The Hindu Business Line : World Economic Outlook — Taking the rough with the smooth

The latest World Economic Outlook places emphasis on setting right global imbalances, with particular reference to the US' current account deficit. The Outlook also notes the challenges faced by the emerging economies in strengthening macro-economic and financial conditions in the face of strong foreign exchange flows. S. VENKITARAMANAN on the effects of a decline in the US economy.

The latest edition of the IMF's World Economic Outlook (WEO) has come out on the usual lines. Of special interest is the emphasis it places on setting right global imbalances, with particular reference to the US' current account deficit, which is running high. While the good news is that the global rate of growth is robust, the bad news is that the US will face difficulties unravelling its current account deficit. Past experience, especially in the 1980s, cited by the WEO suggests that rectification of the current account deficit will need a sharp depreciation of the dollar. It feels that while the dollar has depreciated in recent years, the devaluation is not sufficient to rectify the imbalances.

The upshot of the Outlook's analysis, based on a detailed study of the various episodes of deficit adjustments, is that the US stands a good chance of correcting its imbalances in current account deficit if it devalues the dollar by as much as 10 per cent, given its openness to trade and freedom from structural restrictions.

This WEO's view has grave implications, especially for reserve managers in Asia, particularly China and India. With India's reserves crossing $200 billion now and China's at the $1-trillion level, the bulk of the reserves is concentrated in US dollar-denominated securities.

The reserve managers cannot plead that they have not been warned of erosion of value. History tells us that India started its era of Independence with large sterling balances held in a devaluing currency. The loss India suffered was grave. Will history repeat itself?

The WEO remarks that fiscal imbalances in the developed countries, especially the US and Europe, will grow, partly because of the rising proportion of the aged population in those countries with consequent increase in health and pension burden. The WEO does not mention the increasing burden posed by the US' military expenditure.

Consolidation, saving

The IMF's Outlook emphasises that the US' fiscal policy should be directed at achieving the necessary consolidation and a higher level of saving. This is the only way these countries can provide room for automatic stabilisers to work as needed. A particular challenge is to ensure that adequate employment opportunities are created within an increasingly globalised economy. The trade-off between the increase in prosperity created by rising trade and job losses due to the introduction of new technologies has to be balanced.

Turning to emerging economies, including India, the Outlook notes the challenge faced by these economies in strengthening stable macro-economic and financial conditions in the face of strong foreign exchange flows. This is, in substance, what India faces together with other Asian countries.

The Outlook notes that the exchange rates in several Asian countries are appreciated markedly in the last six months. But, in spite of this, the Outlook is of the view that China would benefit from a more flexible regime to provide a more secure base for monetary policy adjustments.

This is also the view that some Indian economists have recently urged on the Indian policy-makers. If the rupee were allowed to appreciate, the RBI would be freed of the responsibility of buying dollars and adding to the stock of liquidity in the system. Monetary management would be easier provided the exchange rate management is left to the market forces.

Higher rupee

There is, of course, a problem that these analysts have acknowledged, viz., that an appreciating rupee can impact adversely our export competitiveness. But this has to be offset against the fact that it is the real, not nominal, exchange rate that matters. If the appreciation of the rupee achieved by the purchase of dollars causes inflation, the real extent of depreciation would not be the same. In spite of all this, the economists of the IMF must be aware that China and India will face serious problems if they allow their currencies to appreciate in a free manner.

The IMF's WEO is an eagerly awaited document. Its projections in regard to GDP growths of various countries are looked forward to by markets and policy-makers alike. In that sense, the Outlook provides a useful guide to scholars and analysts interested in the world economy.

One point of substance, however, that the Outlook might care to look at in future is to examine why economies, like China and India, with their emphasis on state dominance in industry and banking, have performed relatively better than the market-driven economies, like advanced countries, as also Latin American nations.

There must be something in the state dominance of economies that has enabled them to achieve higher rates of growth with consequent reduction in poverty in rigid times. The difference in the rates of growth between China and India, on the one hand, and the US and Europe, on the other, is striking. This is in spite of the fact that the Asian economies started with a low factor endowment and at large populations to support.

Market forces alone would not have yielded the kind of results that these economies have achieved. It is appropriate to reflect on the fact that the rapid growth of India and China would demonstrate the advisability of continuing more or less on the same cautious track that they have followed in the last two decades.

Link with US

While the IMF has a lower forecast in the American rate of GDP growth by 0.7 per cent, it keeps the forecast for the world as a whole at a higher figure. The world output, it says, will come to 4.9 per cent both this year and the next. This forecast is the same as the IMF held at the last autumn. It is interesting that so far as developing countries are concerned, it has raised the estimate of growth.

This is consistent with the idea that Asia and Europe have become decoupled from America. In spite of growth of international trade on financial integration, this is consistent with the minority opinion that Asia and Europe have domestic demand growth, which is stronger enough to withstand American slowdown.

The WEO devotes one chapter to analysis of evidence regarding this. It finds that America's recent slowdown has so far little effect beyond Canada and Mexico, but it has largely confined to housing and manufacturing. There is not too risk that it will spill into consumption and hence via imports to other countries.

The WEO also had a look at the five American recessions and two mild slowdowns. On an average, growth in other regions fell during these recessions by about ½ per cent as much as the US. The fall varied in both the recessions. What this analysis concludes is that these declines have occurred not so much from the spillovers of the US events, but due to global crisis.

In one sense, it is confident that India's exporters would depend on the US. There is a possibility that we will escape the downside effects of decline in the American economy. This may not, however, hold good in respect of industries such as IT, garments and petroleum products, which are linked to the US market. We have to take the rough with the smooth. With an American decline, these industries may very well decline. The option may be to diversify away from the US as well as graduate to higher value-added services. There is still room for the Wipros and Infosyses of the world to grow.

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