Aiming for growth without tears

Central banks have been in the news in recent years with increased frequency. As lenders of last resort, they’ve become the nerve centres for managing the fallout of the recent financial crises and for navigating with the least amount of economic cost. The political fallout of such crises is not in their control. However, as we saw during the Asian financial crisis that erupted in 1997 and are witnessing in Europe, the evolving political reality alters the nature of the beast, making the adjustment even more challenging.

But even during normal business cycles the tug of war between the politician and the central banker is palpable. This is especially true in emerging economies, where the institutional and market maturity is less evolved than in advanced economies. Further, even if political goals (say, of high non-inflationary growth) are similar, the path to those goals can vary, as continues to be the case in India.

It is in the above global and local contexts that Growth With Financial Stability is refreshingly timely. The book, which is focused on India and offers extensive and detailed analyses, is written by Rakesh Mohan, perhaps best remembered as a former deputy governor of the Reserve Bank of India (RBI). Mr Mohan is not new to policy making, but it was the second (2005-2009) of two stints at the central bank when he seemed to come into his own.

This was also the period during which India’s macro-management was perhaps the most challenging in decades. The surge in capital inflows because of the unprecedented global credit cycle coincided with a more visible structural uptrend in India’s economic growth. Politicians were happy to ride the wave without ensuring growth sustainability, while the RBI was more concerned about the build-up of a potential boom-bust cycle from surging capital inflows. Eventually, it was a series of unpopular macro-prudential measures by the RBI that saved India from collapsing like Iceland following the Global Financial Crisis (GFC). Not toeing the political line can often have its own fallout. But central bankers generally do what is ultimately good for macro-stability. That is the reason they are held in much higher esteem than self-serving politicians.

The title of the book is a useful reminder to India’s politicians and policy makers that higher growth cannot be a goal divorced from other aspects that cater to stability. The latter has several inter-related drivers and is visible in multiple manifestations, such as inflation, fiscal stability, financial and banking sector stress. Until recently, the government was willing to live with high growth even if it was accompanied with higher-than-trend inflation. It was thanks to the sensibilities of the RBI, which punctured that unsustainable approach.

Mr Mohan’s book offers insights on the different aspects of the Indian economy. These cover a wide range of topics such as these: what powered the acceleration in the trend growth and the subsequent downtrend, and related policy issues, including managing capital inflows, the role of the financial sector and well-known list of reforms that are still needed. I was surprised that the book does not have a separate discussion about inflation management – the dharma of any central bank – although the subject features in different sections in the book.

There are also lessons for the current economic juncture. The global backdrop and India’s growth path are different from what prevailed in the run-up to the GFC. Ironically, the hard-working and eloquent Mr P Chidambaram, who was finance minister until late 2008, is back in North Block and is focused on increasing capital inflows and rupee appreciation.

But Mr Mohan warns there is a growing consensus that capital account opening needs to be well sequenced, contingent upon real and financial sector developments, and in fiscal policy. The policy mandarins should keep this in mind since the government will most likely soon increase the foreign institutional investor limit in local currency government debt. After all, attracting foreign money in today’s flushed-with-liquidity global economy is far easier than being able to shrink the fiscal gap.

Just because India is a capital-hungry economy – this is partly a function of the pace at which the government wants the economy to grow – does not mean it has the ability to absorb those capital inflows without causing unpalatable side effects. Increasing the absorptive capacity requires real-sector reforms, which are still missing in the earnest because of politics.

The following excerpt from the book captures the essence of what India needs to do if it is to stand up to run again: “The return to the self-sustaining path of high growth financed by high domestic savings … requires a return to low inflation and sustained fiscal correction.” What is the present status? India’s inflation rate is what the GDP growth rate should be, and its GDP growth rate is what the inflation rate should be. Indeed, inflation remains uncomfortably high, but the RBI has been undertaking “stealth” easing despite its hawkish talk. Fiscal consolidation is more in sound bites than in credible actions and sustainable outcomes. Some politicians and policy makers just chose to ignore the lessons of history.

The reviewer is senior economist at CLSA, Singapore. These views are personal

GROWTH WITH FINANCIAL STABILITY
Rakesh Mohan
Oxford University Press
520 pages; $75