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India’s growth to pick up; don’t junk China: Kaushik Basu

The global growth forecast announced by the World Bank and the International Monetary Fund (IMF) in the past one week have one thing in common; both have downgraded their forecasts for 2015 from their prior estimates. Both worry that despite lower oil prices giving a boost to consumption, the stubborn stagnation/ deflation in Europe and Japan, the slowdown in China and the commodity related sluggishness in some emerging markets will keep growth slow this year.

From an Indian standpoint, the forecast have an interesting commonality; both see India overtaking China in terms of pace of growth. The IMF sees India’s growth faster than China’s in 2016. The World Bank sees that happening in 2017. The World Bank’s Chief Economist has the advantage of being an old India veteran. He is none other than India’s Former Chief Economic Advisor, Kaushik Basu who spoke to CBC-TV18 about growth forecast.

Below is the transcript of Kaushik Basu’s interview with Latha Venkatesh on CNBC-TV18.

Q: In the past three years the bank has been consistently lowering its forecasts from its initial take. Now are there downside risks to your current 3 percent forecast for global growth?

A: There are risks, both downside and upside but the point forecast is indeed very carefully worked out. All I can say is had it not been for the fact that oil prices have gone down, the forecast would have been lower because there were troubling signs. There are indeed troubling signs around the world. However, the lowered oil price has helped and so a 3 percent now seems pretty much on the cards for this year.

Q: Your reading of the eurozone actually was quite pessimistic. Do you think the eurozone can even go through an extended stagnation like Japan in the 90s?

A: Whether it will be that extended, one does not know, but there will be a period of slow growth for the eurozone. If you look at the World Bank’s forecast, we are keeping it just above 1 percent for a while and reason for that is inflation is down; there is a worry of deflation. There are still structural reforms that the eurozone needs to make; the saving grace is that the euro zone understands that.

You will hear it in the speeches being made, in the comments coming out from policy makers but still they have to taken steps on fiscal coordination. They have taken some steps more on banking resolution. So the situation remains somewhat disappointing and it will be that way for a while because these are important structural changes that Europe will have to undertake.

Q: Among the other important steps that the eurozone is taking is quantitative easing (QE)program but will it be enough to pull out the eurozone from the current stagnation?

A: Quantitative easing I think is needed. However one thing that has to be understood in today’s world and we know this from the US experience, quantitative easing is not as effective as it used to be in the olden days when quantitative easing or some other form of liquidity injection would remain in the basin into which you injected the liquidity. So, you inject liquidity into the eurozone, it remains in the euro zone; that is no longer the case.

This money is going to go out to the other parts of the world, to parts of the world that are growing well, some of it to China, some of it to India, some of it to the United States. So, the efficacy of quantitative easing in a globalised world is less than what it used to be in a balkanised world. However, that is today’s state of the world and we will have to live with that.

So, it is an instrument which is important but will not be as effective as it used to be in the past. While it is important, it will get growth going a little bit, we can’t expect a huge turnaround caused by the quantitative easing.

Q: How do you see the impact on the euro, do you think it will actually get to parity with the dollar and will that actually help Europe by boosting euro zone’s exports?

A: It is not impossible; but I have given up forecasting on exchange rates. If it were to happen, it will give the euro zone an export space which it could potentially use and begin to climb out of where it is now. At one level that is a strategy that Japan was trying very early,  when Japan had a new Governor at central bank, to get the exchange rate corrected in some sense and to boost its exports. But there are other structural things. So that will help but it needs labour market reform, it needs variety of other reforms to get full advantage of the space that will get created by the exchange rate depreciation that could come about.

Q: Coming to the other big developed economy, the US. Your own forecast for the US are robust and the recent data have been quite promising in United States. Do you think the US Fed will likely raise rates in the first half of 2015 and will that hike be a tumultuous event for global currency market especially emerging market currencies?

