cycle or low of a cycle. In other words, in short, neither fiscal policy, nor monetary policy today is counter cyclical. What does this mean for Indian business or Indian economy? It means that when there is an upturn, policy will actually make the upturn, go further up, will push up growth rate and when there is a downturn, it could actually further push down the growth rates and it exacerbates the business cycle. The difficulty here is that policymakers are not waking up to the fact of how open India is today, to the fact that they need to change their mindsets, that policy framework needs to respond to the needs of the new India and the new situation today. That is my biggest area of concern that today when there is little bit of down turn or more of downturn what we are doing in response is not the right thing. The way we are thinking is not the right thing. So what can we do about it? We are not the government here. What should we do about it? My sense is that Indian business has gained more than anybody else by the openness that has come to the Indian economy. Today, in the short run, we might be worried that rupee appreciation might hurt Indian exports but if we put pressure on the government, Ok we are going to face rupee appreciation and the government responds by trying to put capital controls, I think it is Indian business which will get hurt by capital control more than anybody else because cheap access to financial globalization has been one of the biggest achievements of Indian industry and India in the last few years what we need is longer term vision. We know India is going to become more and more open, globalized, both in terms of trade, both in terms of finance and we will be moving towards an economy with the flexible exchange rates, we need to be an economy where we can have an independent monetary policy that could be counter cyclical and our role lies in not just always responding to short term pressures perhaps but we are all going to be around for 20-25 years. So, our role lies in pressurizing the government which is usually very myopic because they are only thinking of next election but in pressuring the government to think along because we are here for a very long time.

Thank you.