Suman Bery: Meditations on Chapter 1

This year's Economic Survey illuminates the many uncertainties facing emerging economies

These are confusing times for emerging economies. Led by China, following the financial crisis these economies were the locomotives of the world economy. But since 2010 their collective performance has weakened steadily. Of the celebrated BRICS, only India and China continue to maintain traction. By contrast, the advanced economies have maintained their fitful and slow healing after 2008, admittedly with extraordinary and continuing monetary stimulus, and with inflation and nominal interest rates at unprecedentedly low levels.

Accordingly, one way to read this year's excellent Economic Survey is as an x-ray, or case study, of the challenges and choices that large emerging markets face in the present global economy. To misquote Tolstoy, each emerging market is unhappy in its own way. Among its peers India remains distinctive for being poorer, less urban, younger, and with only a tiny part of its labour force employed in formal employment. Yet, as the Survey correctly points out, after 25 years of external liberalisation India is now as deeply integrated as its peers into the global economy through trade, finance and migration.

Of the many topics analysed in the Survey's dazzling first chapter, I will focus on three: the appropriate mix of monetary and fiscal policy; public sector balance sheets; and social protection.

On the first of these I was reminded of the early 20th-century American cartoon characters Alphonse and Gaston. According to the internet, Alphonse and Gaston are extremely polite Frenchmen to the extent that their "After you, Alphonse", "You first, my dear Gaston!" routine often gets them into trouble, such as when they can't evade a trolley which mows them down while each insists on letting the other go first.

The government's Chief Economic Advisor has been clear and forceful in arguing, in the Survey and elsewhere, that fiscal policy needs to play a counter-cyclical demand-boosting role. This is warranted given the slow growth of global trade, weather-related rural distress and over-stretched corporate balance-sheets. For its part the Reserve Bank of India (RBI) has prioritised fiscal credibility as a key "nominal anchor" to support its loose inflation-targeting regime.

Yet as one reared on Latin American debates I have been struck by the lack of reference to the impact of the fiscal-monetary policy mix on the real exchange rate of the economy. On the Latin view loose fiscal policy (and correspondingly tight monetary policy) creates pressures for high real interest rates and an appreciation of the domestic real exchange rate - the relative price of non-tradables. It might be argued that these outcomes apply to an economy at or near full employment, whereas the Survey believes that the economy is currently constrained by aggregate demand. In any case the finance minister has made the choice of sticking to the consolidation path, and I support this judgement.

The Survey also makes a contribution to the debate on what it calls the "twin balance sheets" challenge. By this, the Survey refers to the interaction between the debt problems of the corporate sector and the stressed assets of commercial banks. As part of its fizzy style, the Survey looks to the reserves of the Reserve Bankas a possible source of public capital to strengthen the public sector banks without diluting the share of state holding below 51 per cent.

This proposal, and the attendant analysis in the Survey, provokes a number of reflections. The first is to evoke the experience of the euro zone and of Japan, where a similar syndrome has slowed economic recovery particularly when compared with the United States and, to some extent Great Britain.

The euro zone comparison, but also the Survey's proposal to tap the RBI raises a broader set of issues on implicit guarantees and fiscal accounting. As many readers would be aware, an additional complication for banks in the euro area has been their large holdings of sovereign debt, in a situation where the sovereign lacks the power to issue its own money.

While this is not the situation in India (or for that matter Japan) the uncomfortable reality is that the Indian public sector banks maintain the confidence of their depositors on the basis that the full faith and credit of the Union government stands behind those banks, irrespective of the technicalities of deposit guarantee limits. The large holdings of government debt by the same banks (indeed all banks operating in India) are equally seen as a source of strength not weakness, reflecting the strong track record of the Indian state in honouring its internal and external debt.

On the basis of standard conventions of fiscal accounting, both the net assets of the RBI and of the public sector banks ought to be consolidated with the accounts of the Union government. This for example is the practice followed in Brazil. Seen from this perspective, an infusion of capital from the RBI to the public sector banks does little for the net worth of the system as a whole and is in the same class of asset reshuffle as LIC purchasing equity in majority-owned state enterprises. Indeed the same could be said for support from the Union Budget. For a country such as India, whose debt is denominated in nominal (i.e. not price-indexed) terms there is always the residual temptation to inflate away the real value of the debt. Once again, a resolute fiscal stance is the best guarantee of low long-term interest rates.

My final observation will be brief, as I have made it in past columns. In my work at Shell, and using the invaluable tables of the economic historian Angus Maddison, I have discovered that India today is roughly at the level of real per capita income as Germany was at the time of Bismarck. The latter is famously described as the father of the European welfare state, despite - indeed, because - he was deeply conservative. So, contrary to some of the commentary surrounding the Budget, I find no contradiction in a centre-right government embracing social protection.

One role, among many, of the Economic Survey is to stimulate debate on important issues within the tribe of professional economists. This Survey has not failed us.

The writer is the chief economist at Royal Dutch Shell. Views are personal.