A: First half or second half, the main thing is it is going to be later than what most people were anticipating and for two reasons – first, oil price being low is generally globally a dampener on inflation and the US is mindful of that – that being so the urgency for raising rates goes down. There is another factor, the United States has done extremely well in terms of growth, in terms of unemployment. But if you look at wages, it actually has not done that well. The real wages have more or less held constantly through last year and in December it declined slightly. So the labour market is doing very well if you look at the complete macroeconomic numbers, total unemployment etc. But once you dig below that – I am sure the Fed will be doing that and the US government will be doing that — there are still a couple of worrying signs and all this will make the Fed wait a bit more for acting on this.

Will this be very momentous and negative for the rest of the world? I do not think so. The reason is that the US —unlike an announcement that we are going to tighten — the actual raising of interest rate goes lockstep with improvements in the US economy. As the US economy improves they tighten, they raise interest rates. The improvement in the US economy is still such an important global driver; exports get buoyancy around the world that the raising of the interest rate is going to come matched with that good news and to that extent I feel the shockwaves for the rest of the world will be small and in particular for India. For United States, India is second biggest trading partner. If you look at the last two-three years’ trend, it is catching up with China. China is the biggest trading partner. US has got closer to China, so it has picked up on trade. So to that extent US’ good news is going to be India’s good news and when it comes matched with raising of the interest rate, I do not think it is going to be such a negative shock for India.

Q: Coming to China, the World Bank has marked down its growth only slightly, actually International Monetary Fund (IMF) and whole host of private economists are more skeptical about Chinese growth but the bigger question everyone has is – will China manage without a major crisis in its banking and shadow banking sector. Your thoughts

A: I think that is the most likely outcome that China will do a soft correction of its growth rate coming down from the current 7.4 percent to 6.9-6.8 percent. IMF is forecasting even lower than what we are forecasting but at this movement, it shouldn’t be able to do smoothly. But does that mean it is zero risk of turbulence. No. China’s debt is large, the Chinese government and the Peoples Bank of China are aware of that. They will try to make corrections to this. But correcting a debt is a very difficult exercise and there is no rule book of how you do it right. It is not an engineering exercise. So, there is a small risk that this will cause turbulence in the economy, some slowdown in growth which will pick up again. But the medium-term prognosis is, as you see in our global economic prospect, that China will be able to handle it well. Its growth will slow down but it will slow down slowly and that is what you want to happen to China.

Q: Now the comparison with India. The IMF thinks India will overtake China’s pace of growth in 2016. The World Bank says it is in 2017. Are you little more skeptical of India’s growth?

A: No but let me tell you our forecast is that that’s going to happen in 2017 and IMF is forecasting that that will happen in 2016. If you look at IMF and our forecast on India, it is roughly the same, in fact in 2016 we are more optimistic in India than IMF. IMF is a bit more pessimistic than us on China and so to that extent IMF is expecting the crossover to take place on 2016, we are expecting it to take place on 2017. But this is just very close to each other’s forecast on what is going to happen, there is going to be a crossover sooner or later and close to each other and that seems very well worked out. The global scenario is such. You have to remember that China has had 30 years of phenomenal growth. So for China to go down to 6.9 percent as we are forecasting or to go down to 6.5 percent or 6.4 percent as the IMF is forecasting is still very handsome. For India it is a slow pick up from the current situation of 5.5 percent  or so to about 7 percent in 2017 and this is entirely within the realm of what is possible for India. In the medium-term India should go even higher than that.

Q: For those of us who are within India, things do not look so rosy. If you looked at the last Index of Industrial Production (IIP), it is so anemic that index is exactly where it was in 2011. The Q3 results of most companies are showing hardly any topline growth. When is India’s inflexon point and where, which sector will it come from?

