The Hindu Business Line : World Economic Outlook's advice for India — Speed up reforms to unleash growth potential

The World Economic Outlook 2004 succinctly outlines the problems threatening the global economy and suggests solutions. Will finance ministers and central bank heads heed the WEO's cautionary advice? Or has a macro-economic crisis to hit the global economy before the solutions are implemented?

COME September and it is the season for all head honchos of Finance Ministries and central banks to assemble under the auspices of IBRD and IMF. The semi-annual meetings are held at Washington DC once in two to three years. Otherwise, the honour falls on assorted locations in the rest of the world.

The meetings used to be occasions when investment bankers used to gather on the sidelines, trying to catch the eyes of Finance Ministers and central bankers, pursuing their ideas of commercial loans.

Those days are long past, now that emerging market economies, such as China and India, have turned to lenders and investors in the developed nations. But the aura persists, and the semi-annual Bank-Fund meetings are still the desired destination for many investment bankers, now pushing investment opportunities for FDI and FII.

The festivities are still very much a feature of these meetings, though not to the extent of the earlier glorious days. The global meetings of the Brettonwoods twins also offer occasions when the IMF comes out with its customary World Economic Outlook (WEO), releasing its own projections of how it expects the global economy to behave in the period ahead.

This report usually has words of advice for both the richer and poorer economies' cheerleaders — words of caution as well as encouragement. The latest World Economic Outlook, released in September 2004, is well-prepared and keeps up the rich tradition of its predecessors. It is incidentally second in the series written under the supervision of Dr Raghuram Rajan, Economic Counsellor and Director/Research Department, IMF.

Chennai residents should delight in this honour because Raghuram Rajan is a Tamilian, although educated in Delhi, Ahmedabad and Chicago. He is an Indian working with a foreign institution — a role reversal of the incubus frowned on by some of our Left parties.

The WEO 2004 (September) notes that the global recovery has become increasingly well-established with global GDP growth now projected to average 5 per cent in 2004, the highest for nearly three decades (see Table 1). In April 2004, the IMF's projection had been more or less at the same level, differing by just 0.3 per cent. Looking further into 2005, the IMF experts predict a growth of 4.3 per cent.

For India, the WEO predicts a rate of growth of 6.4 per cent for 2004 and 6.7 per cent for 2005. Comparable figures for China are 9 per cent and 7.5 per cent respectively for 2004 and 2005. The relevant projections for the US are 3.6 per cent and 2.9 per cent.

World Economic Outlooks usually attempt a forecast of commodity prices. One is intrigued by the WEO's estimates of $28.9 for barrel of oil for 2004. The WEO, however, recognises that very low levels of spare global capacity are raising concerns that the global oil production system will not be able to cope with unanticipated short-term supply stock.

WEO 2004 forecasts a continuing deterioration in the current account position of the engine of global economic growth — the US. Table 2 shows the position of current account in leading economies.

A substantial part of the US' current account deficit is met by its mirror image, the current account surpluses of Japan, newly industrialised Asia and the marginal surpluses of Euro Zone. These effectively mean that the spending splurge of the US consumers and industries is funded by the excess of exports over imports of the economies in Asia and Europe. A credible solution to this problem of the US' current account imbalance short of devaluation seems unlikely. This requires action at both global and national levels. WEO 2004 does not indicate any specific lines of approach to solve this structural imbalance of the world economy, but stresses that all countries and regions should play their part in addressing global imbalances.

The key policy requirements include medium-term fiscal consolidation in the US to boost savings, structural reforms to boost growth prospects outside US and greater exchange rate flexibility in Asia consistent with orderly reduction in current account surplus.

WEO 2004 notes that the first two are, in various degrees, moving forward, although much remains to be done, but little progress has been made with the third. WEO 2004 is right in its diagnosis, but whether its prescription will be accepted is not clear.

The WEO acknowledges the recent rise in oil prices will have serious consequential impact on global growth, but does not suggest any proactive measure — economic, diplomatic or otherwise — to counter its rise and destabilising influence. The WEO states on this account the balance of risks has shifted to the downside, with oil price volatility a particular concern.

Importantly, the WEO makes the point that interest rates will need to rise further as the recovery proceeds, although the pace and timing will vary across countries. The honeymoon with low interest rates, both globally and domestically, is obviously over.

The WEO devotes considerable attention to the question of exchange rate management, in particular, the issue as to whether exchange rates should be allowed to float. In a special section of the report, the WEO deals with the issue of what is the preferred path — pegged exchange rate or intermediate regime or a float.

The IMF's official view seems to be in favour of a float, although it recognises the difficulties and dangers implicit in countries undertaking to float.

The report especially cites India as a successful case of a transition from the peg of the rupee to a dollar to a managed float in March 1993. It notes that while India shifted to greater exchange rate flexibility when reforms to policy framework were still in progress, the managed float has been maintained without major distress, even during times of international market turbulence. Well-deserved praise from the IMF, bastion of international financial prudence!

Remarking specifically on India's perceived strengths and weaknesses, the WEO comments that: "India's GDP growth is projected at 6.4 per cent in 2004, underpinned by the global expansion and supportive monetary conditions, although unfavourable patterns in this year's monsoon are raising concerns about agricultural growth.

"Large budget deficits and high and rising levels of public debt remain the Achilles' heel of the economy. Beyond long-run sustainability concerns, high public borrowing may choke off the nascent recovery in private investment needed to sustain the expansion.

"The newly-elected ruling coalition intends to effect ambitious fiscal adjustment to balance the current budget by 2009 (targeting annual adjustment of at least 1/3 per cent of GDP in the overall central government balance) while increasing expenditure in priority areas — including health and education, and infrastructure investment.

"While this target path appears broadly appropriate, the supporting measures that were recently proposed will take time to be implemented and yield results. In view of this uncertainty, expenditure increases should be contingent on progress on the revenue front. Accelerating structural reforms — including agricultural and trade liberalisation — remains key to step up potential growth and reduce poverty."

WEO 2004 seems to echo some of the views of India's own economic team, including especially the Kelkar Task Force on fiscal responsibility and budget management in regard to front-ending revenue increases rather than focusing on expenditure cuts.

The WEO devotes a special Chapter to the demographic transition in the developed countries, which has resulted in an increasing percentage of the aged population and its macroeconomic consequences. This subject deserves separate discussion. But the problems facing developed nations are truly serious. There is an inevitable increase in fiscal costs, due to pensions and medical care costs.

The obvious, but difficult, remedies are to allow liberal immigration into the countries and to postpone retirement age. But these are difficult politically. One has to wonder what would be the repercussions on a racially-conscious Europe and the UK of policies which open the doors to immigrants. But the problem has to be handled with bold measures, because of the heavy burden posed by the demographic transition.

The WEO 2004 is, indeed, a succinct outline of problems threatening the global economy and possible solutions. Whether in the din and confusion of the festivities surrounding the annual meetings the Finance Ministers and heads of central banks will be able to hear the cautionary advice given by the WEO 2004 is, however, doubtful.

The warnings of IMF are there for those who choose to hear, but the solutions will perhaps come only when a macro-economic crisis actually hits the global economy.