A: Industry is India’s stumbling block. Historically the services sector has done well. Industry and manufacturing has remained small and embarrassingly small for a country at India’s stage of development and that is the sector that we are all looking at. It is true that what you have seen thus far is very small growth, after all we know India’s growth picked up massively in 2005, it had three years of phenomenal growth but the global crisis hit and India slowed down a bit. Even now 5.5 percent in the global landscape is not bad but India needs to pick up more. Where will it come from? Even if you do not see it right now, there are two points where you want India, Indian government, Indian policymakers to lay stress – (1) India needs better infrastructure and (2) India needs much more efficient bureaucratic machinery so that new businesses even self-employed, ordinary small enterprises can do better. You are seeing effort to correct both these, in fact the infrastructure, I am optimistic. that it will happen easily and quick. Bureaucracy transactions caused the ease of doing business, these are harder. But to the extent that moves are being made to these, it is hopeful. I agree that right now you are not seeing those green shoots in the industrial sector but there is so much policy talk and directed effort being given to the ease of doing business and better infrastructure that we do expect that growth will pick up. If you read global economic prospects carefully, it will say that if the reform momentum is kept up, this will happen. We are expecting the reform momentum to be kept up, but there is politics involved, there are important changes that will happen over the next two months and there is a Budget coming up. There is a goods and services tax (GST) on which a lot depends. If these things happen growth will pick up and India should be able to get back to the high growth that India did see from 2005 to 2008, is once again possible, it will take a couple of years to get there.

Q: Let me dwell on the infrastructure a little more. Private sector infrastructure companies’ balance sheet has completely broken, the government would like to invest in the physical infrastructure to pull in private investments but will foreign investors rating agencies, entities where you are the World Bank take kindly to a hike in fiscal deficit from India?

A: The outside observers probably would not take kindly and how they take is important so to that extent the government has to watch that. Now here is my view, given India’s situation today, it can afford to use some of the fiscal space it had created over the last two years. If its deficit does not come down to 4.1 percent or 4 percent, I do not think this year frankly it is going to be a disaster. Having said that let me make it very clear I am not encouraging the Indian government to go that way because it will be picked up as signals by observers. I do not think it will be the right thing to do for the observers but they will do that and to that extent it is worthwhile for the government to continue on the path of fiscal tightening and that will give it space one-two years down the road to go for a fiscal expansion should the need arise and the government should indeed focus on investment and spend money on investment and that will put some pressure on the fiscal deficit but doing that for the reason of investment which will increase productivity in the country is worthwhile.

Q: Fiscal deficit has been the creator of a huge inflation problem and you know how terrible the inflation problem has been in the last five years, double digits for the most part when you were here. It is now getting to single digits for the past five months. Do you think India has managed to rein in inflation for good?

A: We cannot relax but on inflation we are moving into a better phase at least for a few years. The main reason for that is yes, the government and the Reserve Bank of India have been trying to do this but they have been trying to do this for five years. You are keeping interest rate elevated, you are trying to gradually bring down the fiscal deficit it was not getting enough bite. What has happened over the last six-seven months is that inflation has come down. It is this persistent effort on the part of the Reserve Bank and the ministry of finance coupled with something very important; global commodities and oil price these have helped and to the extent that we expect that. I do actually personally believe that oil prices will remain low to moderate very likely over the next two years and maybe even longer. The pressure on prices will be low so to that extent India’s inflation problem is at least over in the next two years, it is going to be minimal. That creates a window of opportunity for the government to be more energetic and actually push on other fronts. This commodity price softening is a great opportunity for India, it is helping the country with inflation being brought down and creating space for reforms and that space has to be utilised by the policymakers in New Delhi.

Q: On the commodity issue itself do you think the Reserve Bank and the Indian policymakers can be reasonably sure that 2015 will be a bear year for commodities? What is your take considering that you are seeing some slowdown in China and euro zone? Do you fear commodity prices may even rise before 2015 ends?

A: I expect oil to remain low because I believe that the drop in oil prices. it is overshot a little bit, it has gone down more than where it will be but the movement took place not because of demand; demand is extremely volatile it can go up and come down but because there has been a flattening of supply around USD 55-75 per bbl and the reason is shale, as supply kicks in somewhere between USD 55-75 per bbl, so for demand fluctuating within this region the price will remain there because shale is ready to kick in and will kick in to the extent that is needed as long as the demand remains in this zone. So, for that reason I expect oil price to remain low and for India that is more important than anything else, there is expectation that the current account deficit and live with that during my entire period in India, is for the first time this is probably going to flip the other way around and India may get current account surplus. All this is creating a huge window of opportunity for the country and it should go full throttle at it at this point of time.  

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